Great all encompassing article: Aphria And Tilray Merge: Here's The Breakdown Of Whether You Should Buy
This article is confirmation of my initial reaction. Aphria did not need this deal. Tilray was desperate to merge, and will be a drag on the combined company until operating synergies are realized. Bringing all of the brands into one company is only going to be meaningful if Simon can reinvent his Hain Celestial Group magic. - FUNMAN
Dec. 19, 2020
5:19 AM ET
To read the article with all of the graphics, use this link:
* The two companies are forming a far bigger entity, and the focus of the new company is cost savings to get to profitability.
* While cost savings would certainly improve the bottom line, been after a large swing upwards in earnings, the stock would be overpriced on forward earnings basis.
* The company has not addressed flat revenues as a goal in the press release, the one variable that these two companies missed during huge surge in industry.
Aphria (NASDAQ:APHA) and Tilray (NASDAQ:TLRY) are merging. Combined, the two companies are likely to save money - the main focus of the press releases - but it will take some time until those savings start showing up in its earnings. And, so I wondered if I were to mathematically "combine" these companies by adding the two companies' individual revenues/costs/earnings together, what would that look like, and is the new and improved version of this company a buy? Another thing I wanted to know was given the metrics on the merger, did either company get a better deal out of this merger?
A little background of how the industry got here
This would be the first of what I think should be many mergers in the industry. When cannabis was legalized in Canada in October 2018, truckloads of money showed up to invest. Massive grow facilities with optimal production capabilities were created. Stocks soared. Then, everything collapsed.
Dispensaries were slow to open, some of which were run by the provincial governments themselves. Product took forever to make it to market. Margins dwindled to that of common produce in the grocery aisle as a race to the bottom of companies producing far too much supply without enough demand was forced to lower prices to near nothing. Nonetheless, I think this will be the beginning of many mega-deals.
I believe that a lot of companies are within arm's reach of profitability. But some are not and they may get bought out from strategic perspectives. Consolidation in a budding industry is always the norm and we may be right at that moment when that is going to begin more and more.
I am systematically working through some 750 or so cannabis companies to put together a portfolio of pure-play cannabis stocks. And from time to time, I find companies that I see that have huge targets on their backs saying that they need to find a partner or make significant changes to their business plans to sustain themselves. In fact, Tilray was one of them I just wrote about with almost those same sentiments.
Whereas I have been mostly very positive with Aphria, I have been extremely bearish on Tilray from day one and have often written about it saying how overvalued its stock was, or that it was in dire straits needing to raise cash. Here are just a couple of my articles on Tilray:
Tilray: Will Raise Money Diluting Shares, Sending Stock Lower
Nov. 19, 2020 10:02 PM ET https://seekingalpha.com/article/4390500-tilray-will-raise-money-diluting-shares-sending-stock-lower
Tilray Leverages Its Overvalued Stock In A Retail Partnership
Feb. 20, 2019 11:36 AM ET https://seekingalpha.com/article/4242454-tilray-leverages-overvalued-stock-in-retail-partnership
Tilray: Sell This And Here's How
Oct. 2, 2018 2:50 PM ET https://seekingalpha.com/article/4209440-tilray-sell-this-and-how
Enough with the past, what I wanted to do now is look at the financials of both companies and then combine them to see what this company could look like and evaluate whether or not this is a good deal.
Revenues for Aphria and Tilray
Here are the combined revenues for both companies:
(Data Sources: Aphria & Tilray - Author's chart)
Simply, I took the two revenues and added them up (as I did with all of the charts in this analysis). Aphria had $110M in revenues for the latest quarter and Tilray had about 50% of that for $47M. Whereas both companies are seeing a move higher in revenues, the moves are incremental.
First, let me show you another chart, that of cannabis retail sales in all of Canada to put this chart into perspective:
(Data Source: StatCan)
This is total retail sales of all cannabis, both medical and recreational. The latest data point of 2020 had cannabis sales in Canada at C$256M whereas September 2019 had sales of C$120M. This is double.
The two combined companies had $158M in the latest earnings release but $142.9M in the same quarter the year before, a change of only $15M. Not sure how good your math is, but I can assure you this is far less than double. The obvious thing is that there was a tremendous amount of sales of cannabis in Canada but these two larger companies have not participated in these sales increases. When you compare these larger companies to the general market, bigger does not necessarily translate to performing better.
So, what's going on here?
This strikes back at what I mentioned earlier. First, these bigger companies are producing far larger quantities of cannabis than the smaller producers. But they are targeting a more broader market that has more to do with cultivating flowers and processing them into either pre-rolls or oils and not into branding premium brands. Granted, each company has subsidiaries that deal in some smaller segment of the industry selling to a smaller, more focused customer.
However, the bigger revenue each of these companies generates comes from the more generic-processed flowers. What I have noticed, however, after reading countless and numerous annual reports, 10-Ks and 10-Qs is that there is a seismic shift in direction from larger companies into branding premium brands. This is where the larger margins are. And, if you have a company as large as what this combined company will be, you have to wonder if bigger is necessarily better, or a path to profitability.
If you read the statement on the merger, https://aphriainc.com/aphria-and-tilray-combine-to-create-largest-global-cannabis-company/
growth in revenues was not even mentioned, but instead the individuals that put out quotes emphasized costs as their primary focus. So, let's look at costs.
Tilray and Aphria Gross Margins and Operating Efficiencies
I wanted to highlight the two important costs metrics that I look at regularly - gross margins and operating efficiencies. When I evaluate a company as a prospective investment opportunity for my personal portfolio, I want to know that costs are kept in check by management. This is a good indication of management's abilities and their focus.
After combining the two costs metrics, I wanted to provide a disclaimer on the next two charts: I like them today but they will be obsolete at a very fast pace. Let me explain. Let's say there are three facilities with the two companies and each is running at lower than optimal levels. Perhaps you chop up production from one and have them do the producing for those products at the remaining two. This creates synergies that will keep costs down and make sense with a merger. This takes time, however. Nonetheless, and for the immediate purposes of this analysis, it is a good starting point.
Here are gross margins for the two companies based upon costs of goods/revenues:
(Data Source: Aphria and Tilray - Author's Chart)
Gross margins of 35% are a healthy starting point for cannabis companies based upon the many companies I have looked at, although not the largest.
Operating efficiencies are healthy compared to some of the other companies I have analyzed for the combined company:
(Data Sources: Aphria and Tilray)
Operating efficiencies below 50% are a solid start for any company in the industry. Both managements are showing a structured approach to costs. A combined company will offer more efficiencies, and so this as a basis to start shows a lot of potential.
Nonetheless, the math does not add up to profitability. More would need to be done and economies of scale may be difficult to achieve from this perspective. The company has 47% of costs but margins of 38% to work with. And if economies of scale were to be achieved with the growth of revenue, exactly when does that start? Just keep looking at the growth increases in total retail sales of cannabis in Canada and then look at the growth levels of the two combined revenues, and it makes you wonder if these behemoths have missed the boat somehow. Canada saw growth of 2x in one year and the combined companies saw growth of only about 10% during that same period.
But I will emphasize that costs were the primary focus from the suits in the merger statement for the company. And I will also emphasize that the charts above are the combined charts for today's activity. In the future, an investor should expect to see gross margins improve while simultaneously operating efficiencies decline. That was the purpose of the merger, to achieve profitability from a cost basis. I will keep a keen eye peeled for these numbers.
Net Incomes for Aphria and Tilray Combined
Truth be told, the combined companies are not too far off from profitability. And they have a solid book value with a very large asset base to work from, so this is one area that I can see the trends and fundamentals moving towards profitability:
(Data Sources: Aphria and Tilray - Author's Chart)
Breaking this down, the loss of $0.04 per share is minimal in the bigger picture for this combined company. Aphria has a massive asset base to work from. However, and I mentioned this in my previous article on Tilray, it was desperate and likely to have had to raise cash within the next year just to stay alive. At $0.04 per share, that is all of $6.2M for the quarter as a loss for both companies combined while there is a combined cash on hand of $477M. The combined company can easily weather the future until it has achieved profitability.
But, and I will emphasize this as much as I can, it was Tilray that was up against the ropes.
Is the Aphria and Tilray Merger a good deal?
My knee-jerk reaction to the deal was "Thank Gawd, I'm not an Aphria shareholder", which I hope puts my initial thoughts into perspective. Let's break down the numbers first, and the best way to value a company that does not have positive earnings is to start with book value:
(Data Source: Aphria & Tilray - Author's Chart)
The vast majority of the book value is derived from Aphria. Aphria had a starting point of $4.80 whereas Tilray's was $1.40.
To put this into perspective, Tilray's stock was at $7.36 when I wrote my last article on this stock. I will repeat this: It had a book value of $1.40. And it was losing money and eventually would have needed to raise cash and likely have done that with an equity raise of stock. That dilutes value. Yet, the stock was trading at a heavy premium to value.
Aphria was far better off. I put an article out where I posted that the company would likely see some gains in revenues and earnings. At the time, the stock was about $4.00 per share, but had gone higher to about $8.00. However, the catalyst that I was looking for that I mentioned in the article never materialized.
Nonetheless, the book value for this combined company is quite healthy; they each have plenty of cash on hand and assets over liabilities. Now, the question is to figure out their potential revenues per share and then factor in the valuation that one might expect from this newly combined company.
First, the stock for Tilray is just about $9.50 per share after the news announcement. If the combined company were to somehow achieve $12M, there would be a swing from -$0.04 per share to $0.04 per share. That $12M is all of 7.5% of the entire revenue for the combined quarter in the last quarter. If this one metric was the key to the company's goal, then this is something I see as being achievable.
That in itself would justify a valuation of the current price of Tilray's stock.
This would make the company a strong hold. But, since the price of the stock is already at that price, why would one want to buy? What's your upside? Plus, the company still has to achieve the metric of whittling down its costs to get to this point.
Is Tilray a Smart Buy?
My thinking on this is that since the price of the stock is already inflated to what would be the target price of the newly combined company if that company were to save some $12M per quarter. I don't see any upside here. While I think the combined companies will profit and eventually may even begin to increase earnings regularly, this may take time to come to fruition.
I am neutral on this deal because I believe the stock price is too high and the metrics may take too long to get there. There are plenty of companies in the industry that are offering spectacular opportunities right now. This is not one of them. I will pass.
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.