Aurora Cannabis ( OTC: ACB) revealed a little deal to get a CBD company in the U.S. for $40 million in shares. We believe the offer is too small to make a meaningful difference to the company. The timing of the deal is also doubtful. The U.S. CBD market is facing an oversupply due to low barriers of entry and adequate supply of low-cost hemp basic materials. Entering a congested and tough market at this time raised more questions concerning Aurora’s technique and capability to fund a new market while it tries to manage a turnaround in its core operation in Canada.
( All amounts in USD)
Going Into U.S. CBD Market
After the marketplace closed on Wednesday, Aurora revealed that it will get Reliva which is a U.S. CBD company. The offer is priced at $40 million in shares at closing and an earn-out of as much as $45 million over two years. Aurora shares soared over 30%on the news which appears excessive given the limited effect this deal will have on the business as discussed below.
The U.S. CBD market has actually existed for years and has actually been interrupted because 2018 after the 2018 Farm Expense passed to legalize commercial hemp growing. Most investors expect the CBD market to experience significant growth for the years to come. However, there is a catch that has impacted market incumbents. Given that the 2018 Farm Costs was passed, a great deal of suppliers went into the CBD market helped by the low barriers to entry and growing consumer need for CBD-infused items. Low-cost hemp crops are also easily offered from farmers around the country. Ever since, we have seen CBD business facing eroding market share and deteriorating monetary performance despite the total market development.
( Source: Bloomberg)
The leading public business in CBD is Charlotte’s Web ( OTCQX: CWBHF) and its recent underperformance serves as a good proxy for the overall industry difficulties. Given That Q4 2018, sales have not grown at CWEB and gross profit remained flat all while the entire CBD market experienced considerable growth. Regardless of investing greatly in infrastructure and sales and marketing, CWEB has dealt with major headwinds in trying to grow its company in the congested CBD market.
Return of Illogical Liveliness?
Aurora shares have bounced off recent lows after it reported fiscal 2020 Q3 results that revealed stabilization in its financial performance. Aurora now has C$ 2 billion of market cap and trades at 8.5 x EV/Sales (Q3 cannabis-only sales annualized) which is in-line with other leading Canadian LPs. We think the shares will continue to be volatile provided its popularity amongst retail investors and speculators. After the recent 12- to-1 share combination and a big rally in the last two weeks, the stock remains 47%down in 2020.
( Source: TSX)
As talked about above, we believe the nature of this acquisition implies that there will be a really minimal impact on Aurora’s monetary performance offered the size of the deal and bleak development prospects. While Aurora didn’t divulge the financial metrics, we believe the offer is likely extremely small considered that market leader Charlotte’s Web presently trades at ~ 5x revenue. Reliva is most likely to fetch a much lower numerous which implies that its income is most likely around $8 million or higher based upon the $40 million base purchase cost. With limited growth opportunities within the CBD market, we see this deal doing little to help Aurora’s growth profile. There will likewise be no synergies offered Aurora basically has no presence in the U.S.
The acquisition of Reliva is a really little offer hence its effect on Aurora will be limited. The all-stock offer likewise causes additional dilution to existing shareholders who have actually been diluted through numerous large acquisitions over the previous 3 years. The choice to enter the U.S. CBD market is also arguable as the market is currently reeling from oversupply and low barriers to entry. Overall, this is a transaction that is not going to dramatically change the development profile or monetary performance of Aurora given the current market conditions which means that any excessive share price movement is likely an overreaction and could be reversed in the near-term. We remain cautious on the company offered its difficult job of pulling off a turn-around.
I have no service relationship with any business whose stock is pointed out in this post.