There has been a surge of mergers and acquisitions activity in the cannabis industry of late. Aphria (APHA) and Tilray (TLRY) are linking up in one of the sector's highest-profile mergers, and other industries are getting in on the action. Jazz Pharmaceuticals (JAZZ -0.58%) is acquiring GW Pharmaceuticals (GWPH), maker of Epidiolex, a cannabis-based seizure medication, for $7.2 billion, and a subsidiary of British American Tobacco is taking a 19.9% stake in OrganiGram.
But the wheeling and dealing may not be over just yet. With multiple companies in the industry potentially looking to make moves -- plus an interesting note in a proxy statement relating to the Aphria-Tilray merger -- there is plenty of reason investors should expect there to be at least one more major transaction this year.
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Another company was looking to merge with Aphria
In a proxy statement filed with the Securities and Exchange Commission (SEC), Tilray disclosed that Aphria was in talks with another company about combining. Only referred to as "Company A" in the statements, the unknown company reached out to Aphria at the time it was in discussions with Tilray. On Sept. 13, 2020, Aphria received an offer from the entity but ultimately decided that Tilray was the better option, because "the proposed Company A transaction undervalued Aphria's contribution to the combined entity." Aphria's board first learned of interest from Company A in July 2020. The proxy statement doesn't offer any details as to who the other company may have been, but there was one rumored pot producer that was looking into a possible deal with Aphria last year: Aurora Cannabis.
Was Aurora Cannabis the other company?
In July 2020, BNN Bloomberg reported that Aphria and Aurora had explored a possible merger. Although they say talks broke off that month, it is certainly possible that the companies started up talks again and that an offer was put together months later. However, the proxy statement says Aphria's board only learned of a company looking to engage in exploratory discussions that month. The rumored deal with Aurora was already well past that stage, with executives even discussing details as to which company would have control of the new entity.
If that's true, it means that in addition to Aurora, there's a second company out there looking to merge. Sundial Growers is one with management that says it's looking at all possible options. And it has 719 million Canadian dollars in unrestricted cash that could help make a deal happen. The company first told investors it was exploring "strategic alternatives," which included a possible merger, when it released its second-quarter results on Aug. 13, 2020 -- not far from when an undisclosed company first contacted Aphria.
However, there could also be other potential companies in the mix. Find a struggling cannabis business that is burning through cash and you can find one that would be interested in merging with a low-cost operator like Aphria that has recorded positive adjusted EBITDA for seven straight quarters. Regardless of whether there is a third company in addition to Sundial and Aurora that could be looking to make a deal, cannabis investors shouldn't be surprised to see another potential merger or acquisition take place later this year as companies in the industry look to penetrate new markets, expand product offerings, or make any other moves that help position them for success in what continues to prove a hot marijuana market.
The bottom line for investors
Knowing which company may have been looking to merge with Aphria may not offer investors any advantages. It is, after all, the terms of the deal that will ultimately dictate where shares of a company will go. Even an acquisition that drives long-term growth may bring a company's share price down if investors think it paid too much to another business. The important takeaway here is to always focus on value, as an undervalued business is more likely to not only be a better investment over the long term but could be more likely to fetch a hefty premium in an acquisition.
Jazz paid a 50% premium for GW Pharmaceuticals. The company behind Epidiolex was trading at a price-to-sales (P/S) multiple around eight before the deal broke -- today it is at a multiple close to 13. Although the average stock in the Horizons Marijuana Life Sciences Index ETF trades at only five times its revenue, GW Pharmaceuticals is also worth more given its impressive sales numbers (its growth rate in 2020 was 69%), and that is likely why Jazz was willing to pay such a high price tag for the business.
Investing in a well-valued business that is growing at a great rate and that still has many more opportunities ahead (GW Pharmaceuticals, for instance, is rolling out Epidiolex into several European countries) is a great way to maximize your potential returns whether the company is in the cannabis industry or in any other sector. And potential acquirers are also likely to pay more of a premium for that type of business.
