Pot Inventories Pay Absurd Premiums for Acquisitions, and Data Demonstrates – The Fool Motley

The green flag is officially brandished on the legal cannabis industry. Last October, Canada ended nine decades of the recreational ban on marijuana and became the first industrialized country in the world to legalize weeds for adults. Soon after, a number of US states legalized the medical pot or extended its use to adult consumers. Then, in December, the Farm Bill, an innovative law, was passed in the United States, giving the green light to hemp and cannabidiol products made from hemp.

This kind of perfect storm of movement of marijuana (and hemp) has led to very robust growth estimates for the sector. A report jointly released by Arcview Market Research and BDS Analytics announces 38% global sales growth in 2019 and a global turnover of more than twice as high between 2018 and 2022, reaching $ 31.3 billion . Meanwhile, investment bank Cowen Group, who is arguably the biggest fan of the cannabis industry among Wall Street businesses, is asking for $ 75 billion in global sales by 2030.

Marijuana buyouts may soon become commonplace

This expectation of rapid growth, coupled with extraordinary demand from Canadian consumers and some legal American states, has prompted the wave of cannabis acquisitions in North America. Although we only see the top of the iceberg in terms of consolidation, particularly in the Canadian pot culture sector, we have seen a number of modest to large acquisitions.

For example, Aurora Cannabis (NYSE: ACB), The leading Canadian farmer at the peak of annual production, acquired CanniMed Therapeutics for $ 852 million, MedReleaf for about $ 2 billion and ICC Labs for nearly $ 200 million last year. Aurora also announced the purchase of $ 132 million of Whistler Medical Marijuana in January, which has not been finalized yet. There were also a handful of small additional transactions for Aurora.

Cover growth (NYSE: CGC)Aurora's biggest rival, at least in peak production, has bought the Colorado-based hemp research firm, ebbu, for about $ 330 million, Hiku Brands, just north of $ 200 million. million, and Mettrum Health, early 2017, for approximately $ 325 million. Like Aurora, Canopy Growth has made other purchases, but these are the most important ones.

As the desire for consolidation increases, transactions should become more common.

But there is just one problem: pot stocks do not appreciate very much the companies that they buy.

Cannabis Acquisitions Have Little Financial Significance In The Beginning

When a company buys another one, it is extremely common for a premium to be paid by the acquirer. In other words, the buying company usually needs to soften the pot to convince the management team, the board of directors and possibly the shareholders of the company of the other. The problem is that it is very difficult to evaluate marijuana stocks now, because the legal sector is still in its infancy. Thus, awarding a bonus to a value that is nothing more than a dart throwing in a black-black piece shows financial difficulties in the balance sheets of the companies.

Although this is a figure that the average investor often ignores, goodwill tells an interesting story for active weed processing companies in the acquisitions department. Goodwill is a means of quantifying the "premium" paid by an acquirer in addition to the tangible assets acquired. Here is a good way to think about goodwill: the more there is, the more a company is potentially overpaid during acquisitions.

Of course, things are never well thought out in the investment world. Goodwill can be something that deserves to be overlooked if the growth prospects, cost synergies of a combination or other intangible factors, such as a superior branding or management team permanently reduce this premium paid over time. The question is: "Will this happen with pot stocks?" Although it is possible, the considerable amount of goodwill that some stocks of bribes carry as a percentage of total assets is staggering.

The main offenders

A few days ago, as a result of Aurora Cannabis' s second quarter report, I distinguished the company for its exceptionally high total acquisition gap, expressed as a percentage of the total actives. At the end of the 2018 calendar year, Aurora had an acquisition gap of 3.06 billion Canadian dollars, which represents 63% of total assets. Approximately 80% of the value of the company's flagship transaction, MedReleaf, has been accounted for as goodwill, with each recent transaction accounted for with a significant amount of goodwill.

But it's not just an Aurora problem, even if it's the easiest pot stock to point to. Canopy Growth closed the second quarter of its fiscal year (up to September 30, 2018) with an acquisition gap of C $ 1.11 billion and intangible assets of US $ 103.9 million. With total assets of nearly $ 3 billion, 37% of the company's total assets are allocated to goodwill, which increases to approximately 41% if the intangible asset is taken into account.

It is not even just a Canadian problem. iAnthus Capital Holdings (NASDAQOTH: ITHUF), a vertically integrated cannabis dispensary focused on the US market, recently closed with the purchase of MPX Bioceutical. The $ 600 million agreement increases the number of states iAnthus has access to from 6 to 11, and brings its retail licenses to 63. not so magically transformed into an acquisition gap of 75.9 million Canadian dollars over a nine-month period, until September 30, 2018. This represents 55% of the total assets of the company.

In summary, it seems that pot stocks are so eager to consolidate that they are paying too much for their acquisitions. While it is possible that the value of these transactions may be realized over time, it is equally likely that large write-downs and subsequent reassessments of investors may be expected.