Canadian pot stock Tilray (TLRY +0.00%) got investors excited this year, following the announcement of a mega-merger deal with Aphria (APHA +0.00%) in December 2020. The marijuana industry, which saw surging sales last year, received a further boost from this merger news.
Investors have enjoyed some solid gains from the dramatic surges of these two stocks, and are hoping for more upside before the merger is completed. Tilray's stock has gained 206% so far this year, while Aphria has surged 178% -- more than double the gain of 68% for the industry benchmark, the Horizons Marijuana Life Sciences ETF.
Both Tilray and Aphria claim the merger will create the largest cannabis company in the world in terms of pro forma revenue. The deal is expected to close by the second half of this year. Now, investors are wondering whether it's too late to purchase Tilray stock. Is there still more upside to be found? Before you make that decision, here's why you should -- or should not -- consider Tilray now.
Image source: Getty Images.
Lots of good reasons to invest in Tilray
To take short-term advantage of the Aphria-Tilray merger, I would say, buy Aphria, not Tilray. That's mainly because of the arbitrage opportunity the merger has presented. Buying Aphria's shares (and, perhaps, shorting Tilray) could help you make a quick gain from this merger.
However, if your goal is not to cash in on the short-term gains, but to invest Foolishly for the long term, then you'll want to wait for the combined entity to become a larger, profitable business. In this case, buying and holding Tilray is the right way to go.
Tilray still holds some true potential. It has firmly established itself in the medical cannabis market, not only in Canada but also in Europe, where it's already making some significant progress; its Portugal operations play a major role in the distribution of its medical cannabis products throughout the continent. And this year, the company entered into various agreements to distribute its products in the U.K., export them to Spain, promote them in Germany, and supply its GMP (good manufacturing processes)-certified medical cannabis products for experimentation in France.
Image source: Getty Images.
The merger with Aphria will also allow Tilray to use the combined entity's pooled resources to expand further in the European market. That market is estimated to grow at a compound annual rate of 29.6% to reach $37 billion by 2027. The companies claim they will generate close to 100 million Canadian dollars of pre-tax annual cost synergies thanks to the combined supply chain and operational efficiencies from the merger. By taking advantage of each other's efficiencies -- including competitive, innovative products, high-class production facilities, growth strategies, and scale of operations -- the companies can reduce costs and ultimately boost revenue.
In Tilray's most recent quarter, the fourth quarter of 2020, total revenue jumped 20.5% to $56.6 million from the year-ago period. The company also saw positive adjusted EBITDA (earnings before income, tax, depreciation, and amortization) of $2.2 million, compared to a loss of $35.3 million in the year-ago period. It is Tilray's first quarter of positive EBITDA, which is impressive -- we have seen how difficult it's been for Canadian marijuana companies to achieve positive EBITDA. A popular name in the space, Aurora Cannabis, failed to achieve positive EBITDA at all last year, and its chances of recovery look minimal despite all its cost-cutting strategies.
New scope in the recreational cannabis market
Not only is the European medical pot market a good opportunity for Tilray, but the Canadian recreational cannabis market also offers more prospects. Recreational products and cannabis derivatives in particular are in high demand now. Derivatives, legalized in Canada as part of the "Cannabis 2.0" legislation in October 2019, include vapes, chocolates, edibles, beverages, concentrates, and more. Consumers who don't want to consume cannabis by smoking it are choosing such derivatives as a substitute.
Tilray entered this segment in October with its wholly owned subsidiary High Park Holding, including a new line of cannabis-infused edibles. Aphria hasn't made any big entrances into the category, though it does have a few vape products. That said, its recent acquisition of American craft beer maker SweetWater Brewing could help it enter the beverage segment -- and it doesn't have to wait for federal legalization to do that. The company plans to leverage SweetWater's innovative expertise regarding its craft beers and other beverages, along with some non-alcoholic products, to introduce its own brands to the U.S. market. It also plans to sell SweetWater's 420 brand and other beverage offerings in the Canadian sector. Aphria expects to add CA$650 million to CA$675 million of annualized pro forma net revenue and CA$65 million to CA$70 million of annualized pro forma adjusted EBITDA from this combined deal.
U.S. federal legalization, which many think will take place in a year or two, will also allow the new combined entity to strengthen its hold on the U.S. cannabis market, the strength of which is evident from the drastic revenue growth and profitability U.S. cannabis companies are enjoying. The U.S. legal cannabis market could grow at a compound annual rate of 21% to be worth more than $41 billion by 2025.
Is Tilray a worthwhile investment now?
Marijuana is a fast-growing industry. New estimates by Grand View Research show the global legal marijuana market could grow at a compound annual rate of 14.3% to be valued at $84 billion by 2028.
Both Tilray and Aphria have their strengths and weaknesses. The new company will operate under the name Tilray, but will be managed under the proven leadership of Aphria's CEO Irwin Simon, and Aphria's strong cash position will also help the new company reach greater heights.
Tilray also is in a good financial position. It ended the fourth quarter with cash and cash equivalents of $189.7 million.So a bigger company with pooled resources could be beneficial over the long run. That said, a larger company can also involve more complications such as merger costs, hidden inefficiencies, personnel issues, and overestimating cost synergies. Also, keep in mind that mergers involve a lot of complications and could take a while to show the desired results.
However, Aphria has a successful track record of generating positive adjusted EBITDA over the past seven quarters, and the fact that this company's management will be driving the bus going forward is reassuring. Investors who have the patience to wait for this merger to become a bigger profitable business should find Tilray to be a worthwhile cannabis investment for the long term.
