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Did HEXO Just Outmaneuver Tilray?

By Keith Speights - Jun 2, 2021 at 5:52AM

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It's vaulting into a leading market share at a much lower cost than Aphria did with its Tilray merger.

Tilray (TLRY 0.96%) has become the darling among Canadian cannabis producers this year. Why? You can credit the company's merger with Aphria. Tilray's shares have skyrocketed around 150% year to date, a much better performance than any of its top rivals.

But it isn't the only cannabis company that's done some wheeling and dealing. HEXO (HEXO 0.67%) announced last week that it plans to acquire Canada's largest privately owned licensed producer, Redecan. Did HEXO just outmaneuver Tilray? 

Hands holding two green jigsaw puzzle pieces close to each other.

Image source: Getty Images.

Who's No. 1?

When Aphria and Tilray first announced plans to merge in December 2020, the companies stated that the combined entity would have a pro forma market share of 17.3% in the Canadian retail cannabis market. That would be enough to give Tilray a clear No. 1 position in the market.

Its tenure at the top might not last very long, though. HEXO had previously stated that its goal was to become a top-three player. The company's CEO, Sebastien St-Louis, said last week in announcing the Redecan acquisition, "We believe that we are on the verge of surpassing that objective to become the No. 1 licensed producer by recreational market share." 

The company already held the top spot in Quebec's recreational cannabis market. The combination with Redecan could give it the leading market share in the three other largest markets in Canada: the provinces of Alberta, British Columbia, and Ontario.

Comparing the deals

Jefferies analyst Owen Bennett called the merger of Aphria and Tilray a "perfect match." Aphria was the dominant player in the deal, with the company's shareholders owning 62% of the combined entity and its top executives in control.

That perfect match came with a hefty price tag. The value of the transaction totaled close to $4 billion. For that amount, Aphria gained a cannabis producer that isn't yet profitable but eked out positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in its latest quarter.

How does this stack up with HEXO's deal? For one thing, the acquisition of Redecan is significantly cheaper at 925 million in Canadian dollars (around $770 million). The Aphria-Tilray merger was an all-stock transaction, but HEXO will pay CA$400 million in cash plus CA$525 million in its stock.

Because Redecan is a private company, we don't have access to the details of its past financial performance. But HEXO stated in the press release announcing the acquisition that "Redecan has proven itself capable of consistently delivering significant EBITDA with a low depreciable capital base and zero debt."

The challenges for HEXO

HEXO will seemingly vault into the No. 1 spot in the Canadian recreational cannabis market at a much lower cost compared to Aphria's merger with Tilray. So has it outmaneuvered Tilray? Not necessarily. The company faces several challenges.

First, HEXO is piling on debt to fund the transaction. The company announced an offering of $360 million in senior convertible notes due May 1, 2023. When you see the word "convertible" in this type of debt offering, dilution in the value of existing shares is likely on the way.

Second, there's no clear timeline for HEXO to achieve profitability. It stated that the Redecan deal would give it an "accelerated path toward positive EPS." However, just how accelerated that path is remains unknown.

Finally, HEXO said that the buyout improves its Canadian market leadership "while positioning the company for future expansion in the United States." But the impact of the deal on its ability to compete in the U.S. seems small. Aphria at least gained Tilray's Manitoba Harvest hemp foods business, which has significant sales in the U.S.

Perhaps over the long term, HEXO's acquisition of Redecan could prove to be an even smarter move than Aphria's merger with Tilray. For now, though, the jury is still out.

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