The cannabis sector saw the biggest deal in its short history play out in late January. Vancouver-based Aurora Cannabis Inc. (TSX:ACB) agreed to acquire CanniMed Therapeutics Inc. (TSX:CMED) during friendly talks after a bitter battle between the two companies since the original takeover attempt. The deal makes Aurora the largest cannabis producer in Canada, ahead of Canopy Growth Corp. (TSX:WEED).
The acquisition comes at a steep price for Aurora. Fool contributor Karen Thomas concluded (quite correctly in my view), that Aurora’s push to almost double its original offer of $24 per share showed a lack of patience. Aurora was able to wiggle its way out of acquiring Newstrike Resources Ltd., which was a sticking point in negotiations up till now. However, CanniMed CEO Brett Zettl has said that Newstrike may still be brought on board before the deal is concluded.
Aurora stock reached an all-time high of $15.20 on the day the deal was announced, but has since dropped to $13.29 as of close on January 26.
Statistics Canada released its Cannabis Economic Account on January 25. In 2017, 4.9 million Canadians between the ages of 15 to 64 spent approximately $5.7 billion on cannabis for both medical and recreational purposes. Over 90% of households spent money on cannabis for non-medical purposes. From 1961 to 2017, spending on cannabis has increased by about 6% per year.
Canopy Growth and Aurora both have market caps of more than $6 billion, which exceeds the estimated amount spent on cannabis by Canadians in 2017. Bruce Linton, CEO of Canopy Growth, said recently that this number vastly underestimates the potential size of the cannabis market. Naturally, Linton pointed out that the survey could be unreliable given that recreational cannabis use is still illegal. Linton projected that the market “is going to be between $6 and $10 billion.”
In October, New York-based Constellation Brands Inc. (NYSE:STZ) purchased a minority stake in Canopy Growth. Constellation Brands is an international producer and marketer of beer, wine, and spirits. Linton has said that the recent Statistics Canada numbers also underestimate the stimulus that edibles will eventually provide when the Canadian government gives the green light for them to be sold legally in stores.
The July 2018 target date of recreational legalization is fast approaching, and both of these companies will soon have much to prove. The rollout will undoubtedly be chaotic, and industry experts are predicting that producers will be stretched thin to meet initial demand. Canopy Growth has long had a leg up on its competition; indeed, it has stockpiled more inventory than any other producer in anticipation of the July date.
Aurora has sacrificed a great deal to scoop up CanniMed and hold bragging rights as the largest producer in the country. Its stock is currently trading at almost a third of that of Canopy Growth, which closed at $35.09 on January 26. Aurora’s stock has climbed an astonishing 366% over a three-month span.
In truth, investors may be better off sitting on the sidelines than buying into cannabis stocks at this stage. For those holding, I recommend Canopy Growth ahead of recreational legalization as the most prepared of the big three producers.
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Fool contributor Ambrose O'Callaghan has no position in any stocks mentioned.