Aurora Cannabis Should Think Twice About Buying MedReleaf

MedReleaf Corp.’s (TSX:LEAF) $2.3 billion market cap would be a giant mouthful for Aurora Cannabis Inc. (TSX:ACB) to swallow

SmallCapPower | May 7, 2018: Aurora Cannabis Inc. (TSX:ACB), less than a week after announcing completion of the CanniMed acquisition on May 1, confirmed on Thursday that it had discussions with MedReleaf Corp. (TSX:LEAF) regarding a possible merger. The cannabis sector in Canada continues to witness hectic consolidation activity amid fears of pricing pressures as players boost their capacity in anticipation of recreational legalization. Although both companies denied that a deal was near, making another big acquisition after the first one with CanniMed would be not a wise decision for Aurora. Below are some of the reasons why the acquisition would be ill timed for Aurora Cannabis.

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Oversupply concerns: The Canadian cannabis sector is a crowded marketplace with players continuing to boost capacity that may result in glut. Some research firms have estimated the recreational market opportunity at just 800,000 kilograms per annum in Canada, less than the one-million-kilogram demand estimate from Health Canada. To put that into perspective, the top two players – Canopy Growth and Aurora Cannabis alone could have combined capacity exceeding 800,000 by 2019. Post the CanniMed acquisition, Aurora has fully-funded capacity of 280,000 kg and with the recent construction of Aurora Sun, the capacity could reach a whopping 430,000 by 2019/20. Hence acquisition of MedReleaf, which has 140,000 kg of funded capacity would not be desirable given the possible glut in the industry.

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Rich purchase price: MedReleaf has market cap of $2.3 billion and any premium above that would make the deal value almost double that of the CanniMed acquisition. To make an acquisition of this size Aurora Cannabis would need to take on a lot of debt or dilute existing shareholders with a big equity raise.

Fall in market cap post CanniMed acquisition does not bode well: In the run up to the acquisition and immediately following the acquisition announcement in January 2018, the combined market of Aurora Cannabis and CanniMed was nearly on par with the industry leader, Canopy Growth Corporation (TSX:WEED). However, the market cap difference has been widening (currently at $1.4 billion) as Aurora Cannabis shares continue to fall more than Canopy Growth’s stock price over the past few months. Hence, any large acquisition involving equity does not bode well for Aurora Cannabis at this stage.

Conclusion

Aurora’s growth has been largely driven by acquisitions since its inception and it is currently the second-largest producer in Canada, behind Canopy Growth. Although bigger is better in a competitive marketplace such as cannabis, another large acquisition does not bode well for Aurora Cannabis as the industry seems to be grappling with possible oversupply concerns heading into recreational legalization. Aurora Cannabis currently trades at a market cap of $4.5 billion, behind Canopy Growth’s $5.96 billion.

Disclosure: Neither the author nor his family own shares in any of the companies mentioned above.

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