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Is a Merger Between These 2 Major Pot Stocks Inevitable?

By David Jagielski – Jul 25, 2020 at 8:40AM

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It's been a while since investors have seen a big merger or acquisition in the industry.

There's been a lot of talk lately that Canadian pot giants Aurora Cannabis (ACB -1.64%) and Aphria (APHA) have been discussing a potential merger. With competition in the industry on the rise and a potentially tough road ahead in the sector amid the COVID-19 pandemic, a merger is one way the two companies could strengthen their footprint in Canada and be in a better position to succeed over the long term.

Let's take a look at whether a deal between the two companies is inevitable and what that might mean for investors.

Discussions were in "advanced" stages

According to BNN Bloomberg, in mid-month, Aurora and Aphria "held advanced talks" about a possible deal.

The talks did end up breaking down, but not before they went into the details, including that Aphria shareholders would come away with a majority (51%) stake of the new company and that Aphria's current CEO, Irwin Simon, would be in charge of the new entity.

Two people shaking hands on a deal.

Image source: Getty Images.

Why the deal makes a lot of sense

A merger would give the combined company close to one-third market share in Canada and a presence in 25 countries around the world. And the two companies have reportedly already been able to identify approximately 200 million Canadian dollars in cost savings from working together. That's no small figure given that in Aurora's third-quarter results, which the company released back on May 14, the pot producer incurred a net loss of CA$137.4 million.

It makes sense that Aphria's CEO would be leading the new company, given the Ontario-based pot producer's low-cost operations and focus on profitability. The company has reported a profit in three of its last four quarters, while Aurora's been profitable in just one of its past four quarterly results. 

Another reason the two could come together: They're both without a big partner from another industry. Unlike their common rival, Canopy Growth, which has a 38.6% investment from Constellation Brands, neither Aphria nor Aurora are able to tap into the deep pockets of a larger partner. By joining forces together, they add more resources to the mix and create more stability for their investors, and they don't need to worry about a large investor nixing the deal.

Why the deal may be inevitable

A deal between the two companies didn't end up materializing, but although the talks appear to be off for now, that doesn't mean they'll stay that way. If the two companies went into the details of discussing who would be in charge and even looked for synergies that would result from working together, that suggests there's real interest there. And the longer the pandemic goes on, weighing down the economy and also the industry, the more pressure there will likely be to make a deal happen.

Back in February, investment bank Ello Capital noted that Aurora was in horrible shape and that it had perhaps a couple of months of liquidity left.

In its third quarter, Aurora reported cash and cash equivalents of CA$230.2 million, but it burned through CA$288.3 million over the course of its day-to-day operating activities during the past nine months.

Aphria's in a much stronger position. When it released its Q3 results on April 14, it reported cash and cash equivalents of CA$515.1 million. And it was also burning far less cash from its operations -- just CA$124.4 million over a nine-month period.

Aphria's strong cash position looks like it could give the company the upper hand right now. If Aurora continues to struggle and burn cash, it may become more desperate to work out a deal. And all it takes is one side in a negotiation to get desperate for a deal to come together quickly, which is what could very well happen if Aurora's financial position deteriorates as the year goes on.

What this means for investors

A deal involving these two Canadian pot producers will instantly create an industry leader, one that would be poised to take advantage of the U.S. market once marijuana is legal across the country. A combined entity would also make for a more stable investment over the long run, as it would have greater resources and market share.

As of today, however, all of that means nothing. Talks are just talks, and investing in a company because of a potential deal can be risky. Things can change quickly in the industry, and a better partner for a merger or acquisition -- for either company -- could emerge, putting these discussions to a definitive end.

However, whether it's Aurora and Aphria or another pair of cannabis companies, it's likely that a large deal will happen at some point over the course of the next 12 months. Marijuana companies are struggling, and as it becomes more difficult to raise cash and expand, consolidation will be much more attractive.

Year to date, shares of Aphria are down 1% while Aurora's stock has crashed more than 55%, which is worse than the Horizons Marijuana Life Sciences ETF's (HMLSF -8.37%) loss of 20% over the same period.

If you're a contrarian investor, Aurora may be an attractive buy today given the potential the stock has to skyrocket if a deal with Aphria or another company is announced. However, for long-term investors, Aphria offers much more stability right now and is the better overall buy.

David Jagielski has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Constellation Brands. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Aurora Cannabis Stock Quote
Aurora Cannabis
$1.20 (-1.64%) $0.02
Aphria Stock Quote
Constellation Brands, Inc. Stock Quote
Constellation Brands, Inc.
$231.26 (-2.25%) $-5.33
Canopy Growth Stock Quote
Canopy Growth
$2.84 (4.41%) $0.12
Horizons Marijuana Life Sciences Index ETF Stock Quote
Horizons Marijuana Life Sciences Index ETF
$4.49 (-8.37%) $0.41

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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