MedReleaf is Smart to Sell Out to Aurora Cannabis

Aurora Cannabis Inc. (TSX:ACB) said it has an agreement to acquire MedReleaf Corp. (TSX:LEAF) in an all-stock transaction valued at approximately C$3.2 billion

SmallCapPower | May 14, 2018: Aurora Cannabis Inc. (TSX:ACB) early Monday announced that it has reached an agreement to acquire MedReleaf Corp. (TSX:LEAF) in an all-stock transaction valued at approximately C$3.2 billion on a fully-diluted basis. MedReleaf shareholders will receive 3.575 common shares of Aurora for each MedReleaf common share held.

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On consensus estimates, Aurora Cannabis is paying 23x 2019E sales and 9x 2020e sales, as well as 82x 2019 EBITDA and 23x 2020 EBITDA, which is a rich premium.

MedReleaf shares, since our initial report on June 27, 2017, have soared more than 200% to its recent price of $24.90 for a market cap of $2.3 billion. MedReleaf has significantly expanded its capacity, with the recent 164-acre property purchase increasing its fully-funded capacity to 140,000 kgs annually.

The purchase makes MedReleaf one of Canada’s largest cannabis producers and helps it to capture a slice of the recreational market opportunity set to be legalized in mid-2018. Additionally, the greenhouse facility will produce required raw material inputs for extract production, complementing MedReleaf’s portfolio of premium indoor grown cannabis products.

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Alongside increasing capacity, MedReleaf continues to ink supply agreements to strengthen its distribution capabilities. Some of the recent supply agreements were struck with – Société québécoise du cannabis (supply of 8 tons over three years) last month; Cannamedical Pharma GmbH of Germany in March 2018; and Shoppers Drug Mart in December 2017.

One can only speculate as to why MedReleaf would want to sell out at this point given that it is a premium cannabis producer with superior margins and trades at a discount to the top three cannabis producers. That being said, the Top 4 shareholders control ~50% of MedReleaf with the CEO holding 2.8 million shares, and they could be exiting because of concerns of domestic oversupply in the near future as well as having to compete with larger players who have the ability to outmaneuver on costs and distribution.

The Canadian cannabis sector has become 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. The top two players – Canopy Growth and Aurora Cannabis alone could have combined capacity exceeding 800,000 by 2019. Hence consolidation could intensify as smaller players try to cash out.

MedReleaf distinguishes itself from other cannabis producers by focusing on high-quality premium products through its ICH-GMP and ISO 9001 certified facilities. In addition to quality, the Company also generates one of industry’s highest operating margins. Similar to other cannabis producers, MedReleaf has significantly expanded its capacity, with the recent 164 acre property purchase increasing its fully funded capacity to 140,000 kgs annually. Consolidation could intensify in the cannabis industry as more and more players try to cash out on oversupply concerns and realization that the recreational opportunity may not be as big as was originally envisioned.

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

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