Driving Factors, Trends & Sample Transactions from 2019
S T O N E B R I G H T
Cannabis M&A Advisory
The fragmentation of the cannabis industry, resulting from the disparate regulatory environment in the United States and throughout the world, often forces operators to favor accretive acquisitions over organic growth. In just five years, the industry has transformed from cottage to skyscraper, producing many transactions valued at at $100 million or more. In this article, we analyze global factors and trends driving M&A activity for the industry, together with specific examples of transactions illustrating those factors and trends.
The global cannabis and hemp markets already operate at light speed. Mergers and acquisitions will continue to shape the face of the global cannabis markets over the next decade – a trend consistent with any nascent industry. Near-term consolidation will progress at every level from micro-cap to large-cap issuers, inevitably leading to mega-mergers after federal legalization occurs in the United States.
2018 M&A in Cannabis Topped $15 Billion USD
SEVEN GLOBAL TRENDS SHAPING THE M&A LANDSCAPE IN CANNABIS
- Boards and management teams face increased pressure from investors to perform.
- Large scale production assets need expansive sales channels creating vertical integration opportunities.
- Opportunities abound to leverage huge valuation gaps between private and public transactions.
- Otherwise restricted by the NYSE, NASDAQ, or TSX/TSX-Venture stock exchanges, large-cap issuers are getting creative to gain exposure to the US prior to federal legalization.
- Having made a few “bets” – Big Alcohol, Big Tobacco, and Big Pharma are just scratching the surface.
- Global stock exchanges will allow or expand their tolerance for cannabis-related listings – driven by continued legalization.
- Emergence of Special Purpose Acquisition Companies (SPACs) increase access to capital for M&A transactions.
HOW THE 7 TRENDS AFFECT M&A ACTIVITY
Boards and management teams face increased pressure from investors to perform. Put simply, buying operating companies provides a quantifiable increase to revenue, margins, and in many instances – profits. Licenses and/or licensed facilities create faster entry to (or expansion within) markets when compared to new applications. Companies can instantly leverage their existing brand and product portfolios through acquisitions. Further, acquirers often integrate proven management teams that have demonstrated success in this dynamic industry – which can save them years of pain and instability. Jared Younker, Chief Compliance officer of CREC Compliance, a leading licensing and consulting firm, estimates that “groups may spend well in excess of $300,000 on average and not secure an eventual license.” With license competitions increasing risk and cost, regulated operators have increasingly turned to an acquisition strategy to eliminate the risk of securing a license, while diversifying both geographically and frequently vertically along the supply chain.
- Curaleaf Holdings (CSE: CURA) announced in June 2019 that it agreed to acquire Glendale Greenhouse and Phytotherapeutics Management Services for a total value of $25.5M USD – with $22M USD in cash and $3.5M USD in stock1. This transaction provides Curaleaf with production and retail assets in Arizona – together with $7.4M USD in annual revenue.
- On October 8, 2019 – Cresco closed the acquisition of Gloucester Street Capital, LLC2 – providing the leading multi-state operator Cresco with one of only ten (10) vertically integrated licenses in New York State.
- In July 2019 – emerging MSO Jushi Holdings, Inc. expanded into Virginia through a $16M USD investment for a controlling 62% interest in Dalitso3, after agreeing to acquire various interests in Pennsylvania for $63M USD the month before.
Large scale production assets need expansive sales channels creating vertical integration opportunities. Operators who have built vast production infrastructure in hopes of selling their wares can instead acquire brands with existing demand. Alternatively, well-positioned brands with customer demand are acquiring production assets to secure reliable supply for their wanted products to ensure quality, consistency, and availability. Channels to the market can also be purchased to ensure off-take of production, such as producers of indoor flower acquiring retail or distributors.
- Cresco Labs (CSE: CL) agreed to buy Origin House (CSE: OH) for approximately $850M USD4, after originally buying a majority stake of SLO Cultivation in California – a large-scale greenhouse operation – and entering the California market with their brands. The transaction provides Cresco with definitive access to most dispensaries in California, while increasing the likelihood for offtake or sales of their raw materials produced by SLO Cultivation. The Origin House acquisition recently passed a mandated waiting period under United States anti-trust laws and is expected to be finalized in the coming months.5
- Cresco buys Gloucester Street Capital, LLC for $32.5M USD in cash and 13,466,667 Class F units – providing Cresco with one of only ten (10) vertically integrated licenses in New York State.6
- The pending acquisition of private company Curaleaf Partners, Inc. and the Select brand by Curaleaf Holdings, Inc. was followed by aggressive M&A to leverage the Curaleaf brands through the acquisition of production or vertically integrated assets across key markets in the United States. In addition to the Glendale Greenhouse and Phytotherapeutics Management Services deal in Arizona, Curaleaf also announced the closing of Acres Cannabis in Nevada on October 31, 2019 – providing the company with 269,000 square feet of cultivation and 3,200 square feet of processing in Nevada – with a dispensary acquisition in Las Vegas still pending. Curaleaf currently operates in 12 states with 49 dispensaries, 14 cultivation sties, and 13 processing sites to power the Curaleaf and Select brands.7
Opportunities abound to leverage huge valuation gaps between private and public transactions. In more stable and efficient capital markets within mature industries, valuation gaps between public and private issuers typically hover near 30% — with a public issuer achieving a 30% premium to valuation based upon the revenue or earnings of their target. Public cannabis companies still trade above 5X revenue (even after recent corrections in valuations), whereas private transactions often range from 1X to 2X revenues. With issuers raising capital or utilizing their stock as currency, acquisitions present immediate shareholder value over organic growth. Private companies may also favor share exchanges, granting shareholders liquidity as they spin privately held assets onto public company balance sheets.
- The aforementioned Curaleaf acquisition of Glendale Greenhouse and Phytotherapeutics Management Services featured a multiple of approximately 3.5X revenues – however, Curaleaf’s market cap as of October 20, 2019 was approximately $2.8B USD on an annual revenue run rate of $194M USD (based on their quarter ending June 30, 2019). That means Curaleaf traded at a revenue multiple approaching 14.5X, suggesting this transaction was a premium for the buyer compared to other industries… but a major win for Curaleaf shareholders based on this metric.
- Further, the Curaleaf transaction upon its initial acquisition terms valued the company at $950M USD on revenues of $117M USD for the prior year – or a multiple of more than 8X last-twelve-months revenue. Acquisitions with higher revenue, such as this one, or within limited license states, tend to drive higher valuations of private-to-public transactions. Interestingly, on October 30, 2019 – Curaleaf announced a restructuring of the original deal, reducing the minimum consideration by 42.5% and structuring additional payments as an earn-out. This tracks back to trend number 1: boards and management face increased pressure to perform. While some observers8 have suggested that this is a broader trend related to M&A, we estimate this restructuring is more closely related to falling sales attributed to the “vape crisis.” In any event, by mutually agreeing to change the terms, this transaction now has an increased chance of success to drive value for Curaleaf shareholders.9
Otherwise restricted by the NYSE, NASDAQ, or TSX/TSX-Venture stock exchanges – large-cap issuers are getting creative to gain exposure to the US markets prior to federal legalization. Capital just “finds a way.” Variations on the structures below will allow aggressive acquirers to pave their eventual way into the United States while tip-toeing around their respective exchange regulations.
- Canopy Growth, a leading Canadian operator with a global footprint, structured a deal to acquire Acreage Holdings in the future, a company with substantial United States operations – combining the two behemoths conditioned upon the federal government legalizing cannabis in the United States. The proposed $3.4B USD deal was approved by an estimated 99.05% of shareholders.10
- Canopy Rivers (TSX: RIV.V), an offshoot of Canopy Growth (NYSE: CGC, TSX: WEED) structured as a “venture capital investor” that is publicly listed, invested in TerrAscend (CSE: TER)11 – helping to drive a series of transactions with TerrAscend investing in or acquiring US-based, operating assets like those of Ilera Healthcare. Ilera gives TerrAscend one of the few vertically integrated licenses in Pennsylvania, and incredible top-line growth (from $8M USD in revenues in 2018 to a run-rate of $43M USD in 2019).12
- Cronos, a leading Canadian operator (NASDAQ: CRON) leverages its investment from Altria to acquire Redwood Holding Group13 – giving Cronos immediate scale for the hemp and CBD markets in the United States.
- Innovative Industrial Properties (NYSE: IIPR), a public REIT dedicated to cannabis, was an early pioneer as the first industry issuer to get NYSE approval, granting them exposure to the enhanced lease terms and cap rates of the cannabis industry while concurrently benefitting from a “big board” listing in the United States. Leveraging insider experience from the biotech industry – Innovative Industrial Properties gives operating companies a platform to divest real estate assets through a sale-leaseback structure, providing much-needed cash for growth or acquisitions to the operating company. As of October 30, 2019, Innovative Industrial Properties owned 38 properties in 13 states totaling 2.8 million rentable square feet (including approximately 903K square feet under development/redevelopment). Per the company, the average annual yield on these investments is 13.8% with an average remaining lease term of 15.6 years.14 Measuring this yield against the entire market, REITs average an 11.8% annual return.15 Look for other cannabis REITs to pop up on major exchanges that allow US institutions to play, driven by our first and fourth trends – management is under increased pressure to perform, and issuers are getting creative to gain exposure to US markets. Real estate is simply not the core business for an operating company seeking to expand market share with their products, but cannabis real estate offers a premium yield compared to other industries.
Big Alcohol, Big Tobacco, and Big Pharma are just scratching the surface. These industries feature market caps that completely dwarf the largest players in cannabis. The last two years have already seen Big Alcohol and Big Tobacco make initial bets. With Big Beer struggling to grow, and Big Tobacco facing a crisis to retain market share – particularly in light of the new vape crisis – the coming years will see more transactions in global markets where these players can easily transact in countries with federal legalization.
- Constellation Brands, Inc. (NYSE: STZ), owner of Corona and Robert Mondavi wines, made a $4B investment in Canopy Growth Corporation (NYSE: CGC, TSX: WEED) in 2018. Considering Canopy Growth Corporation also agreed to acquire Acreage Holdings (CSE: ACRG.U), and Constellation Brands, Inc. has a relatively easy path to own a majority of Canopy Growth – Constellation’s reach extends to both Canopy Growth and Acreage Holdings, providing Constellation with future consolidation opportunities to become what could become the largest cannabis company in the world.
- Also in 2018, Altria Group, Inc. (NYSE: MO), maker of Marlboro cigarettes, made a $1.8B investment for a 45% stake in Cronos Group Inc. (NASDAQ: CRON) – a company engaged in the production and sale of cannabis in federally legal jurisdictions.16 Expect Cronos to face increased pressure to creatively gain exposure to the US cannabis market, leveraging their NASDAQ listing and strong market cap – and positioning Altria for a future, majority stake (or outright acquisition/consolidation).
- Molson Coors (NYSE: TAP; TSX: TPX) took a controlling interest in a JV with HEXO (NYSE: HEXO) to develop cannabis-infused beverages17, while InvBev (NYSE: BUD) and Tilray (NASDAQ: TLRY) each committed to invest up to $50M USD into a JV dedicated to cannabinoid-infused beverages.
- Another Big Tobacco juggernaut – Imperial Brands (OTC: IMBBY) invested $123M CAD through a convertible debenture in Auxly Cannabis Group (TSX: XLY) to acquire a 19.9% interest – also granting them the exclusive partner rights for cannabis-related initiatives.
- While some observers believed that Big Pharma would stay on the sidelines until cannabis became federally legal in the United States – Novartis AG (NYSE: NVS) crushed that assumption by inking a global supply and distribution agreement for medical cannabis with Tilray (NASDAQ: TLRY) in December 2018. This expanded upon a previously inked deal between the parties. Novartis CEO Vas Narasimhan told the market that “cannabis is not a priority,”15 although this was the first major partnership (of what will inevitably be many) between a pharmaceutical company and a cannabis business.
Global stock exchanges will allow or expand their tolerance for cannabis-related listings – driven by continued legalization. The once fledgling Canadian Stock Exchange (CSE) is a thriving market with hundreds of issuers, known now by many as the “Cannabis Stock Exchange.” The trend of new stock markets or acceptance by large, existing stock markets will continue to invite M&A strategies because public capital leads to consolidation.
- Aequitas NEO Stock Exchange (“NEO”). Canada’s “next generation stock exchange, founded on the principles of fairness, liquidity, transparency, and efficiency” – the NEO benefits from an overrun and logjam on CSE listings in the cannabis industry. Listings from Columbia Care, Inc. (NEO: CCHW), Horizons US Marijuana Index ETF (NEO: HMUS), Halo Labs, Inc. (NEO: HALO), Jushi Holdings (NEO: JUSH.B), and several SPACs as detailed below are strong indications of NEO’s bright future in cannabis.
- London Stock Exchange (“LSE”). Cannaray, a British medical cannabis company, is planning to list “a £100M float”17, making it the biggest company on the LSE. While this transaction may be small by current standards established by Canada and the United States exchnages, this signals a broader trend of acceptance by yet another major global stock exchange. Medical cannabis in England is defined according to low-THC content, but if history is any indication, the LSE will likely expand acceptance of high-THC issuers as consumer and patient acceptance increases.
Emergence of SPACs increase access to capital for M&A transactions. A SPAC, or special purpose acquisition corporation/company, allows an issuer to raise capital before they identify a target to acquire. The leading investment bank in the cannabis industry in terms of total underwriting and transaction size, Cannacord Genuity, has been actively involved in creating and underwriting these vehicles through their affiliates. Using a SPAC solves the chicken-or-egg scenario of raising material blocks of capital first, then deploying it opportunistically. Funds are raised into a trust for a SPAC, an acquisition is identified, and a transaction is completed within 24 months with shareholder approval to conform to the various restrictions placed on a SPAC structure by regulators. Look for SPACs to increase as federal legalization occurs in the US, and as other capital markets globally increase acceptance of cannabis listings of all forms. This structure may become the preferred avenue for larger transactions as opposed to the tried-and-true reverse-takeover, or “RTO.”
- Cannacord Genuity Growth Corp. (formerly NEO: CGGC) agreed this year to merge with Columbia Care18 – a New York-based medical cannabis business. Prior to the agreement, the SPAC estimated Columbia Care’s value at $1.35B USD. The entity is now known as Columbia Care, Inc. (NEO: CCHW).
- Ayr Strategies, Inc. (NEO: AYR.A) was previously Cannabis Strategies Acquisition Corp. (NEO: CSA.A, CSA.WT, CSA.RT) prior to its qualifying transaction with Ayr Strategies, Inc. Ayr’s strategy is predicated upon M&A, targeting revenue of $750M CAD by 2020 according to early information from the company.19
- Mercer Park Brand Acquisition (NEO: BRND.U) raised $402.5M USD, and intends to focus on acquiring companies with an enterprise value between $300M USD and $800M USD.20
- Subversive Capital Acquisition Corp. (NEO: SVC.UN.U), was formed and capitalized to “identify, acquire, and…assist in the growth of a business in the cannabis industry.” It raised $575M USD in its IPO, making it the largest SPAC IPO in Canadian history.21 The company is now focused upon identifying and closing its qualifying transaction with a large war chest.
- Canaccord Genuity Growth II Corp. (NEO: CGGZ.UN) also completed its IPO in 2019, and is “targeting companies with an enterprise value between $50M and $250M.”22
THE FUTURE OF CANNABIS INVESTING IS SHAPED BY CURRENT M&A TRENDS
The days of irrational exuberance when cannabis was a novel investment are officially behind us. Increased activity in the M&A markets will invariably impact seed- and venture-stage companies seeking capital – as investors have more options than ever to add cannabis to their portfolio.
Once promising business opportunities featuring entrepreneurs who have little to no experience in the industry (or business, generally) will have reduced access to capital. Established executives, previously reticent to dip their toes in the once muddy waters, are becoming increasingly receptive to the global cannabis industry. Relationships of these executives will lead to even more access to capital and mainstream acceptance of cannabis – and the path of least resistance to scale in the global cannabis market for new entrants will be through aggressive M&A.
Expect consolidation to continue at every level of the market, preceded by more mega-mergers intended to create economies of scale (or to diversify and hedge against the loss of consumers). The Aurora Cannabis (NYSE: ACB) acquisition of MedReleaf in a deal valued at more than $2.5B USD 23 was only an indication of the future. Expect non-industry juggernauts to leverage their market cap and balance sheets to enter the industry through near-majority investments like those made in Canopy Growth by Constellation Brands or Cronos by Altria, only to be followed by outright absorption of those companies. SPACs will increase in size, leveraging the firepower and wisdom of investment banks like Canaccord Genuity.
When the United States federal government finally legalizes cannabis, expect the Goldman Sachs of the world to aid in massive consolidation by underwriting transactions that could shape the future of the United States economy – not completely unlike the industrial revolution.
Stonebright is an M&A advisory firm dedicated to the cannabis and hemp industry. The firm operates the cannabis practice for a leading, middle-market investment bank in the United States. Uniquely suited to closing premium-priced transactions, Stonebright utilizes senior resources and a proven process that has successfully closed more than 500 transactions across multiple industries with numerous awards – with sell-side and buy-side transaction experience ranging from $1M to $1B+ in enterprise value. For information on selling or buying companies in the industry, please contact us through www.Stonebright.com or via email: email@example.com
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