Is M&A Going To Heat Up In The Cannabis Sector With U.S. Federal Legalization Right Around The Corner?

Is M&A Going To Heat Up In The Cannabis Sector With U.S. Federal Legalization Right Around The Corner?

During the last few years, there has been increased consolidation in the cannabis industry and we have identified trends over the course of this time period.

The first wave of acquisitions started in Canada and this trend lasted several years. This wave of acquisitions still ranks as some of the most expensive transactions and was highlighted by Aurora Cannabis Inc. (ACB.TO) (ACB) acquired two Licensed Producers for a combined price that was greater than $7 billion.

The second wave of acquisitions took place in 2018 and 2019 and was primarily related to US cannabis retailers. Since cannabis is illegal at the federal level in the US, these transactions took much long to complete (when compared to Canada) and many of the deals were scrapped due to plunging stock prices. The most significant failed acquisition in this vertical was MedMen Enterprises’ (MMEN.CN) (MMNNF) deal to purchase Pharmacann. After this transaction was called off, MedMen has come under considerable pressure and was assigned a $0 price target from Canaccord Genuity (CF.TO).

From an acquisition standpoint, 2020 has been a slower than normal year for the cannabis sector. Companies are being much more strategic when it comes to acquiring or investing in businesses that could be complementary or accretive in nature.

One of the more interested trends that we have identified with the cannabis M&A market is related to the types of businesses that are being purchased. Previously, cannabis companies were focused on acquiring assets that would increase production capacity, improve brand awareness, or expand into a different vertical.

In the current market environment, technology is playing a much larger role in M&A activity and we consider this to be the third wave of acquisitions. In this phase, we believe that companies are focused on purchasing businesses that can lead to margin expansion, positive cash flow generation, or improved profitability.

One of the best examples of this is the merger between Stem Holdings Inc. (STEM.CN) (STMH) and Driven Deliveries Inc. (DRVD). The companies operate completely different businesses and are levered to different parts of the cannabis value chain. We consider the merger to be strategic in nature and expect the combined company to record stronger revenue growth, margin expansion, and positive adjusted EBITDA.

Stem Holdings owns cannabis assets that are located in strategic US markets. Driven utilizes a state-of-the-art delivery platform to service the California cannabis market. The combined company can use Driven’s technology to capitalize on cannabis delivery opportunity in the markets that Stem is levered to and are bullish on the potential value that can be created through this strategy.

At current levels, the combined company is trading at a considerable discount to its peers and we believe that it has a compelling valuation. Due to the technology side of the business, the combined company should be valued at a higher multiple and we believe that the market is missing out on something significant with it.

If you look at the performance of other cannabis companies that have acquired tech assets, you will notice a positive trend after an initial period of weakness. We are not sure if this is the case with Stem Holdings and Driven but are bullish on the long-term opportunity that is associated with the combined company.

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Authored By

Michael Berger

Michael Berger is Managing Partner of StoneBridge Partners LLC. SBP continues to drive market awareness for leading firms in the cannabis industry throughout the U.S. and abroad.

Published at Fri, 23 Oct 2020 12:07:15 +0000

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