Hostile Takeovers and Poison Pills: Canadian Cannabis Gets CombativePaul RobertsDecember 11, 2017
In November, Edmonton-based medical marijuana producer Aurora Cannabis offered to buy rival CanniMed Therapeutics, in an “all-stock” deal that valued the smaller firm at a whopping $562 million—the largest deal in the cannabis sector to date.
If successful, the takeover would cement Aurora’s position as the second-largest player in the Canadian cannabis industry.
When CanniMed’s management declined the offer, Aurora announced that it would appeal directly to the company’s investors—a so-called “hostile” bid. If successful, the takeover would cement Aurora’s position as the second-largest player in the Canadian cannabis industry, right behind the $3.8-billion Canopy Growth, just as the sector is about to explode under the soon-to-be-opened adult-use market.
CanniMed isn’t rolling over. The Saskatoon-based company has countered with a so-called “poison-pill” strategy intended to keep Aurora from buying up a majority stake in CanniMed’s shares directly. CanniMed is also pursuing an ambitious expansion play of its own—a $248 million bid for Newstrike Resources, an Ontario-based venture that aims to produce cannabis for the adult-use market.
But it’s unclear whether CanniMed can outrun Aurora. Aurora officials say their offer has already gained the support of investors holding at least 38% of CanniMed’s shares. That’s no surprise. Aurora’s “all stock” offer, which would “pay” CanniMed shareholders with shares of Aurora, is the equivalent of $24 per share: that’s 57% above what CanniMed’s shares were trading for last month, and still represents a premium of around 20%. If enough additional investors take advantage of that premium, CanniMed’s management will be out, and Aurora will gain some seriously valuable assets, including CanniMed’s large customer base, substantial cultivation capacity, top-ranked research talent, and a suite of successful pharmaceutical-grade cannabis products.
The addition of these assets will help position Aurora to take on Canopy Growth and the other top-tier Canadian firms—notably, Aprhria and Med ReLeaf—when the adult-use market opens next July. An Aurora-CanniMed union, says Cam Battley, Aurora’s executive vice president, would create “a very powerful player in this space. It’s a brilliant strategic fit.”
No Guarantees of Success
It’s also a fairly bold move. Hostile takeovers are rare in any sector—and with good reason. A protracted fight for corporate control is almost always more expensive and time-consuming than a friendly acquisition, with potential for litigation and lots of bad press. It’s worth noting that more than half of all attempted mergers and acquisitions, or M&A, whether hostile or friendly, either aren’t completed, fail to deliver the promised benefits, or actually destroy “shareholder” value by killing the share price.
That Aurora is undertaking such a risk underscores just how rapidly the cannabis market is changing.
That Aurora is undertaking such a risk underscores just how rapidly the cannabis market is changing. With full Canadian legalization just six months away, players of all sizes are scrambling to assemble the optimal combination of scale, product mix, geographic reach, and technological know-how. Cannabis companies “know that July is coming and that they’re going to need scale and they’re going to need product on the shelf,” says Vahan Ajamian, a research analyst at Beacon Securities who follows the cannabis sector. And while most firms are the midst of frenzied efforts to expand production capacity, Ajamian says, there are limits to how fast a company can grow internally. “M&A is one way to accelerate your plans,” he says, “and you can do it basically overnight, or however long it takes to make and strike a deal.”
Supply & Demand & Production Costs
This latest round of acquisitions is being fueled by several factors. One, clearly, is simply the desire to have enough supply on hand when retail and online stores open next summer.
But there are other drivers, starting with the ever-present push to drive down costs of producing that supply. Typically, the more total cultivating and processing capacity your company can bring into operation, the lower your per-gram production costs. Those lower costs, in turn, mean your company can preserve its profit margins even as it lowers prices to attract price-conscious customers.
Because some provinces may insist that cannabis products sold via government-licensed stores be locally sourced, large firms are using acquisitions to build up their cultivation 'footprint' in each province.
“In the not too distant future, producers will have to compete in a marketplace where most of the sales volume is expected to come from a relatively small number of heavy users who are highly price-sensitive,” says Louis Barre, president of the consulting firm Cannab Intel Inc. Although there will be a market for higher-end “craft” products, Barre says, “based on the experience of the US states, the bulk of the market will be the low-cost product.”
But acquisitions can also deliver on other strategic goals. For example, because some provincial governments may insist that cannabis products sold via the government-licensed retail systems be locally sourced, large firms are using acquisitions to build up their cultivation “footprint” in each province. Aurora’s recent purchase of H2 Biopharma, for example, gives Aurora a local presence in Quebec’s massive consumer market.
Likewise, companies looking to quickly enter a new consumer product category can simply buy up a firm with an existing product line and an established customer base. Such a strategy will be crucial in an industry where strict limits on advertising will make it difficult for companies to launch a new consumer product from scratch.
For example, if the federal government follows through with a proposal to legalize the very profitable edibles category, in 2019, “you would expect to see the big producers go out and acquire some of these gray-market edible producers, which have been operating in the gray market, and which have already built up brand traction among consumers, and bring them into their regulated platforms,” says Hugo Alves, at the investment firm Wheaton Cannabis.
The Money Rush
But there are other factors driving the acquisition binge. With investors pouring into the Canadian cannabis space, companies are flush with cash and looking for strategic ways to spend it. Aurora, for example, just secured $115 million in financing in November, and has $340 million in cash, according to company reports.
The same forces that put Aurora and CanniMed on a collision course will continue to reshape the entire Canadian industry.
Investor interest has also sent cannabis company share prices soaring, which also tends to encourage acquisitions. That’s because the acquiring companies often use their own shares to buy other companies (as in the Aurora bid, shareholders of the target company are paid in shares of the acquiring firm). And the higher a company’s share price, the more company it can buy.
But that shares-as-currency concept cuts both ways. Cannabis companies whose share prices lag behind their rivals can become tempting acquisition targets, particularly if they have attractive assets, such as a successful technology or a strategically located greenhouse. That, by many accounts, was the reason Aurora took an interest in CanniMed, whose share price was regarded as low relative to the value of its assets—assets that Aurora feels would be even more valuable as part of its own “platform.”
Whether Aurora can actually get its hands on those assets is far from clear. CanniMed has asked its investors to delay any decision on Aurora’s bid until CanniMed’s management publishes a formal critique of the offer, known as a director’s circular, which is slated for December 9. And, under Canadian securities law, CanniMed has a grace period of 105 days, during which it can work with its investors or, conceivably, counter Aurora’s takeover bid by striking a defensive merger deal with one of Aurora’s rivals. And in the meantime, CanniMed is still moving ahead with its own plans to buy Newstrike—although Aurora also wants to halt that deal as well.
What is certain is that the same forces that put Aurora and CanniMed on a collision course will continue to reshape the entire Canadian industry.
The “big four” in Canadian cannabis—Canopy Growth, Aurora, Aphria, and MedReLeaf—may continue making acquisitions as they fine-tune their platforms for full legalization next July.
But for firms below the top tier, which lack the scale or the breadth of product offerings to compete directly with the top-tier companies, the options may be more limited.
Some may try to quickly gain scale by making their own acquisitions. Others may try to bulk up by joining forces with one or two other mid-size firms, says Ajamian, the Beacon Securities analyst. But, again, mergers can be extremely hard to pull off. For that reason, Ajamian says, many smaller firms may opt for an exit strategy and simply sell themselves to one of their larger rivals.
That isn’t necessarily a bad outcome, he says. “If your stock price is doing well and someone offers you a 57% premium, the way Aurora did for CanniMed, I think a lot of shareholders will be in favor of that type of arrangement.”
And if a company’s management team doesn’t happen to share that inclination? In that case, the Canadian cannabis sector’s first attempt at a hostile takeover might not be the last.