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HIGHLIGHTS
  1. Mid-sized cannabis companies are being purchased for fractions of their peak valuations
  2. Analysts expect low-premiums will become the new normal in cannabis M&A, especially for cultivators
  3. Wave of consolidation expected to continue as CIBC warns of “material risk” for smaller players

The days of mid-sized cannabis companies getting bought out for big premiums might be over.

Since recreational marijuana was legalized in Canada last year, two licensed pot producers have been sold for a fraction of their peak value. Emblem shareholders agreed to sell their holdings to Aleafia Health last week for $1.21 per share, despite the stock having previously traded as high as $4.37, and on Wednesday, Hexo struck a friendly deal with Newstrike Brands to buy the company backed by the Tragically Hip for 47 cents per share, or barely one-sixth of what those shares were once worth.

Hexo’s all-stock offer, worth a total of $263-million, represents a roughly 4 per cent premium to Newstrike’s recent valuation. That is a “significant discount to the Canadian [licensed producer] average transaction premium of 29 per cent,” Eight Capital analyst Graeme Kreindler said in a Wednesday afternoon note to clients, adding the deal “underscores a shift” in the cannabis M&A world.

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“Despite the modest premium, we do not currently expect another player to make a competing offer,” Mr. Kreindler said.

Retail investors, who continue to make up a sizable proportion of cannabis company shareholders, lamented the low premium attached to the Emblem deal and are doing the same for this latest proposed transaction.

Newstrike management “gave their company to Hexo for nothing!” commented one user on Twitter. “Just gave it away, shareholders be damned!”

It is unclear how much of Newstrike’s stock is held by retail investors, though the Hexo deal will require support from the holders of at least two-thirds of the company’s shares. Newstrike’s largest shareholders are also company insiders, with CEO James Wilgar, co-founder Travis Kanellos and director Niklas Anthony Van Haeren collectively owning roughly 28 per cent of its stock, according to S&P data, and all three have already accepted Hexo’s terms.

“Still, there is this general investor belief that it doesn’t matter what happens because there is going to be all this consolidation in the industry and my penny stocks will get acquired so I’ll be rescued with a huge premium,” said Matt Shalhoub, managing director of cannabis-focused venture capital firm Green Acre Capital, which is not invested with either Newstrike or Hexo.

“I think days like today serve as a prime example of that no longer being the case.”

Anyone who bought shares of Newstrike when they were valued at a dollar or more “is probably not too happy,” said one analyst who covers the Canadian cannabis space, but asked not to be attributed directly as the person was not authorized to comment publicly. “But if you did buy at a dollar or higher than you’re insane if you bought at that price, that would be more than a billion-dollar valuation, which is ludicrous.”

“If you’re in the low-to-mid-tier of cannabis operators in Canada and you’re seeing this valuation for this level of player in Newstrike being accepted as a takeout premium, then you might not be able to expect much more,” the analyst said.

CIBC analyst John Zamparo said in his own note to clients on Wednesday that despite the move reflecting “a divergence from Hexo’s stated core strategy of pivoting away from pure cultivation/production facilities… we believe the valuation is attractive.”

“We believe the industry will see a wave of consolidation [as] small- and medium-sized licensed producers face material risk in the longer term when it comes to competing with industry heavyweights with much larger marketing budgets," Mr. Zamparo said.

Not only does Green Acre’s Mr. Shalhoub agree further consolidation involving meager-at-best premiums is inevitable, he also argues companies offering little more than cultivation assets will struggle to find any buyers at all.

“I don’t think we are going to see too many more deals that are about adding capacity and distribution, maybe a handful more,” he said. “Most of the M&A from here is likely going to flip over to [big producers] looking to acquire other parts of the cannabis value chain” such as cannabis oil processors and infused-product makers as the country prepares to legalize cannabis edibles, extracts and vape products later this year.

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