At this time last year, marijuana was considered the greatest thing since sliced bread. According to an assortment of estimates, the cannabis industry was on track for $50 billion or more in legal weed sales within a decade. Those estimates grew even more robust in 2019, with one Wall Street firm opining that $200 billion in annual worldwide sales was a possibility by the end of the upcoming decade.
Acquisition activity has been on fire in the marijuana industry
With such incredible growth figures overhanging the industry, it should come as no surprise that cannabis stocks have been active acquirers over the past two years. Taking the large equity investments from Constellation Brands and Cronos Group out of the equation, we've seen a host of major deals announced and/or completed.
While not a complete list, here are some of the more notable deals to date:
- Canopy Growth's (NYSE:CGC) contingent-rights acquisition of Acreage Holdings for $3.4 billion when announced (still pending)
- Aurora Cannabis' (NYSE:ACB) acquisition of MedReleaf for $2 billion (completed)
- Curaleaf Holdings' (OTC:CURLF) purchase of Cura Partners and the Select brand for $949 million when announced (still pending).
- Curaleaf's acquisition of privately held multistate dispensary operator Grassroots for $871 million (still pending)
- Harvest Health & Recreation's all-stock purchase of privately held multistate operator Verano Holdings for $850 million (still pending)
- iAnthus Capital Holdings' buyout of MPX Bioceutical for $634 million (completed)
I'd be remiss if I didn't mention that Aurora Cannabis has made more than a dozen acquisitions since the summer of 2016 or that Canopy Growth doesn't trail too far behind Aurora in the buyout department. The point is that pot stocks have been eager to gobble up early-stage market share, and these acquisitions provide the easiest means of achieving this goal.
However, a substantial decline in marijuana stock share prices over the past seven months and a game-changing announcement this week from Curaleaf could rightly signal trouble for a number of companies.
Curaleaf just amended the terms of its Cura Partners deal
On Wednesday, Oct. 30, Curaleaf announced that it would be amending the original terms of its purchase of Cura Partners. Originally, it was to be an all-stock deal, with Curaleaf sending 95,555,556 subordinate voting shares (SVS) to Cura Partners. However, the press release states that: "Due to changes in market conditions since the original merger agreement was signed in May, Curaleaf and Select [Cura Partners is the company behind the Select brand] have mutually agreed to reduce the base consideration payable upon close under the Proposed Transaction."
Under the new terms, Cura Partners will receive 55,000,000 SVS, which now values the deal at a mere $286 million, based on Wednesday's close for Curaleaf. The remaining 40,555,556 SVS are payable to Cura Partners' equity holders if certain 2020 calendar-year revenue targets are met.
According to Curaleaf, these payouts kick in when Select's extract sales cross $130 million in 2020 and max out at $250 million in 2020 extract sales. Further, an earn-out of up to $200 million in additional SVS could still head Cura Partners' way if Select-branded retail extract sales top $300 million next year.
Long story short, rather than handing Cura Partners an all-stock deal that'd still be worth up to $700 million today, including all contingencies, Curaleaf has made this more of a "prove-it" purchase by backloading more than half of the incentives. It's a pretty smart move for Curaleaf, and it pushes the potential for share-based dilution out another year if the Select brand is successful in hitting these extract sales goals.
But what's good for the goose isn't always good for the gander.
Uh-oh! This amendment suggests trouble in acquisition paradise
Even though Curaleaf's decision to alter the terms of its acquisition makes complete sense, it's also an after-the-fact admission that it was grossly overpaying for Cura Partners and has now adjusted the compensation more appropriately. The mere fact that this deal needed to be amended because of "changes in market conditions" likely signals that a vast majority of previously completed cannabis acquisitions were also grossly overpriced.
For example, Aurora Cannabis, the kingpin of inorganic growth, has built up a mountain of goodwill on its balance sheet totaling 3.17 billion Canadian dollars. Goodwill is the premium paid when one company acquires another, above and beyond tangible assets.
In a perfect world, Aurora is going to be able to build out the infrastructure of its purchased businesses, monetize all acquired patents, and recoup all CA$3.17 billion. But based on the magnitude of the deal amendments Curaleaf just made with Cura Partners, it becomes increasingly unlikely that Aurora Cannabis will ever come close to recovering this CA$3.17 billion in goodwill. This makes a future writedown all the more likely.
The same could rightly be said for Canopy Growth, the largest marijuana stock in the world by market cap. Canopy, which has made a number of mid-sized purchases, is now sitting on CA$1.93 billion in goodwill. Whereas Aurora's goodwill accounts for 58% of its total assets, Canopy's has now crept up to 22%.
Given Curaleaf's amended deal, there seems to be little doubt that Canopy overpaid for most (or all) of its deals. This makes it probable that the company will write down some portion of its more than CA$1.9 billion in goodwill in the not-so-distant future.
It's great that pot companies are using a more discerning eye when making acquisitions, but boy, it makes already completed deals look that much worse.