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  1. Home
  2. / Investing
  3. / Stocks

After Smoke Clears, Pot Industry Could See M&A Activity Light Up

Real Money tapped an industry expert to discuss the outlook for buying and selling of cannabis companies.
By DEBRA BORCHARDT
Aug 19, 2020 | 09:00 AM EDT
Stocks quotes in this article: STZ, CGC, MO, CRON, SMG

We're finally positioned to see some buying and selling of cannabis companies as stock valuations rise.

With their increasing stock prices, public companies are now in a better position to gobble up private pot businesses, say some experts.  

But there are many uncertainties lingering, especially in the U.S. as the election approaches, the pandemic rages on and strict federal policies remain in place. What can we expect for mergers and acquisitions in the months ahead? Who will be the targets? Who will be the buyers?

I recently spoke with Jason Wilson, cannabis research and banking expert at ETFMG and asked  about what he expects for mergers and acquisitions in the industry. Among ETFMG's funds is MJ, which is designed to measure the performance of companies within the cannabis "ecosystem."

Are you expecting an uptick in M&A? Why? What would mergers and acquisitions mean for industry?

Wilson: In the near term, no, I do not expect to see an uptick in M&A activity.  Given the uncertainty surrounding the economy and the Covid-19 pandemic, the FDA's lack of clarity regarding CBD-based products, and the upcoming U.S. election, I would expect most cannabis companies to put their M&A plans on hold.  As these uncertainties fall away and the landscape becomes clearer, companies will be able to properly evaluate their strategies and business plans, and to properly value potential targets.  At that point, we will see an uptick in M&A activity.

Are there concerns in investors' minds about cannabis deals right now? 

Wilson: To date, investors have heard a lot of narrative regarding how management will position platforms to take advantage of this emerging and rapidly growing industry.  And while the cannabis industry has grown substantially and continues to grow at a very strong pace (albeit in a rather lumpy and incongruent manner), most investors are still waiting to see execution by management. Until the continued sales growth we are seeing in the industry translates into sustained profitability at the company level, investors will remain cautious.  Clarity in regulations is a much-needed catalyst. With the upcoming U.S. election, as well as the U.N. voting in December to reschedule cannabis, we may soon get that clarity.

What type of deals are we expecting to see? Distress funds, special purpose acquisition funds (SPACs) making any moves into this industry?

Wilson: I would expect that most of the deals in the near term will be opportunistic -- deals that allow a company with a strong balance sheet and access to capital to take advantage of a distressed situation. This is an interesting time for SPACs, as some cannabis companies are well priced at the moment. To the extent a SPAC sponsor could demonstrate that a proposed transaction would have a reasonable timeline to profitability, a SPAC could bundle together some well-priced assets and platforms and obtain shareholder support and related financing to complete an acquisition.  

Have banks become more willing to work with cannabis companies, now than they were, say, a year ago? If not, how will deals be financed?

Wilson: Banks have become much more supportive of financing cannabis companies with legal operations. For example, many Canadian licensed producers have access to traditional bank financing, as well as efficient access to the capital markets. For companies with U.S. operations, banking remains difficult and will remain so until U.S. regulations change. In the interim, cannabis companies with U.S. operations will continue to obtain financing from private equity firms, family offices, and high net worth individuals, as well as from a number of investment banks in Canada (several independent Canadian advisory firms that are not affiliated with a Canadian bank have raised capital for companies with U.S. operations).  Generally speaking, this form of capital is significantly more expensive than traditional financing methods available to companies with federally legal operations.

What will strategic focus be for most deals?

Wilson: A lot depends on how regulations change. In a "status quo" type of environment, most companies are focusing on expanding their core businesses (including developing products that appeal to customers that still purchase from the illicit market), and on derivative/2.0 products (both recreational and medicinal) that will expand their range of customers. So, in the near term, I would expect deal flow to mostly focus on synergistic acquisitions that could help meet these goals.  If U.S. and global regulations change, and we have clarity on what types of products can be sold and in what markets they can be sold, then the focus will expand to include cross border acquisitions.  In this scenario, I could envision a significant uptick in M&A activity.

Which companies have buying power, which companies most pressed to sell -- why?

Wilson: Companies with strong balance sheets and cost effective access to capital have buying power.  This includes companies that are not currently involved in the cannabis industry, but have synergistic businesses that could help accelerate the sales and distribution of cannabis-based or cannabis-related products. Good examples to date are Constellation Brands (STZ) investing in Canopy Growth (CGC) , Altria (MO) investing in Cronos (CRON) , and Scotts Miracle-Gro (SMG) acquiring Hawthorne.  Constellation Brands and Altria both have large and synergistic distribution channels to sell cannabis and cannabis-based products.  Currently, we do not have clear guidance from the FDA relating to hemp-derived CBD products, but as regulations change and provide clarity, the value of the breadth of these partner channels will become apparent.  Likewise, Scotts Miracle-Gro has been able to leverage their distribution channels to effectively sell products and equipment related to growing cannabis. On the flip side, the companies most pressed to sell are those that are smaller and with weaker balance sheets -- if they are not profitable, their best available option to raise capital may be to divest assets or accept dilutive equity financing. 

Is there a timeline for deals to start? Some say Canada needs another quarter to come out of current wave of restructuring -- would this push M&A out to the fourth quarter there?

Wilson: I would expect activity to pick up early to mid-2021.  With respect to companies with Canadian and global operations, we need to see profitability or a clear path to profitability.  Many are on their way for this to occur in 2021.  With respect to companies with U.S. operations, we need to see a change in regulations.  With cannabis legislation gaining support in Congress, the control of Senate potentially changing in November, and the dire financial position of many local and state governments, 2021 could see a lot of change and be a very busy year for the cannabis industry.

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At the time of publication, Debra Borchardt has no positions in any of the stocks mentioned in this story.

TAGS: Mergers and Acquisitions | Investing | Stocks | Canada | Cannabis

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