Canopy Growth Acreage Holdings Merger Dissected

Canopy Growth Corporation (TSE:WEED), one of Canadian marijuana stocks, announced results of its special meeting to approve its merger with Acreage Holdings Inc. (CNSX:ACRG.U)

John Brooker | June 21, 2019 | SmallCapPower: Canopy Growth Corporation (TSX:WEED) (NYSE:CGC), one of the Canadian cannabis stocks, announced on June 19, 2019, that the proposed merger with Acreage Holdings, Inc. (CSE:ACRG.U) passed with 99.1% of votes cast. Recall, the merger was announced on April 18, 2019, whereby Canopy would acquire Acreage in a cash-and-stock deal valued at $2.55 cash/share and $33.23/share (47.7% premium) over Acreage’s closing price of $22.49 on April 17, 2019. For reference, this implied a 2020E takeout multiples of 6.1x sales and 21.4x EBITDA. At the time U.S.-based major MSOs were trading at 4.6x and 12.7x multiples, respectively.

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There is a high likelihood that the U.S. Department of Justice (DOJ) Antitrust division may request a “Second Request” for additional information after the initial first review. There is evidence of this, as the DOJ requested a “Second Request” in two similar U.S.-based MSO deals: The Origin House/Cresco Labs and Cannex/4Front Holdings acquisitions are both currently under a second review by the DOJ. In our view, this is significant as only 3.7% of acquisitions over the past 10 years have resulted in a “Second Request” by the DOJ (Source: Federal Trade Commission).

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Acreage Holdings is one of the largest, vertically-integrated, multi-state operators (MSOs) in the U.S. Acreage owns licenses or has management services agreements in place in 19 states with a combined population of more than 172M Americans. The Company’s portfolio has diverse holdings in the cannabis industry, including cultivating, processing, and dispensing operations.

Acreage Holdings Operational Dispersion as of December 2018

Source: Acreage Holdings Annual Information Form.

The U.S. is currently the world’s biggest cannabis market. New Frontier Data estimates that the U.S. cannabis market could reach $26B by 2025. Even though Canadian cannabis companies have a first-mover advantage due to relatively less regulation, a strong position in the U.S. is necessary for any of these cannabis companies to have a chance at reaching large-cap status. It is important to consider that the U.S. makes up 34% of the total addressable global cannabis market (illegal + legal market), while Canada only makes up approximately 3% of the total addressable global cannabis market.

It is no secret that Canopy’s strategy in this agreement with Acreage is to penetrate the U.S. market, but when we look closer at the agreement, it is evident that there are other benefits to this deal apart from just access to the U.S. cannabis market.

  • Canopy Growth has locked in its price for expanding into the U.S. The cost of expanding into the U.S. would likely skyrocket given federal legalization. Therefore, the return on an investment into the U.S. for Canopy will likely be high due to the low relative cost of expansion.
  • Canopy Growth Corp is entering into this agreement with little legal risk. This acquisition is contingent on the U.S. federal government legalizing cannabis by 2026.

A move like this is not unprecedented in the cannabis industry. Aurora’s investment arm is listed on the CSE and is called Australis. Due to restrictions around U.S. operations due to its listing, Aurora Cannabis doesn’t currently own any shares in Australis, but has warrants to do so within 10 years should U.S. federal regulations change. This would allow Aurora to acquire 20% of the issued and outstanding shares at approximately $0.20 per share and give them the option to purchase an additional 20% at the prevailing market rate at the time of exercise.

Canopy Growth is already the largest Canadian cultivator by market cap and acquiring a company that has ownership in 19 states would be a large stepping stone in dominating the U.S. cannabis market.

Shares of Canopy Growth Corporation ended Wednesday’s trading session 0.87% higher at C$56.85. Canopy Growth stock trades at a market cap of C$19.5 Billion.

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