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A worker checks cannabis plants inside the Tilray factory hothouse in Cantanhede, Portugal, April 24, 2019.

RAFAEL MARCHANTE/Reuters

Two of Canada’s largest cannabis companies are merging in an all-share deal aimed at cutting costs and positioning the combined entity for potential changes to marijuana laws in the United States and Europe.

The merger of Aphria Inc. Aphria and Tilray Inc., Tilray announced Wednesday, is the first major takeover in Canada since recreational cannabis was legalized in 2018. The combined company, which will continue under the Tilray name, will have the largest cannabis sales footprint in the country and an implied equity valuation of close to $5-billion. Current Aphria shareholders will control roughly 62 per cent of the company.

The Canadian cannabis sector is widely seen as ripe for consolidation, but deals have been scarce over the past two years. Much of the M&A boom that led up to legalization was fuelled by optimism about Canadian companies also becoming big international players as cannabis was legalized in other jurisdictions.

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But since then, most cannabis growers have been looking to downsize rather than expand in the face of a supply glut in Canada and lower-than-expected consumer demand. The M&A boom has been replaced by the steady shuttering of underutilized facilities across the country.

The deal between Leamington, Ont.-based Aphria and Nanaimo, B.C.-based Tilray is aimed at sharing costs between the two companies. They believe they can find around $100-million in savings over the next two years by combining production assets, sales teams and reducing expenses.

“The market in Canada is way oversaturated, there’s too many [licensed producers], there’s too much [growing capacity] for the size of the market here,” Aphria chief executive Irwin Simon, who will lead the combined company, said in an interview.

Aphria spoke with several potential partners earlier in the year. In the end, a deal with Tilray made the most sense, Mr. Simon said, because there isn’t a significant overlap in assets. Tilray buys most of its cannabis wholesale rather than growing it, while Aphria has underused capacity at its massive greenhouses in Leamington. Tilray’s brands are strong in Quebec, while Aphria’s products sell well in Ontario.

“We’re not closing down assets and mothballing all this [capital expenditure] ... Tilray has about 35,000 kilos that can be moved into our facilities and there’s a lot of absorption that takes up in our current facilities,” Mr. Simon said.

Alongside the potential cost savings in their Canadian operations, the deal is being pitched as a renewed growth play in international markets where the companies believe they have complimentary assets.

Tilray owns a large growing facility in Portugal, while Aphria owns a drug importation company in Germany, giving the combined entity a production and distribution network within the European Union, where about half of the countries have legalized some form of medical marijuana.

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Tilray and Aphria also own businesses in the United States, although not directly related to cannabis. Cannabis remains illegal at a federal level in the U.S., so neither company can conduct “plant-touching” businesses there without risking being delisted from the Nasdaq or Toronto Stock Exchange.

The election of Joe Biden as president gave a shot of adrenaline to pot stocks, as investors bet a Democrat-led government will push through federal recreational cannabis legalization. But with the Senate still controlled by Republicans, meaningful legislative change may be a long way off.

In the meantime, Aphria and Tilray are both trying to build brands and distribution networks obliquely in the U.S. Tilray owns a hemp food company, Manitoba Harvest, that operates south of the border, while Aphria recently bought Atlanta-based SweetWater Brewing Co. for US$300-million. The plan is to have SweetWater beer branded with Aphria’s cannabis brand names.

The deal comes after a turnaround at Aphria over the past two years. In late 2018, the company was the subject of a report by a short-seller that alleged Aphria overpaid for assets in Latin America and the Caribbean that were owned by individuals close to company management. The allegations torpedoed the company’s stock price and reverberated across the industry. Aphria’s CEO, Vic Neufeld, stepped down.

Mr. Simon, the long-time head of The Hain Celestial Group, a multibillion-dollar food and personal care products company based in Long Island, N.Y., was brought in.

“You go back two years ago, just around this time, we went through a short report, we went through a hostile takeover [bid], we had to divest assets, we had to clean up the C-Suite. We needed a transformational type of deal that really leapfrogged Aphria ahead,” Mr. Simon said.

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Tilray, for its part, has struggled to live up to investor expectations after going public during the headiest days of the cannabis stock bubble. After its July, 2018, IPO at US$17 a share, its small number of available shares – about 10 million – and status as the only pot seller on the Nasdaq at the time caused a frenzy that pushed the shares to US$300 by that September.

But, from a peak of cannabis stocks in October, 2018, through Tuesday’s trading, Tilray shares had fallen 96.4 per cent, according to S&P Global Market Intelligence, making it one of the very worst pot stocks among a whole host of poor performers.

The deal with Aprhia offered Tilray shareholders a 23-per-cent premium to the company’s closing share price of US$7.87 on Tuesday. Tilray shares jumped 18.5 per cent on Wednesday to close at US$9.33.

Tilray’s long-time CEO, Seattle-based financier Brendan Kennedy, will exit management but stay on as a company director.

With files from David Milstead

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