This past week, cannabis producer Aphria Inc. (TSX:APH) announced that it would be changing the cash portion of its acquisition offer for Nuuvera Inc. to $0.60 from $1 per share as Nuuvera looks to close an acquisition of its own of the remaining portion of a subsidiary, Avanti Rx Analytics.
With most acquisitions in the cannabis sector largely taking place as all-stock, or nearly all-stock transactions, the cash portion of any transaction is largely viewed as nominal to the overall value paid to the target firm. As stock prices have continued to soar, larger cannabis firms have been leveraging the paper value which has been created through skyrocketing stock prices to acquire smaller firms and build production capacity prior to legalization which is expected to take place late-Summer 2018.
In my view, this reduction of the cash portion of this deal indicates to me the fact that the Canadian cannabis sector may not be as healthy as many think, with cash flow considerations a huge issue heading into legalization.
With the vast majority of all cannabis producers' bottom line earnings numbers coming from IFRS-related accounting markups related to the value of cannabis plants under production, I believe that the cash flow discussion will begin to really take hold end of 2018 and beginning of 2019, leading to a reduction in the valuation multiples investors will be willing to pay for such companies.
Should stock prices begin to really plummet in the cannabis sector, I expect the pace of acquisitions to slow down as targets will demand higher cash compensation to consider a deal; investors should therefore be skeptical of any merger or acquisition in this space, given the fundamental realities of how profitable these cannabis producers will be long-term.
Invest wisely, my friends.
