For years, marijuana has been a big moneymaking investment. As recently as the end of the first quarter, early entrants into the legal pot industry were likely sitting on triple-digit or quadruple-digit gains in a matter of two or three years. It was easy for investors to get behind the idea of cannabis considering that Wall Street has been forecasting as much as $200 billion in annual global sales in a decade.

But between the end of March and today, the wheels fell off the wagon. While this wasn't unexpected, the timing of when the bubble would burst was never known, and the speed at which pot stocks have declined over the past six-plus months has certainly caught investors by surprise.

However, falling valuations aren't the only thing catching the attention of cannabis investors. Last week, we saw the very first marijuana megamerger implode before our eyes.

A smoldering cannabis bud that's beginning to turn black.

Image source: Getty Images.

A mammoth cannabis deal just went up in smoke

In October 2018, MedMen Enterprises (OTC:MMNFF) announced what was, at the time, the largest U.S. marijuana deal in history. It agreed to an all-stock deal to buy privately held multistate dispensary operator PharmaCann for what amounted to $682 million. Since cannabis stocks have had minimal access to basic banking services, paying for PharmaCann in an all-stock deal was viewed by investors as par for the course, with MedMen's stock shooting up to an all-time high following the deal announcement.

This deal was designed to double MedMen's reach from six states to 12, as well as provide more than two dozen new retail licenses. Based on the most recent pro forma update, MedMen was nearing 90 combined retail licenses and 37 operational dispensaries.

But my how a year has changed things in the cannabis space.

Just three days shy of the one-year mark of announcing the deal to acquire PharmaCann, MedMen instead informed Wall Street and its shareholders on Tuesday, Oct. 8, that the deal was being terminated. In exchange for forgiving $21 million in credit lent to PharmaCann, including accrued interest, MedMen will receive an operational growing facility in Illinois, a dispensary and additional retail license in Illinois, and a license for a vertically integrated facility in Virginia.

A black silhouette outline of the United States that's partially filled in with baggies on cannabis, rolled joints, and a scale.

Image source: Getty Images.

Why did this deal fall apart?

With most U.S. multistate operators expanding as quickly as possible to gobble up early stage market share, you're probably wondering why the deal fell apart. In essence, it would have MedMen one of the top-five retail license holders in the U.S., as well as top-three in terms of operational locations.

MedMen listed four reasons for abandoning the acquisition in its press release.

First, MedMen noted the capital headwinds currently impacting the cannabis industry. Namely, pot stocks are plunging, and access to capital is still dicey, with the exception of selling stock and diluting shareholders. Rather than acquire PharmaCann, which would have boosted its expenditures for existing and developing locations, it chose to "allocate capital efficiently" by forgoing the deal.

Secondly, the company believes it prudent to focus on core markets, such as California, where it plans to have 30 stores open by the end of calendar year 2020. It currently has 17 licenses in the Golden State. Buying PharmaCann would have exposed it to a handful of non-core markets where spending may not have been prudent given the current state of the marijuana industry.

Third, MedMen blamed regulators for the length of time it took to review the deal. What synergies could have been realized were delayed or altered as a result of this long wait.

And fourthly, MedMen wants to focus on its omni-channel sales in core markets, such as "delivery and loyalty platforms." In many of the new markets that PharmaCann would have provided, the company has no current operating leverage. 

Or, to put a nice neat bow on these points, MedMen wants to curb spending and dig into the core markets where it already has a presence. Buying PharmaCann simply didn't mesh with that strategy any longer.

A one hundred dollar bill on fire atop a lit stove burner.

Image source: Getty Images.

This is bigger news than you probably realize

Coincidentally, the announcement that MedMen would terminate its merger with PharmaCann comes just a day after Aleafia Health ended a supply agreement with Aphria for 175,000 kilos of cannabis over a five-year period in Canada. The marijuana industry is maturing, and that means there may not be enough room for all current participants.

The termination of the PharmaCann merger may finally bring to light the seriousness of MedMen's financial situation. You see, the company has lost $178.4 million on an operating basis through the first nine months of 2019, and has negative cash free cash flow that exceeds $220 million over that same time frame. Mind you, this loss includes targeted reductions in general and administrative expensing from the company. MedMen is set to report its fourth-quarter and full-year results at the end of this month, and they're probably not going to be pretty.

What's more, private equity firm Gotham Green Partners has committed $280 million to MedMen via convertible secured notes. Despite this commitment, MedMen's losses and cash burn haven't slowed much at all, putting into serious question whether the company will have the capital to survive over the long haul. 

As the icing on the cake, the company also announced in its PharmaCann merger-termination press release that Chief Financial Officer Michael Kramer, who was hired as CFO on Dec. 6, 2018, was fired from his post. That's two CFOs MedMen has gone through in less than a year.

It's unclear which big-name cannabis stock could be the first domino to fall, but if my arm were twisted, MedMen is at the absolute top of the list of pot stocks to avoid.