Sometimes deals are meant to be. And sometimes deals are meant to be changed. Canopy Growth (CGC 22.15%) opted for the latter alternative last week.
Canopy and Acreage Holdings (ACRGF) first struck a deal last year in which Canopy agreed to acquire Acreage for $3.4 billion if and when the U.S. legalizes marijuana at the federal level. But last Thursday, Canopy announced new terms for its arrangement with Acreage. Here are two reasons for Canopy Growth investors to like the revised deal -- and one reason to dislike it.
A much better price
By far, the best thing about Canopy's revised terms with Acreage was the new price tag of the deal. Instead of forking over $3.4 billion in total to fully acquire the U.S.-based cannabis operator, Canopy will now pay around $843 million (based on the share prices of both marijuana stocks at the time of the announcement) to acquire 70% of Acreage.
An already complicated agreement got even more complicated to make this happen, though. Acreage is creating two new classes of shares -- fixed shared and floating shares. The fixed shares represent 70% of an existing share and will entitle Acreage shareholders to receive 0.3048 of a share of Canopy Growth if the U.S. legalizes marijuana at the federal level. The floating shares represent the remaining valuation of Acreage that Canopy isn't obligated to acquire if U.S. legalizes marijuana.
However, Canopy can still acquire the remaining 30% of Acreage Holdings if it chooses to do so after U.S. marijuana legalization. The price it would pay for the rest of Acreage's shares will be based on a 30-day volume-weighted average trading price of the floating shares but will be at least $6.41 per floating share.
What does Acreage get in return for agreeing to lower the price of the deal? An upfront cash payment of $37.5 million and a loan of up to $100 million. For Canopy shareholders, these amounts are chump change compared to the overall reduction in the cost of potentially acquiring Acreage in the future.
Another thing for Canopy Growth shareholders to really like about the revised deal with Acreage is its timing. Why? The chances of U.S. marijuana legalization are arguably greater now than they've ever been.
When Canopy first announced its agreement to potentially acquire Acreage Holdings last year, the probability that the GOP would retain control of the Senate in the 2020 elections appeared to be pretty high. As long as Sen. Mitch McConnell is Senate Majority Leader, the prospects of the Senate voting on changing federal marijuana laws are slim to none.
Now, though, the GOP's hold on the Senate is in danger based on the latest polls. If the Democrats hold onto the House (which seems likely) and regain control of the Senate, the chances that federal marijuana legalization will be passed by both legislative chambers will be much greater. With the near-certain bipartisan support of such a bill, it would probably be signed into law by whoever wins the presidency.
There's another timing advantage for Canopy with the revised deal as well. The original agreement provided a 7.5-year window for the U.S. to legalize marijuana at the federal level before the deal expired. Canopy now has a 10-year window for U.S. legalization of pot.
Betting on the wrong horse?
So what should Canopy Growth shareholders dislike about the modified deal to acquire Acreage Holdings? It's looking more and more like Canopy might have bet on the wrong horse for entering the U.S. market.
The new terms are much less attractive for Acreage than the original terms were. But the company is in a position where it needed the upfront cash and the loan from Canopy so much that it was desperate. There's no question that several other U.S. cannabis operators are in better shape than Acreage is.
You also know something's amiss when part of the revised agreement was that Acreage's CEO, Kevin Murphy, is stepping down. Murphy will remain as chairman of the company's board of directors and is still Acreage's largest shareholder. However, it seems that Canopy didn't have confidence in Murphy's leadership.
My overall view of Canopy's updated deal with Acreage is that it's good for Canopy shareholders. I think there's a reasonable chance that U.S. marijuana laws will change within the next year or two. Canopy absolutely has to get into the U.S. market to deliver the kind of long-term growth that investors expect. The new terms make the company's entrance into the U.S. less expensive than they would have been under the original terms.
Sure, there are stronger U.S. cannabis companies than Acreage that arguably would have been better partners for Canopy. But that's water under the bridge now. Canopy wouldn't have been able to get similar terms with the stronger U.S. cannabis operators that it now has with Acreage. I think Canopy Growth's CEO David Klein has again demonstrated that he's capable of leading the company in the right direction.