Aurora Cannabis (ACB +0.43%) rocked the boat on Aug. 25 when it announced that it had acquired a 50.1% stake in Bevo Agtech, a provider of vegetables, flowers, and houseplants. The unusual deal cost the Canadian cannabis cultivator 45 million Canadian dollars up front, and it's also on the hook for up to CA$12 million in milestone payments over the next three years, assuming Bevo continues to grow as planned.
Now investors are debating whether the transaction changes much of anything for Aurora's stock over the next few years. Can Bevo help to transform Aurora into the more profitable version of itself that it envisions, or is this a case of "diworsification" rather than fruitful diversification?
NASDAQ: ACB
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To set the stage for the deal, let's take a moment to recap Aurora's recent history. The last three years have been brutal for the cannabis grower, with its shares falling by more than 97%, quarterly revenue crashing by 28.6%, and its gross margin sharply deteriorating. The biggest cause of this abysmal performance was building too much manufacturing and cultivation capacity, relative to demand, in the Canadian recreational cannabis market.
While going big on producing cannabis allowed it to capture the leading position by revenue in the Canadian medicinal market as well as dominant positions in specific segments of international markets (as in Poland), its overhead costs forced it to close numerous facilities to stop burning so much cash. Management's transformation plan for the business is ongoing, and calls for it to reach positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in the first two quarters of 2023. Management also claims that the Bevo purchase will help achieve that goal.
From the second quarter of 2021 to Q2 this year, Bevo reported sales of CA$39 million and adjusted EBITDA of CA$9 million. That CA$9 million will indeed inch Aurora closer to positive adjusted EBITDA, and by quite a bit. In its fiscal Q3, which is its most recent quarter, the cultivator reported an adjusted EBITDA loss of CA$12.3 million.
So, if it can maintain that performance with the addition of Bevo, it'll be within striking distance of breaking even -- and potentially reach positivity within a quarter or two, just as planned. Because Bevo agreed to purchase one of Aurora's cultivation facilities (in Edmonton, Alberta) as part of the deal, it's even plausible that the company's expenditures on overhead will be put to more efficient use. But that doesn't necessarily make the stock worth buying for most investors.
It's best to watch this one play out from afar
One trouble with the Bevo acquisition is that it doesn't necessarily add much to Aurora's core capabilities. Management claims that the purchase "may have the potential to drive long-term value to Aurora's existing cannabis business via the application of Bevo's industry-leading plant propagation expertise," which isn't exactly the most committed stance on whether there are genuine synergies to take advantage of.
And while it's true that Bevo's earnings mean that the transaction is accretive, there's still the possibility of the company losing its ground and becoming a liability. It's hard to imagine much of a boom in the market for vegetables or decorative flowers, but it's easy to see how a recession could force consumers to cut spending on pretty plants or beds of grass for the yard.
Then there's the elephant in the room: The Canadian cannabis market is struggling with an overabundance of products. Nothing Aurora does (aside from continuing to scale down) can change that. Last year, cultivators were forced to destroy 26% of the country's annual production, accounting for 425 million grams of unpackaged and unsold product. That's not a market environment that most investors find thrilling.
Therefore, it's best to avoid buying shares of Aurora for now. If its net profit margin -- a metric that the business hasn't set a target for -- starts to improve, it'll be a sign that conditions have improved significantly and could continue to improve more. Until then, steer clear.
