The Wave of M&A Activity in the Canadian Cannabis Industry Continues

Hexo agrees to purchase struggling Canadian cannabis company Zenabis in an all-stock transaction

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Friends, 

As previously discussed here at Four PM, there is a substantial surplus of cannabis in Canada. 

With many producers optimizing for growth at all costs in the lead-up to adult-use legalization in order to present themselves as worthy candidates for additional investment dollars, the Canadian cannabis industry has quickly reached a point whereby there is simply too much mediocre cannabis and too few consumers to purchase it. 

How Does This Play Out?

With the quantity of cannabis outstripping consumer demand by more than 10x, there simply isn't a path forward for every producer to fulfill the promises they made to their investors. 

As this becomes clearer by the day, a wave of consolidation appears to be on the horizon, with many of the largest producers now seeking to devour smaller producers whose balance sheets have left them with all but two options. 

Option 1: Declare bankruptcy and wipe out their existing shareholders, followed by the liquidation of their assets—such was the fate of cannabis startup Lift & Co.

OR

Option 2: Join forces with a larger producer, thereby protecting their existing shareholders by providing them with shares in a larger venture. 

Case-in-point 

Yesterday it was announced that Canadian cannabis company Zenabis would be acquired by Hexo Corp in an all-stock transaction, valuing Zenabis—a company once worth billions of dollars—at a mere $235 million.

Does this deal make sense?

As many of you will know from reading past editions of Four PM, I have a great willingness to criticize M&A activity as more and more companies go down the well-trodden path of becoming “the largest cannabis producer in Canada”—a once-coveted title now synonymous with producers who simply bit off more than they could chew.

That said, in this specific case I’m rather optimistic that this deal makes sense for both parties.

For Hexo, the acquisition of Zenabis allows for the production of cannabis at an extremely low rate—$0.76/gram courtesy of Zenabis’ greenhouse facilities—which will pair nicely with Hexo’s “value brand” Original Stash, currently selling at less than $4/gram in an effort to displace the illicit market.

In addition to lowering the price of producing cannabis, Hexo will also gain access to the nascent European cannabis market, courtesy of Zenabis’s joint venture with ZenPharm.

For Zenabis, however, I have mixed feelings.

Yes, this deal represents a means to an end that doesn’t leave existing shareholders completely wiped out; however, everything comes at a cost, and many of their employees will have to bear the burden of this transaction.

With discussions of “cost savings” already having occurred, I anticipate that much of their workforce will be eliminated as Hexo chases the most valued word in every cannabis company's dictionary: profitability.

Was there a better outcome available to Zenabis? Probably not.

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