When we first discussed Aurora’s (OTCQX:ACBFF) acquisition of MedReleaf (OTCPK:MEDFF) in our article “Why Would MedReleaf Sell To Aurora Now?“, we concluded that Aurora was mainly eyeing for MedReleaf’s market position in Ontario, its patient base, and operating and production assets. Now that the transaction is closed and MedReleaf no longer trades as a public company, we would like to discuss the importance of MedReleaf to Aurora. Acquiring MedReleaf was a significant upgrade for Aurora, in our opinion, both in terms of operating capabilities and market positioning. Aurora’s stock price has been stagnant and underperformed certain large-cap names materially in 2018 so far, but we think things could have been worse without MedReleaf.
What Did Aurora Buy?
As the acquisition closed on July 25, 2018, we would like to take a moment to review what exactly did Aurora acquire in this case. The first thing that is obvious to see is the production capacities that MedReleaf brings to the table. Aurora acquired 140,000 in total planned capacity from MedReleaf’s three production facilities, with Exeter being the largest. Aurora has announced significant capacity expansions in the past, and the addition of these facilities will bring its total planned capacity to over 500,000 kg per year, one of the largest in the industry compared Canopy (CGC) and Aphria (OTCQB:APHQF).
(Source: Investor Presentation)
The inclusion of these additional capacities not only helped expand Aurora’s growing operations but also significantly improved its geographic footprint by adding a significant presence in Ontario to Aurora’s existing network of facilities in Western Canada and Quebec. All of MedReleaf’s facilities are located in Ontario, which is highly complementary to Aurora’s existing operations of which none are located in Ontario. Being the largest market in Canada, it was crucial for Aurora to acquire a leading competitor in the province in order to secure access to this important market.
(Source: Investor Presentation)
Besides the production facilities and complementary geographic dispersion, Aurora also acquired a competitor with significant expertise in oils and extracts. Dried cannabis flowers are sold at lower prices and come with lower margin, whereas oils and extracts represent more lucrative markets and are growing faster than the dried cannabis products. MedReleaf brings its existing manufacturing best practices and will help Aurora ramp up oils and extracts offerings by combining its R&D and product developments with CanniMed (OTC:CMMDF), another operator with deep expertise in oils and extracts.
Another point to be made about the value of MedReleaf is that the company has been executing well during the period between transaction announcement and deal closing. MedReleaf was able to secure multiple provincial supply contracts in the last few months, including:
The most notable win above has to be the success in Ontario, which was announced by Aurora as the deal already closed. Based on the deal announcement, only MedReleaf received a contract from Ontario meaning that Aurora did not receive an order (it is possible that Ontario combined their application since the deal is now closed). Nevertheless, MedReleaf delivered a strong performance in its home market and proved its value as an entry point into Ontario for Aurora. There are risks that Aurora would not have scored as well in Ontario without MedReleaf, given that the company was not able to establish a foothold in the competitive Ontario market. We think the acquisition quickly helped Aurora become one of the largest competitors in the province and provided a significant runway for growth in the province.
It is worth noting that Ontario has also changed its retail model from relying on provincial-run stores exclusively to allow private retailers open physical stores while provinces run the online store. We think the change is a hugely positive development for the cannabis sector because many of them, Aurora included through its subsidiary Alcannaa (OTCPK:LQSIF), have established their retail strategies and will operate physical retail stores. We believe Aurora’s model of vertical integration can be better implemented in Ontario after the acquisition of MedReleaf, given its local production advantage.
The other upgrade that Aurora received from the acquisition of MedReleaf is its enhanced corporate and capital markets profile. The combined company has more than 900 million shares outstanding. Given its share price of $6.78, as of Tuesday, the market capitalization reached more than $6 billion, only behind Canopy. Canopy saw its market value soaring after Constellation (STZ) announced a further $4 billion investment into the company. The combined company has better liquidity and appeal to institutional investors. However, MedReleaf majority shareholders will most likely liquidate their locked-up shares once allowed to do so. On the long term, Aurora has to deliver the promises implied by its share price and make use of the assets it acquired from MedReleaf for a very large premium.
Share Price Performance
Aurora shares have performed in line with Aphria in 2018, but both have significantly underperformed Canopy. We have discussed extensively our preference for Canopy in the large-cap space. The acquisition of MedReleaf caused significant dilution to Aurora shareholders and have caused a strong overhang on its share price. We expect the selling pressure to continue, given that MedReleaf shareholders were eager to liquidate and cash out, to the detriment of Aurora’s share price. The insider shares were locked-up and will enter the market later in 2019, causing another wave of strong selling pressure on Aurora shares. The outperformance of Canopy can be mostly explained by its investment from Constellation and the lack of development at Aurora relating to any potential third-party investments.
Putting Everything Together
We think the acquisition of MedReleaf represents an upgrade for Aurora due to its enhanced production profile, competitiveness in Ontario, and an established presence in the medical cannabis market. The significant dilution and premium paid by Aurora represented an excellent outcome for MedReleaf shareholders, but Aurora shares have since languished relatively and still sit at >20% loss for 2018 YTD. We think the integration risk and dilution caused the stock price to stall, but overall, the transaction was a must-do for Aurora in order for it to become a truly national player in the cannabis space. Looking ahead, Aurora needs to execute on its facilities buildout and start building its ancillary businesses such as beverages, tobacco, and pharma. Until now, Aurora and Aphria are the only two large-cap stocks without an industry spin on it. Canopy has Constellation, Tilray (NASDAQ:TLRY) has Novartis (NYSE:NVS), HEXO (OTCPK:HYYDF) has Molson Coors (TAP). We think Aurora needs to decide whether it wants to partner with an established player or pursue its own growth trajectory.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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