Investing in the cannabis industry has been quite the adventure over the past couple of years. Through March 2019, buying almost any brand-name pot stock would have yielded a triple-digit or quadruple-digit gain for investors. But over the trailing 15 months, the vast majority of these gains have been wiped away, with most marijuana stocks losing anywhere from 50% to 90% of their value.
While few pot stocks have been spared, the Canadian marijuana industry has been hit particularly hard. Canada bungled its chance to become a global cannabis leader, and licensed producers to our north have paid the biggest price. Perhaps none more so than Aurora Cannabis (NASDAQ:ACB).
Aurora tries to backpedal to profitability
At this time last year, Aurora Cannabis was still widely viewed as the kingpin of marijuana. Although it didn't have Canopy Growth's cash pile, it had 15 production facilities that, if fully operational, could produce more than 650,000 kilos of cannabis a year.
Aurora was also slated to have a production, export, research, or partnership presence in two dozen countries outside of Canada. With domestic markets expected to peak at an estimated 800,000 kilos a year, Aurora was counting on export demand from these foreign markets (especially in Europe) to gobble up its excess production.
But a quick glance at Aurora's stock chart shows that things did not go as expected. Regulatory issues at the federal and provincial level led to all sorts of supply bottlenecks throughout Canada, and the kingpin of cannabis found itself overextended well beyond its capacity needs. As a result, Aurora Cannabis has been cutting costs at an extraordinary pace to conserve cash and push toward profitability.
Last year, the most popular pot stock halted construction on two of its largest production facilities and laid off 500 workers. Then, this past week, the company announced plans to close five of its smaller production facilities (Aurora Vie, Aurora Eau, Aurora Prairie, Aurora Mountain, and Aurora Ridge).
Though these moves have resulted in a number of one-time charges, management now believes the company is on track to generate positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in the fiscal first quarter of 2021, as required by its new debt covenant.
This affirmation that Aurora Cannabis appears to be on track to meet its selling, general, and administrative (SG&A) cost guidance of $40 million to $45 million Canadian per quarter ($29.3 million to $33 million) was enough to nab the company an upgrade from Wall Street investment bank Stifel. And upgrades have been hard to come by for the company.
In other words, Aurora is attempting to backpedal its way into the profit column.
Aurora's worst deal ever just got even uglier
While some stringent cost-cutting was going to be necessary at Aurora to halt its enormous cash burn, no one was quite sure how management would trim the fat. The closure of five production facilities proved to be the answer. But as one problem appears resolved (i.e., reducing SG&A expenses in an effort to generate positive adjusted EBITDA), another is magnified.
You see, between 2016 and 2019, Aurora Cannabis primarily grew on an inorganic basis. This is to say, it made more than one dozen acquisitions, with the crème de la crème being the CA$2.64 billion deal (that's $1.94 billion U.S.) to buy licensed producer MedReleaf. Not counting equity investments, it's still the largest completed deal in cannabis history.
The MedReleaf buyout was expected to be a game changer. Aurora would absorb MedReleaf's unique brands, as well as its Markham, Bradford, and Exeter facilities. Markham and Bradford were already complete and producing at 7,000 kilos and 28,000 kilos, respectively, of annual capacity. Meanwhile, Exeter needed to be retrofit for cannabis production. Once complete, Exeter was forecast to yield 105,000 kilos annually, for a grand total of 140,000 kilos from the deal.
However, since this $1.94 billion all-share deal was closed in July 2018, Aurora sold the Exeter greenhouse for a meager CA$8.6 million ($6.3 million) after failing to retrofit the facility. And it announced this week that Aurora Ridge (the new name of the Markham facility) would be permanently closed. This means that of the touted 140,000 kilos of peak annual output from the MedReleaf deal, only Aurora River (the new name of the Bradford facility) with its 28,000 kilos of annual output over 210,000 square feet remains.
To put this in another context, even after subtracting the token $6.3 million Aurora raised by selling Exeter, it paid about $1.93 billion for 28,000 kilos of annual production capacity, a handful of unique medical marijuana brands, and CA$328 million in net assets (around $240 million) that were on MedReleaf's books as of June 2018, a month before the deal closed. Today, entire companies capable of 28,000 kilos of output can be scooped up for less than $50 million.
With the understanding that some of MedReleaf's $240 million in net assets are no longer being utilized or have been sold off, the $1.93 billion MedReleaf deal might have a real value of $200 million to $300 million, in my view. With goodwill already accounting for 51% of the company's total assets, this would represent a massive future writedown for Aurora, but one that management would have to consider taking sooner rather than later if it wants to regain the trust of shareholders.