When it comes to growth industries, legal marijuana is either at or near the top of the list. Investment firm Cowen & Co. estimated back in 2016 that the U.S. could be generating $50 billion in annual legal weed sales by 2026, while a more recent forecast from ArcView, in partnership with BDS Analytics, pegs total North American sales at $24.5 billion by 2021. Sales growth is certainly robust, as is consumer support for cannabis, which has led to massive appreciation in pot-stock valuations.
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Yet it’s Canada, not the U.S., that’s been leading the charge for the marijuana industry. Canada wound up legalizing medicinal cannabis back in 2001, and it’s on the verge of becoming only the second country in the world, after Uruguay, to green-light the sale of cannabis to adults by this coming summer. With tax regulations and implementation mostly ironed out, it’ll come down to a Senate vote in less than three months’ time. If legalized, adult-use pot is expected to add $5 billion or more in annual sales.
In response to this expected legalization, Canadian cannabis growers have been expanding their production capacity as quickly as their balance sheets will permit. Among the companies expected to be a top-tier produce is Aurora Cannabis(NASDAQOTH: ACBFF).
Here’s what you need to know about Aurora’s acquisition of CanniMed Therapeutics
This past week, Aurora Cannabis closed on its acquisition of Saskatchewan-based CanniMed Therapeutics, creating an even bigger powerhouse to take on Canopy Growth Corp., the Canadian marijuana kingpin. With Aurora providing a post-closing update on strategies and output to come, here are five important things shareholders and interested investors should know.
1. This was a pricy deal
To begin with, this is easily the most expensive marijuana acquisition of all time. When announced, the cash-and-stock deal was worth about CA$1 billion ($765 million). The final tally, according to a press release from Aurora Cannabis post-closing, shows that the company issued roughly 62.8 million shares of common stock, as well as paid CA$121.5 million ($93 million) in cash to acquire the remaining 87% of CannIMed that it didn’t already own. Considering the price of this deal — Aurora paid nearly triple what CanniMed was valued at on a per-share basis in mid-November — investors will be expecting huge returns in the years to come.
2. Aurora Cannabis should produce even more marijuana than expected
Next, it’s worth pointing out that Aurora Cannabis is expecting to produce even more cannabis on an annual basis than it guided to during its somewhat recently reported second-quarter operating results.
Following the closing of the CanniMed deal, Aurora notes a fully funded estimated output of 283,000 kilograms of cannabis per year, placing it probably at either No. 1 or No. 2 in terms of total annual domestic production. Since Canopy Growth Corp. is tight-lipped about its annual production capacity, it’s still a bit of a toss-up, even though Canopy has more capacity expansion to work with.
In addition, the combined entity has more than 45,800 medical patients, and purported has 23.1% market share relative to the top 15 licensed producers, based on their most recent quarterly filings. With recreational legalization seemingly around the corner, Aurora is in prime position to secure long-term supply contracts.
3. It’s making a serious push into cannabis oils
Third, Aurora outlines a number of the strategic objectives and goals of the now-combined company, of which this sits near the top of the list:
Accelerate construction of the previously announced (by CanniMed) cannabis oils processing facility, with a design capacity of up to 720,000 liters of annual oil production. Leveraging this capacity and the extraction capabilities of RTI [Radient Technologies] will position Aurora as leader in cannabis and hemp extraction capacity.
As I described recently, the most profitable pot stocks are probably going to be those that focus on cannabis oils and extracts, rather than solely on dried cannabis. Cannabis oils and extracts come with substantially higher price points, and much better margins. Being less commoditized and competitive than dried cannabis, they’re the "X-factor" that could really juice marijuana stock margins.
4. Geographic diversification is a core strategy
The update also suggests that Aurora Cannabis is continuing to be aggressive with its international expansion opportunities. It’s already operating in seven countries — Canada, Germany, Denmark, Italy, Australia, South Africa, and the Cayman Islands — and has plans to further expand. CanniMed’s distribution network, along with Aurora’s own burgeoning production, should make it an attractive company for medically legal countries to form supply agreements with.
Keep in mind that international expansion is probably going to be critical for cannabis growers given the growing likelihood that domestic demand in Canada will be overwhelmed by aggregate production from licensed producers. These export channels may provide a means to offload excess production without wrecking margins in the process.
5. Its shareholders are drowning in dilution
Finally, as has become typical with Aurora Cannabis, the deal dilutes existing shareholders even further. As noted, the company issued 62.8 million shares in conjunction with cash payments to acquire the remaining stake in CanniMed. While this was fully expected, it’s yet another in a series of moves Aurora has made that’s ballooned its outstanding share count. Between the end of fiscal 2014 and the company’s latest quarter, its share count has exploded by more than 2,900% to almost 490 million shares. Soon, through convertible debentures, warrants, stock options, and now shares issued for an acquisition, we can add even more to the moat.
Remember, these shares have two negative consequences. First, they reduce the scarcity of each existing share, thus diluting investors. But they also make it harder for the company to produce meaningful profits. A few years ago, a $50 million profit would have meant $1 in earnings per share. Today, $50 million wouldn’t even equal $0.10 in EPS, once the new shares are factored in.
In short, while Aurora continues to position itself as a cannabis industry leader, there are no guarantees that shareholders will benefit.
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