One of the largest acquisitions in recent years in the marijuana industry is over. Cresco Labs (CRLBF 5.13%) and Columbia Care (CCHWF -2.00%) reached an agreement in 2022 that would create an industry-leading entity in the cannabis market. The combined company would be neck and neck in revenue with the top multi-state operators in the U.S., including Curaleaf Holdings and Trulieve Cannabis.
Alas, the deal is for naught. On July 31, the companies announced that they were walking away from the merger. Neither company will need to pay a termination fee as a result of the decision to mutually step away from the deal.
Why did the deal fall through?
On March 23, 2022, Cresco Labs announced it would "become the new leader in cannabis with the acquisition of Columbia Care." The transaction valued Columbia Care at approximately $2 billion. The one hurdle was that the companies competed in many states, and they were planning to divest in order to obtain regulatory approvals.
There were signs of trouble, as the merger has been delayed multiple times. Most recently, on June 30, Cresco announced that the companies would not be able to meet their June 30 deadline to obtain all necessary regulatory approvals. It did not specify a new date, only that there would be an update in the near future.
One big problem, however, is that valuations have plummeted for growth stocks, and the cannabis industry is no exception. Since March 2022, Columbia Care's stock has fallen 84%. Cresco hasn't fared much better, nosediving 77% over the same timeframe. The deal wouldn't have made much sense anymore, given what has happened with the valuation of pot stocks over the past year and a half.
Cresco CEO Charles Bachtell suggested that changing economic conditions did play a role, stating that "in light of the evolving landscape in the cannabis industry, we believe the decision to terminate the planned transaction is in the long-term interest of Cresco Labs and our shareholders."
Cannabis companies have struggled with growth in the past year, and focusing on mergers and acquisitions (M&A) and getting bigger simply isn't as attractive as it once was in the industry. Becoming leaner, being more efficient, and having sustainable operations is much more of a priority.
Is this a bad sign for M&A in the industry?
This deal collapsing isn't a good look for the cannabis industry. At the time the deal was announced, Cresco highlighted many positives, including becoming a leading brand in multiple markets while also taking advantage of synergies to improve the bottom line. The deal made sense on multiple fronts, and for it not to go through shows the perilous situation that many cannabis companies are in right now.
While Cresco and Columbia Care aren't in financial distress, it's evident that it makes more sense for companies to be smaller these days and weather the storm of inflation and challenging macroeconomic conditions than to try to expand. Rival Curaleaf is an excellent example of that, as it announced that it was exiting multiple markets this year -- California, Colorado, and Oregon.
The industry isn't proving to be resistant to inflation, as the illegal market still offers people cheaper options for cannabis. The economic landscape simply isn't great for cannabis companies. That's why even though valuations are much lower in the industry than they were a year ago, I wouldn't expect to see much M&A in the near future.
Are Cresco Labs and Columbia Care good buys on their own?
Although the deal is dead, Cresco Labs and Columbia Care may still be good pot stocks to buy individually. They are trading at price-to-sales multiples well below one, and they are among the top companies in the industry. Cresco generated more than $840 million in revenue last year, while Columbia Care's top line totaled $511 million.
Cresco is a bit of a safer option. Its operating cash flow was positive at just under $19 million for the year, while Columbia Care burned through $111 million.
There's always going to be risk in this industry, but both companies could be among the better investment options for long-term investors who are willing to be patient. While the merger falling apart isn't necessarily great news, it could be a blessing in disguise for these businesses. Trimming and focusing on having leaner operations may help improve their financials in the short run, potentially leading to stronger share prices in the future.
