Acreage: This Canopy Doesn't Protect

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About: Acreage Holdings, Inc. (ACRGF), Includes: CGC, CRLBF, CURLF, HRVSF
by: Stone Fox Capital
Summary

Acreage Holdings is down substantially despite the future merger right from Canopy Growth.

The corporate upheaval at Canopy Growth places the merger at risk and raises the prospects of failed math used to consume the deal.

Avoid the stock until Canopy Growth gets on stronger financial footing.

The Canopy Growth (CGC) firing of the founding CEO and the related market ramifications aren't going to help Acreage Holdings (OTCQX:ACRGF) shareholders. The original merger was heralded as a big premium for Acreage shareholders, but the stock hasn't fared well and the risk is to the downside unless the merger dissolves.

Acreage logo

Image Source: Acreage Holdings website

Bad Deal

On April 18, Canopy Growth announced the intent to acquire the right to purchase Acreage Holdings once a triggering event occurred. Basically, the deal gave Canopy Growth the right to purchase the U.S. cannabis multi-state operator (MSO) once cannabis becomes federally legal in the U.S.

The listed transaction value of $3.4 billion included a 42% premium to the 30-day weighted average price of Acreage Holdings. The problem for Acreage shareholders is that the deal was based on 0.5818 Canopy shares and a $2.55 up-front cash payment for the right to buy Acreage in the future.

In essence, Acreage shareholders are tied into Canopy Growth shares on a deal that might never close with a termination date 90 months away. With the stock at $40 and the cash option premium already paid, Acreage Holdings has a value of $23.27 on a deal. The amazing part is that Canopy Growth never presented the valuation scenario where their stock actually fell below $45.

Source: Canopy Growth information circular

At a dip to $25 (not included in the table), the Acreage merger value would dip to only $14.55. The problem here is that Canopy Growth appears in disarray with the firing of founding CEO Bruce Linton and the market price suggests that the deal only officially approved on June 27 could be doomed.

Either way, the U.S. MSOs haven't performed well since this deal was announced in mid-April. Of course, Acreage should've done better with a large premium bid, but Cresco Labs (OTCQX:CRLBF), Curaleaf Holdings (OTCPK:CURLF) and Harvest Health & Recreation (OTCQX:HRVSF) are all down in the 20% range since April 15.

Chart Data by YCharts

Failed Math

The ultimate problem for Acreage Holdings shareholders is that the buyout right was based on failed math. The U.S. cannabis stocks tended to trade at lower forecasted EBITDA multiples than the Canadian LPs listed on the major U.S. stock exchanges.

Marcato Capital Management LP used this playbook to propose voting against the merger. The investment firm called the transaction a valued-destroying deal using EV/EBITDA targets as a prime example:

  • Canopy Growth - 178.2x
  • Acreage Holdings - 20.7x

The equation is usually swapped where the acquisition target has the far higher multiple or the target firm goes for cash. Rarely would an investor base want to switch a currency (Acreage shares) for another currency (Canopy shares) that trade at higher valuation multiples.

Grizzle uses this chart to indicate how Canopy Growth still trades at the upper limits of the '20 EV/EBITDA multiples in the sector. Acreage Holdings shareholders are swapping shares for the most expensive stock in the Canadian cannabis sector.

One has to even question if Canopy Growth can reach these multiples following the firing of founding CEO Bruce Linton. The company just reported that the March quarter generated a $97 million adjusted EBITDA loss. An EV/EBITDA multiple of 40x suggests positive EBITDA of $250 million in '20 with a recent EV of $10 billion.

The Marcato Capital estimate of '20 adjusted EBITDA more in the $50 million range appears much more accurate, if not still high. One really has to question, if the company can turn EBITDA positive in the next year without completely cutting growth prospects and crushing the stock in the process.

On top of this, my previous research highlighted how Acreage Holdings isn't in a good position in the U.S. market. The other large MSOs have outflanked Acreage in the last year while Acreage was looking for a deal.

Takeaway

The key investor takeaway is that Canopy Growth doesn't protect Acreage Holdings shareholders. The large cannabis company is now in disarray with the founding CEO fired and the stock still trading at the richest valuation multiple in the sector. The merger was always based on failed math and unfortunately shareholders aren't realizing this problem until approving the merger only a few short weeks ago.

Unless the company figures out how to get out of this deal with Canopy Growth, Acreage isn't heading anywhere fast. Avoid the stock despite the large merger premium.

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.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

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