Why Canopy Needs Aphria Takeover to Balance Aurora-Medreleaf Deal

Canopy vs Aurora
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Canopy vs. Aurora

Canopy Growth Corp (OTCMKTS:TWMJF, TSE:WEED) is the biggest player in the burgeoning marijuana market. Or at least it was until the $3.2-billion Aurora-MedReleaf deal was announced. This report considers the impact of that deal on our Canopy Growth stock forecast, while also speculating what Canopy might do in response.

Let’s start with the Aurora-MedReleaf acquisition.

Combined, the two companies—Aurora Cannabis Inc (OTCMKTS:ACBFF, TSE:ACB) and MedReleaf Corp (OTCMKTS:MEDFF, TSE:LEAF)—will have nine grow-ops in Canada and two in Denmark, not to mention a production capacity of 570,000 kilograms per year. That’s pretty impressive.

Did I mention that the Aurora-MedReleaf hybrid will also have a footprint on four separate continents? Because that’s also true.

As for investors’ reactions to the deal, here’s a quick summary:

  1. The Aurora stock price jumped initially, then fell, ending with a net negative result.
  2. The MedReleaf stock price ended with a net positive result.

In other words, the market thinks MedReleaf won the deal.

That perception might have something to do with Aurora’s already over-stretched finances. After all, the $3.2-billion acquisition of MedReleaf wasn’t Aurora’s first big-ticket purchase this year. Remember the $1.1-billion acquisition of CanniMed Therapeutics Inc.?

If you don’t, let me enlighten you.

Aurora offered to buy CanniMed last year, but was rejected. Then CanniMed flirted with another company, going as far as signing papers, before ultimately backing out of that deal and returning to the bargaining table with Aurora. It was a disaster for the Aurora stock price.

In the first quarter, the Aurora stock price fell from $10.00 to $6.00.

I think that’s a mistake. Aurora is playing the long game by spending money on expansion. It burned through a lot of money, sure, but that doesn’t mean it’s running short of cash. The company raised $279.0 million in 2018 alone.

So, when you look at the next year or two, the Aurora-MedReleaf deal starts to look like a tailwind rather than a drag. It makes Aurora “Canada’s leading marijuana company,” a title that used to belong to Canopy Growth.

What should Canopy Growth do in response? One answer is—as the title of this article might suggest—to buy Aphria Inc (OTCMKTS:APHQF, TSE:APH).

Should Canopy Consider Aphria Takeover?

At the moment, Aphria has a market capitalization of $2.71 billion. It’s not exactly cheap.

Canopy Growth would have to offer a generous mix of cash and shares to complete the deal, but the balance would have to be perfect. A majority cash offering would eat into the company’s coffers, whereas giving away stock would dilute existing shares.

Even with a carefully measured ratio, one that satisfies shareholders on both sides, Canopy would still have to cough up a lot of dough. Does the company have that much cash?

The answer: Maybe.

Canopy has roughly $237.0 million in cash and equivalents. While that’s not quite enough to complete the transaction, the company also plans to list on the New York Stock Exchange (NYSE), which means it could raise a significant amount of capital by June.

Canopy could devote that money to expanding its empire.

One option is to build more production facilities, the other is to acquire existing ones. I think that straight acquisitions are probably wiser at this point, because competition is heating up, and waiting another two years to build out additional infrastructure is a dangerous game.

Buying Aphria would give Canopy Growth’s market cap an adrenaline shot.

Production capacity would rise by 30,000 kilograms per year (potentially 230,000 kilograms per year over the long haul), plus Canopy would inherit several projects that are already nearing completion. (Source: “Aphria More Than Triples Production Capacity with Health Canada Approval for Part III Expansion,” Cision, March 13, 2018.)

But there’s more.

Canopy might not have a choice at all. You see, consolidation is an unavoidable stage in business. The strong survive, the weak do not. The big fish eat little fish. Whatever analogy you choose, the essential truth remains the same: Namely, that industries are not the Wild West forever.

Sooner or later, order replaces chaos. And if Canopy wants to be on the winning side of that equation, sooner sounds a lot better than later.

Canopy Growth Stock Forecast

Most of our TWMJF predictions came true in the last 12 months.

We said that the Canopy stock price could hit $15.00. It did. Then we upped our forecast to $20.00. That also came true. What about $25.00? Not a problem, apparently.

Chart courtesy of StockCharts.com

No matter how many times we raised our TWMJF predictions, the stock continued to perform. In fact, investors who bought the stock a year before this article went to print could have made 308% returns.

But the rubber is going to hit the road on July 1, 2018.

Canada is officially legalizing marijuana at the federal level. At that moment, the hype train for weed stocks comes to an end. What will begin to matter are sales, brand recognition, price per gram—all the things that usually matter in business.

I suspect many cannabis companies will be wiped out by reality. Only a handful will remain, but those that do could become the 21st-century versions of alcohol giants Anheuser Busch Inbev NV (NYSE:BUD) and Diageo plc (NYSE:DEO).

So, the ball is in Canopy’s court. If it successfully manages its growth, I could see the Canopy stock price rising to $55.00 and beyond.

Analyst Take

Canopy hasn’t signaled any interest in buying Aphria, but I think it’s an interesting idea that the company should consider, if for no other reason than it would preserve its size advantage.

That said, it’s not a deal breaker. Canopy Growth has some upside left to explore even without an Aphria acquisition.