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Why HEXO Stock Popped on Today's Merger News

By Rich Smith - May 28, 2021 at 12:43PM

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The marijuana company wants to be No. 1 in Canada, and is willing to pay for the privilege.

What happened

Shares of HEXO (HEXO 8.72%) were hopping Friday morning, up 7.8% at 11:30 a.m. EDT, on news that the Canadian cannabis company will acquire Canada's largest privately owned licensed producer, Redecan, for a purchase price of 925 million Canadian dollars ($765 million), paid in cash and stock.  

Upon closing of the transaction, HEXO will pay CA$400 million in cash, plus enough new HEXO stock to be worth CA$525 million to acquire Redecan. 

Rising stock chart is labeled Cannabis Inc with dollar signs and marijuana leaves decorating

Image source: Getty Images.

So what

As HEXO explains, this acquisition will give it the No. 1 market share in Canadian recreational cannabis, including leading shares in four of Canada's largest markets: the provinces of Alberta, British Columbia, Quebec, and Ontario. Investors like this because, as Redecan co-founder Will Montour explained, "We've now entered a phase where scale is key" -- and HEXO will have it.

HEXO also predicts it will enjoy "improved future financial performance and [a greater] potential to generate cash flow" after the merger, which is slated to take place in the third quarter this year.

Now what

Investors seem excited by the news, but if I were one of them, I'd be a bit more concerned over my company laying out close to CA$1 billion for just the potential to generate cash flow.

That seems like an awfully big bet to make on just the chance of generating operating cash flow, and with no mention of positive free cash flow or of GAAP profits.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends HEXO Corp. The Motley Fool has a disclosure policy.

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