Tilray: Not A Buy On Aphria Deal Close
Summary
- Tilray and Aphria are set to approve the merger at shareholder meetings next week.
- The stocks are up substantially since the deal announcement, yet the prospects of the business haven't improved meaningfully.
- The new entity isn't the cannabis market leader needed to justify a $9+ billion market valuation.
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Next week, Tilray (NASDAQ:TLRY) and Aphria (APHA) will host stockholder meetings to approve the proposed Canadian cannabis merger. The stocks are up substantially since the deal was announced back in December. My investment thesis remains bearish on the stock, especially due to the excessive rally.
Image Source: Tilray website
Deal Closing
Back in December, Tilray entered into a definitive agreement to acquire Aphria in a deal with a listed market valuation of ~$4 billion, at the time. Aphria shareholders will receive 0.8381 shares of Tilray and end up controlling 62% of the company.
With Tilray trading at $21.00, the deal values Aphria at $17.60 per share. Aphria shareholders will see a very small boost when the deal finally closes after the shareholder votes next week.
The combined company now has a listed market value in the $9+ billion range with the stock price surges following the Blue Sweep in the U.S. November elections. The new Tilray is now one of the most valued cannabis stocks in the world with Canopy Growth (CGC) worth $12 billion and Curaleaf Holdings (OTCPK:CURLF) worth $10 billion.
The prospects for the company haven't changed much since the deal announcement. The 2022 revenue estimates for the Tilray business are actually down ~$8 million to $375 million since the Q4 earnings announcement in February.
Source: Seeking Alpha earnings revisions
Aphria has seen revenue estimates rise due in a large part to improving revenues from the distribution business. The investment picture hasn't gotten any better for Tilray and Aphria, yet the stocks are up substantially.
Not A Market Leader
Aphria was a Canadian cannabis stock that was appealing long before the Tilray deal was announced, but the new Tilray isn't the market leader needed to justify the current market valuation. The combined company presented this misleading picture of the cannabis market when announcing the deal.
Source: Tilray/Aphria merger presentation
The new Tilray was listed as the largest cannabis company by revenue using LTM revenues. The problem with this number is that Aphria has substantial distribution revenue in Germany via CC Pharma and Tilray has hemp food product revenue via the Manitoba Harvest business.
CC Pharma has about $70 million in quarterly revenue with low margins amounting to $280 million in annual revenue. Manitoba Harvest had $15 million in Q4 revenues and $77 million all of last year.
These combined businesses are close to $350 million in annual revenue, leaving only ~$750 million in cannabis revenue out of a company forecast to generate ~$1.1 billion in FY22 total revenues. The numbers are paltry considering Parallel in a business combination with the Ceres Acquisition (OTCQX:CERAF) SPAC could approach $900 million in 2022 revenue, while Curaleaf is forecast to reach $2 billion in sales next year.
In essence, Tilray isn't even close to being the largest global cannabis company by any metric. Whether the stock valuation is at $9 billion for this reason or not is unknown. The stock probably surged partially on excitement related to potential U.S. legislation, though the new Tilray has no real cannabis business in the U.S. to benefit from THC becoming legalized.
The worst case scenario is for companies such as Parallel to become further entrenched with the Windy City Cannabis purchase adding $75 million in annual revenue from Illinois alone. The new Tilray will have to pay up to acquire such stocks in a highly competitive market where a few relatively strong MSOs will command premium valuations. Remember, Parallel is a relatively unknown MSO that isn't even technically public yet and the company has a larger cannabis revenue target than one of the best known Canadian cannabis companies following a major deal.
Takeaway
The key investor takeaway is that Tilray just isn't attractive to own heading into the Aphria deal close. The stock is likely to face pressure as some Aphria shareholders look to sell after obtaining the merger arbitrage when the deal closes. Besides, the stock just remains very expensive and the combined entity won't directly benefit from U.S. cannabis approval, while some MSO stocks set to benefit aren't that expensive.
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