This article first appeared on our U.S. website.
Marijuana’s effect on most humans is to make them more mellow and content. So it felt a little out of character when U.S. cannabis company Curaleaf (TSX:CURA) launched a hostile takeover bid for its Canadian peer, Aurora Cannabis (TSX:ACB) on Tuesday.
Curaleaf’s attempt is ambitious. Let’s take a look at what it’s offering, and how its play might affect investors in both companies.
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The direct approach
Curaleaf said it made its offer public to Aurora shareholders after several unsuccessful attempts to initiate direct discussions with company management.
The bid is a mix of cash and stock valued at US$4 per share for Aurora. It breaks down into slightly over 0.34 of a Curaleaf share plus US$0.75 in cash per one Aurora share. The U.S. company said the total represents a premium of 45% over the 30-day volume weighted average price of its Canadian peer (which, like Curaleaf, is traded both in Canada and the States).
Curaleaf pledged that if Aurora stock were to experience a “substantial rise” prior to the company’s acceptance of the offer, it would cap the total bid price at US$5 per share.
Curaleaf quoted its executive chairman, Boris Jordan, as saying that “by combining Curaleaf’s global distribution platform with Aurora’s leading international medical cannabis franchise and EU-[Good Manufacturing Practices] cultivation and manufacturing capacity, we see significant potential to unlock value through substantial cost and revenue synergies.”
Curaleaf provided no details about how it aims to finance the cash portion of the deal (which could amount to more than US$46 million in the most extreme case). As of the end of June, it had a cash position of US$107 million.
Medical marijuana money
These days, Aurora is almost a pure-play in the medical segment. In its most recently reported quarter, this accounted for almost 95% of its total revenue of CA$67.6 million. That makes it the No. 1 medical cannabis purveyor in Canada.
Aurora is also that country’s top exporter of medical product. It either ships its wares to several foreign countries that have permitted their sale and consumption or grows the pot abroad (it has a licensed grow facility in Germany).
Curaleaf is prohibited by U.S. law from directly exporting its medical pot, so it does so through fully owned subsidiaries and business units (and foreign grow facilities). By comparison, less than half of its total revenue derives from medical.
First refusal
On Tuesday afternoon, Aurora published an official response to Curaleaf’s bid. It criticized its main aspects, particularly the US$5-per-share limit and the lack of detail on financing. As might be expected of a company beholden to do its fiduciary duty to shareholders, it said it plans to convene a special committee of its board members to consider the offer.
On paper, it makes sense to combine the two companies. The appeal of medical marijuana is that, while the segment is smaller than the recreational business, profit margins are notably higher thanks to advantages such as direct distribution and thinner competition (not to mention potential U.S. tax relief under the recent federal rescheduling of medical pot).
This is particularly appealing in the cannabis industry, which has long struggled with profitability arising from the many challenges of selling a drug that remains technically illegal at the federal level in the U.S.
Both companies have posted headline net profits in two of their trailing five quarters, but for most of their histories, they’ve been loss-making. Another appeal of combining would be the chance to eliminate redundancies and (ideally) lift the unified pair to more habitual profitability.
I have a feeling that this is the start of what promises to be a long saga. That could apply to the takeover attempt itself, as hostile bids haven’t had a great track record over the past few decades. It could also stretch out if and when an acquisition succeeds; at that point, much work would be needed to fuse companies operating in two very distinct markets. That might go double for combining two foreign sales networks/grow operations that are complex to begin with.
So I wouldn’t be eager to own either Curaleaf or Aurora in anticipation of the two tying the knot. If I had to choose one or the other, I’d go for the latter, as there’s more than a small chance of Curaleaf sweetening its bid to make the deal more appealing, either to management or shareholders.
