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Streetwise Cross-border cannabis deal between Canopy Growth and Acreage confuses investors

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A major deal in the cannabis sector has proved so confusing that the target, U.S. company Acreage Holdings Inc., has decided to address investors in writing about its potential acquisition by Canadian giant Canopy Growth Corp.

In an unusual letter to shareholders, Acreage CEO Kevin Murphy drafted responses to frequently asked questions about “the innovative and novel structure of the transactions proposed.” The hope, he said, is that a fuller explanation will help investors “see the forest through the trees.”

Earlier this month, Canopy said it would pay US$300-million to secure the right to buy Acreage should federal marijuana laws change in the United States. Canopy agreed to pay US$3.4-billion for Acreage in the future, based on where its own shares were trading at the time of the agreement.

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The deal has drawn attention because it was the first by a large Canadian cannabis company looking to expand into the United States. The assumption is that it could pave the way for future cross-border transactions.

However, the terms are complicated. The transaction is structured as a call option that does not expire for 7½ years. If it is approved by shareholders in June, Canopy will only pay the US$300-million unless the United States relaxes its laws around cannabis, which is still a Schedule I illegal drug in that country.

The overwhelming majority of Acreage shareholders are retail investors – a common feature of cannabis companies. In his letter, Mr. Murphy acknowledges that some shareholders are struggling to wrap their heads around the deal, which helps explain why Acreage’s stock price has not substantially moved since the transaction was announced. Canopy agreed to pay a 42-per-cent premium in the event of a full-blown takeover – again, based on where the shares were trading at the time of the announcement.

Acreage is largely controlled by Mr. Murphy through his multiple voting shares, but the deal terms stipulate that two-thirds of holders of the company’s publicly-traded subordinate voting shares must give their consent.

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Canopy pays $300-million to secure right to buy Acreage Holdings

When the deal was announced, Canopy and Acreage talked up the potential. For Canopy, the deal offered a bridge to the U.S. market, and Acreage has a reputable team. Its board members include former prime minister Brian Mulroney and former U.S. speaker of the House of Representatives John Boehner.

For Acreage, the deal secured a potential takeover by one of the most respected cannabis producers in the world. In an interview, Acreage spokesperson Howard Schacter described this as the "incredible upside of hooking our wagon up to a company like Canopy.” And in the meantime, Acreage would be able to license Canopy’s retail brand names.

But in the formal arrangement agreement, Acreage disclosed that it must abide by certain deal covenants. It cannot reorganize or “materially change its business or regulatory strategy" without approval from Canopy. It also loses some control over compensation, because it cannot be “materially inconsistent” with what Canopy decides to pay its own staff.

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Theoretically, these handcuffs were priced into the financial model that was used to calculate the option value embedded in the transaction. However, some details are more symbolic than others, and in an interview Canopy vice-president Jordan Sinclair said the US$300-million upfront payment is largely a “sweetener" for Acreage shareholders because they’re “voting for an option" instead of an immediate takeover.

Details of the negotiations between the two companies will be available in the takeover circular.

For its part, Canopy has agreed not to acquire any other U.S. cannabis companies that do not comply with federal laws. However, Mr. Sinclair said neither party is expecting the next development in this relationship to take 7½ years to occur.

As an example, he noted that more than half of all U.S. states have legalized cannabis for either medical or recreational use and Congress is considering legislative changes that would either legalize the drug or offer protection to states that have legalized it. If such legislation is passed, Mr. Sinclair said, that "could give us the confidence that we need to pull the trigger” on the full-blown takeover.

However, he added, any decision will have to be run by all stakeholders, such as banks and stock exchanges, and they may have different views. “Those opinions are incredibly important to us," he said.

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