Canadian Marijuana Investors Should Be Giddy By Recent Takeover Premiums

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Future expected premiums could keep producers out of the acquisition game, or push them into it sooner – good for Canadian marijuana investors either way

David Bar | February 10, 2017 | SmallCapPower: As spring time moves closer, and the tabling of legislation nears, activity in the marijuana industry could pick up following the completion of the acquisition of Mettrum Health Corp by the Amazon of the pot industry, Canopy Growth Corp (TSX: WEED). This is because, unless other producers want to be left in Canopy’s shadows, consolidation should start soon before any more progress towards legalization is made and share prices are pushed higher. With the Number 1 and Number 4 producers (by market cap) coming together, and for the price that they did, it opens up a number of questions for the future. With this deal, Canopy really set itself up nicely to make future transactions even more expensive, and harder to close for its competitors – good for Canadian marijuana investors either way.

By inking a deal that entitled Mettrum shareholders to 0.7132 of a common share of Canopy, a consideration of $8.42 for each Mettrum share as of prices on November 30th this represents a premium of more than 42%! Although not an exact comparison according to a Flashwire US Monthly, published by Factset Research Systems Inc., the median premium for mergers in Q4 2016 was just 28.2% and approximately 32.3% for the year. That price tag puts Canopy’s premium way higher than the median but strategically so, at least in my opinion.

With a huge premium paid for the acquisition of a business that is not yet profitable, has negative cash flow from operations and before legislation is even tabled, it sets the comparable precedent transaction quite high. This could affect the probability of successful M&A activities of other public companies as shareholders could be reluctant to accept a deal without a comparable premium. As companies are only growing and share prices are, for the most part, sprouting higher, this will make further consolidation an expensive and less justifiable undertaking.

Figure 1: Revenue Growth of Major Marijuana Producers

We have pointed out in our Marijuana Bubble index that valuations are unjustified, but with huge revenue growth (Figure 1, above) and patient registry already beating projections (Figure 2, below) you can expect that valuations won’t retract anytime soon. Adding in the fact that as we near spring, the pending legislation will boost news and investor interest in the sector, further pushing up prices, it appears that the present seems like the time to consolidate if other companies hope to compete with Canopy.

Figure 2: Health Canada’s Projected Patient Registry vs. Actual to September 31st, 2016

With the entrance of two new public players into the market in December 2016, CanniMed Therapeutics (TSX: CMED) and Emblem Corp (TSXV: EMC), along with the other 24 companies trading on the Canada’s stock exchanges, there certainly is no shortage of opportunity. The question that does remain is which ones might be up next for consolidation, and for what price? If you pick the right one, you could end up with a vote that will earn you a nice premium.