Written by: Stone Fox Capital – Seeking Alpha
After making the case for Aurora Cannabis (ACB) reaching old highs, the full stock breakout never occurred as pot sales in their home territory of Canada have never materialized in a meaningful way. The large cannabis company desperately needs access to the massive U.S. market, but the Canopy Growth (CGC) path isn’t working out so well for either of those companies leaving Aurora Cannabis out in the cold and the stock struggling until a real solution is found.
The easy thesis for a big rally in the Canadian LPs was the expected boom from the legalization of adult-use cannabis last October. The bullish scenario hasn’t come to fruition due to a combination of limited supplies and a black market still in full force.
Statistics Canada numbers show that legal sales of cannabis hasn’t grown as the inventories are starting to build. The latest data only goes through sales as of February. February sales were only C$49.9 million, down from a peak of C$57.3 million in January.
A big part of the problem is that daily consumers of pot haven’t increased usage. These regular users were highly familiar with the illegal market that now co-exists with the legal market and undercuts prices due to not having to pay taxes.
The big user jump has come from weekly and less frequent users that were more likely to take the legal route having likely not participated in the illegal market. These consumers aren’t large contributors to the market leaving the large cannabis companies in a precarious position of bringing large supplies onto the market without customers.
While the Canadian cannabis market continues to struggle to get off the mat as imposed restrictions such as the lack of Ontario retail store locations until April 1 and edibles and beverage products until October held down sales, the U.S. cannabis market is booming. Cowen predicts the U.S. cannabis legal market to surge to $80 billion by 2030 as a $50 billion illegal market grows up.
Source: Green Thump Industries presentation
The better part of the story for domestic investors is that the vast cannabis opportunity in the U.S isn’t matched with crazy wild market valuations. One would have to add up the valuations of the majority of the major multi-state operators to reach the $17 billion valuation of Canopy Growth. Not to mention, the additional $10 billion valuation of Aurora Cannabis with 1.1 billion shares outstanding now.
The problem facing the Canadian LPs like Aurora Cannabis and Canopy Growth is that the major stock exchanges don’t allow stock listings of companies in a business federally illegal such as cannabis in the U.S. For this reason, Canopy Growth has made some aggressive moves into industrial hemp farms and a creative acquiring deal while Aurora Cannabis has fallen behind in locking down a major entry into the U.S. market.
Aurora Cannabis bought the remaining part of Hempco Food and Fiber(OTC:HMPPF) that the company didn’t already own, but the move isn’t as aggressive as Canopy Growth. Aurora Cannabis paid C$1.04 for each Hempco share in a deal valued at C$63.4 million.
Hempco provides a new hemp processing facility, but the company isn’t focused on the U.S. with their hemp-based foods and nutritional supplements. Aurora Cannabis CEO Terry Booth made this statement about the deal:
We look forward to executing with the Hempco team on our global hemp and CBD strategy, and we invite the Hempco shareholders to join us on this exciting journey.
In fact, in the last quarter Hempco didn’t even generate C$1 million in sales and has a goal of only reaching C$25 million by FY20. A global expansion plan seems so unwise with North America expected to dominate the global hemp markets for the next 5+ years. The below chart highlights the hemp-based food products portion of the market.
Source: Hempco presentation
The most valuable cannabis company made a big move to enter the U.S. market via a right to purchase deal with Acreage Holdings (OTCQX:ACRGF). The ~$3.4 billion has one big hiccup in that the deal can’t close until cannabis is federally legal in the U.S.
Since the original hype regarding the deal propped Canopy Growth up over key resistance above $50, the stock has quickly lost altitude. The all-stock deal isn’t as appealing now with Acreage Holdings only trading at $20 despite a deal valuation over $30.
The problem that my research highlighted was that the deal had an uncertain time frame and might never occur. Activist investor Mick McGuire’s hedge fund Marcato Capital Management has come out against the deal providing another unthought of reason for the deal failing.
According to the numbers from Marcato, Acreage Holdings trades at ~21x forward EBITDA estimates while Canopy Growth trades up at 178x. A great question for shareholders is why one would want to trade out the cheaper stock for a far more expensive one when all of the growth and market opportunity is in the U.S. cannabis market.
Even worse for American shareholders, one has to wait for a future event to even cash in the stock at a decent price. Right now, Acreage Holdings shareholders find their stock trading at $20 while the deal still offers an incredible $30 value based on the upfront $2.55 rights payments and 0.5818 shares of Canopy Growth now valued at $28.
The recent shareholder blow back on the deal questions whether Aurora Cannabis could even complete such a deal as the U.S. MSOs are likely empowered to hold out for higher valuations. The real opportunity is via hemp and CBD, but the company isn’t even pushing that move after buying Hempco with a global focus.
The key investor takeaway is that Aurora Cannabis still appears set on global expansion while missing the huge market opportunity in the U.S. The company reports on May 15 and the market will want to know what the large cannabis player is going to do with the large supplies coming onto the depressed Canadian markets while global markets remain relatively closed.
The stock is trapped below $9 until the company actually unlocks business in a viable market whether Canada, the U.S. or globally. The risk is actually to the downside, if the Canadian market doesn’t open up soon.