Emerging industries usually follow a natural business cycle: They blossom, then they consolidate. Canada's scorching, but nascent, marijuana sector seems to be entering the second phase.
What's unusual about this round of merger mania is the speed at which it's unfolding.
Last week, Aurora Cannabis Inc. inked a $1.2-billion deal with its long-sought target, CanniMed Therapeutics Inc., after a hostile takeover battle. On Monday morning, Aphria Inc. announced its own friendly transaction for Nuuvera Inc., worth $826-million.
Aphria hasn't yet closed its previous deal, the $230-million purchase of Broken Coast Cannabis Ltd., but it has already agreed to pay $8.50 per Nuuvera share – $1 in cash and the rest in its own stock – marking a 31-per-cent premium to Nuuvera's volume-weighted average price over the last 10 days.
It is common for a new industry to shrink, because bigger players buy smaller companies to ensure they keep showing investors growth. It has happened in mining many times over; the same goes for oil and gas.
But usually, the cycle plays out over years, not months. Canada's marijuana sector caught fire in September and it's already seeing a race to consolidate.
Nuuvera went public just four weeks ago, and in an interview, Aphria CEO Vic Neufeld said this merger came together in only 10 days. The marriages probably won't stop here, either.
"This is going to continue," Mr. Neufeld said in an interview. "There are far too many small LPs [licensed producers] in Canada."
"I know the amount of kilos that we're being asked to bring forward. I'm not sure how smaller LPs are going to be able to survive unless they join forces," he added.
What investors – and acquirers – must consider is whether the rich premiums required to take out rival targets are worth it. Aurora had to nearly double its bid for CanniMed, because valuations across the sector have soared. Aphria is paying $826-million for Nuuvera, which lost $6.9-million in the first nine months of 2017.
Aphria's CEO acknowledged the sector has a lot of hot air. "I'm disgusted sometimes when I read some of these press releases," Mr. Neufeld said, adding that some companies put heavy spin on their production or marketing prospects, simply to garner attention. "We don't press release for sake of a marketing buzz."
On a conference call outlining Aphria's latest deal, some analysts asked about Nuuvera's outlook. The deal is being marketed as a marriage of Canadian production and international export markets: Aphria produces within its home borders, while Nuuvera has international relationships in countries such as Italy, Germany and Spain.
"Make no mistake, there is a global secular trend" toward more marijuana consumption, Nuuvera CEO Lorne Abony said on the conference call. "It is no longer a question of if; it's a question of when."
The Italian market is seen as one of Nuuvera's crown jewels, because the company believes the medical marijuana market there will be bigger than the recreational and medical markets in Canada combined. Italy also has only one domestic producer and has issued only seven import licences. On Monday, Nuuvera's CEO crowed that the company has one of them.
The reality is that Nuuvera does not hold an Italian import licence; a week and a half ago it made an offer to acquire FL Group S.r.l., which currently holds the licence, for a total of €1-million ($1.5-million). That deal has yet to close.
As for the German market, the company has formally bid to obtain a growing licence and an import and export licence. Asked about the realities of these prospects, Aphria's Mr. Neufeld acknowledged there is still some uncertainty. But he said the merger's financial advisers presented detailed analyses to the boards of directors that assumed, on average, a 50-per-cent success rate for approvals. In other words, even if the Germany prospects dim, there's still Italy.
Using these assumptions, "all of the [financial] models kicked out a market share price far greater than the $8.50 a share we just paid," he said.
Usually, there is a third phase of the business cycle: Writedowns. When everyone is tempted to consolidate, purchase prices hardly matter. Eventually, though, they do. And when investors start caring, it gets ugly. Just ask the miners and energy companies.