Replies to post #5980 on Tilray Brands Inc (TLRY)

[FUNMAN]

Tilray Will Be the Largest Cannabis Company Once It Merges With Aphria
TLRY stock is likely to do well over the next year once its merger with Aphria closes

By Mark R. Hake, CFA Feb 19, 2021, 2:43 pm EST

Tilray (NASDAQ:TLRY) just reported its Q4 and full-year 2020 earnings on Feb. 17. The most important news was that the company finally was able to achieve EBITDA (earnings before interest, taxes, depreciation,and amortization) profitability. This news, along with the upcoming merger with Aphria (NASDAQ:APHA), could push TLRY stock up over the next year.

https://investorplace.com/2021/02/tlry-stock-will-be-largest-cannabis-stock-once-it-merges-with-aphria/

Tilray reported that it achieved its stated goal of becoming breakeven or positive EBITDA. It made $2.2 million in adjusted EBITDA during Q2. This is compared to negative $35.3 million in adjusted EBITDA last year.

The company did this by both raising revenue by 26% over last year and by cutting costs by $57 million over that period. Tilray said it now operates with a “more focused, efficient and competitive cost structure.”

It did not produce a cash flow statement in its press release. That will come out with the 10-Q in several days. However, I suspect that it shows that the company still is burning cash. This is because EBITDA does not include things like capex spending, working capital changes, debt and tax payments.

Merger With Aphria

Tilray’s merger with Aphria, announced in December and set to close in Q2, will create the largest cannabis company. The company says that the “new Tilray” will have synergies of over 100 million CAD in cost savings from both companies. This will bring significant value to the combined company.

If those synergies work out within the next year, that could potentially mean roughly $80 million in adjusted EBITDA. Assuming half of that leads to free cash flow (FCF), along with 20% growth, the FCF of the combined company could be as high as $50 million.

Therefore, assuming the merger results in a new market capitalization of approximately $13 billion, the FCF yield of the new company would be 0.38%. That is a fairly high valuation. But the market will likely realize that once the company is FCF positive then it is likely to grow over time.

In several years, if the combined company’s FCF were to triple to, say, $150 million, the market value of the two would have a 1.15% FCF yield. This means that at today’s price the company is probably fairly valued.

However, the market is going to want to see more of this. For TLRY stock to move higher after the merger, the combined companies would have to be much more profitable than today.

What to Do With TLRY Stock

Short interest in TLRY stock is now at 20% of the public float, according to Yahoo! Finance. That is a very high level, although it is down from 36.6% over a week ago.

This is because short-sellers think the combined merger will likely lead to further losses. Or, even worse, that the merger may not even occur at all. Although I doubt the latter, it is true that Tilray and Aphria are going to have to show how profitable they can become after the merger.

Others think the merger will benefit from President Joe Biden’s administration loosening up restrictions on the purchase and sale of cannabis. So far nothing has happened along these lines, but it is still early.

Cantor Fitzgerald has a $30.25 price target on Tilray but said in their note that the volatility in the sector may keep investors away from TLRY stock.

Other analysts are not as sanguine on the stock. For example, Yahoo! Finance, which uses data from Refinitiv, has a much lower average price target. Their data from 11 analysts show that the average price target is just $18.25, or 36% below today’s price of $28.61.

TipRanks.com says that the average price target of 10 analysts is $19.39, or 32% below today’s price. MarketBeat reports that 15 analysts have an average target price of $18.40, implying a 36% drop in TLRY stock. In essence, no one is positive on the stock. The company has a lot to prove to analysts and investors.

Most investors will probably wait until they can see evidence of sustained profitability, not just on an EBITDA basis, but also with cash burn.

On the date of publication, Mark R. Hake does not hold a long or short position in any stock or security mentioned in this article.

[FUNMAN]

Aphria And Tilray: Reassessing With Q4 Numbers

Written by Trading Places Research
Feb. 20, 2021 4:44 AM ET

You really want to read the article at this link to see all of the charts and graphs:

https://seekingalpha.com/article/4407667-aphria-and-tilray-reassessing-q4-numbers

Summary

* Executives at Aphria and Tilray had more information than we did in December when the deal was first announced. But now with both fall quarters reported, we have greater clarity.

* While it looked like Aphria was overpaying by about 22% using the numbers we had in December, that looks like a much more modest 9% now.

* Despite that, on balance I like the combination for Aphria. It fills holes in their portfolio, and gives them a chance to bring Tilray’s underperforming assets up to their level.

* There is a long-short spread trade to be had right now, but both stocks are being batted around by Reddit users, so it can be dangerous.
Big Changes

An indica variety just after trimming. © 2021 Trading Places Research

Back when the Aphria (APHA)-Tilray (TLRY) merger was first announced on December 16, the companies had more information than we did. Aphria’s fall quarter had already ended, and Tilray was two weeks off, but neither had reported out the quarter. So we were a little blind, still looking at summer quarter numbers.

With both companies now reported out, we have a better understanding of what both groups of executives were looking at when they approved the deal as structured. Both companies had big changes on their balance sheets in the fall quarter:

Aphria had a jump in liabilities; Tilray went in the opposite direction.
Both companies had big increases in share counts, for different reasons.
Aphria’s cash position went down, while Tilray's stayed steady.
Using the summer quarter numbers, I concluded that Aphria was overpaying for Tilray by about 22%, but that it was a good strategic move regardless. The fall numbers provide more clarity. It looks to me like Aphria is overpaying by about only 9%, which is a small premium given the strategic fit here.

The general consensus on December 16, which included me, was that Aphria had overpaid, and the market has reacted quite vigorously to that.

ChartData by YCharts
Keep in mind all these stocks are also being batted around by Reddit users right now. But I believe this is a huge overreaction, especially now in light of the fall quarter numbers. Once Tilray reported and I redid my calculations, I opened up a long-Aphria/short-Tilray trade, and I will keep it open until the share prices are closer to my target price ratio of 1.2 Tilray:Aphria. I had the opposite trade back in December when they announced.

Canada Is A Different Country

Screenshot from SEC filing

One of the problems in analyzing this merger is that while both are headquartered and operate primarily in Canada, Tilray is domiciled in the US, and reports in US dollars. One of the things Aphria gets out of what is technically a reverse-merger is that it gets the US domicile and listing with the deal. It was headed that way anyway. So regarding that:

Unless noted, all dollars are US dollars.
For balance sheet, I will be using the exchange rate they used for the purposes of the merger, which is 0.7835 CAD to USD. We will also look at how today’s slightly different rate changes things.
Price and market cap figures will be based on the stock prices at close the day before the merger was announced. Aphria was C$10.31 on the Toronto exchange, so that’s $8.08 at our conversion rate.
Tilray’s fiscal year is the same as calendar quarters, but Aphria’s ends in May, which is the one thing I truly hate about it. All quarters are calendar quarters, with charts adjusted for the month’s difference.
But this brings up issues beyond exchange rates, because Canadian reporting is different. The primary difference is that the Canadian cannabis companies put fair value changes in sold inventories and biological assets into cost-of-goods. As has been noted in many places, this is kind of silly:

In a business this new, with a whole new class of products coming online, it is near impossible to put the right number on inventories, and we’ve seen huge changes here that distort the income statements.
Biological assets are plants and clone mother plants at different stages of development. The value of these are literally changing every day. Putting that into a quarterly income statement really doesn’t tell us anything.
It really distorts the reported numbers on the income statement from gross profit on down. But when analyzing new companies, I find the GAAP numbers to not be entirely helpful anyway. I like to focus on: what are the questions I want answered, and how can I answer them?

How efficient is production? Here I will remove the non-cash portions of Canadian cost-of-goods for “adjusted COGS”. Revenue minus adjusted COGS is “adjusted gross profit,” and that as a percentage of revenue is “adjusted gross margin.”
How much is that adjusted gross profit costing them in customer acquisition? For this we will uses sales and marketing as a percentage of adjusted gross profit, or “customer acquisition cost rate.” Lower is better.
How efficient are non-production operations? For this we will use general and administrative as a percentage of adjusted gross profit. Since lower is better, we’ll call this “office inefficiency.”
Netting it all out yields “adjusted operating profit” and “adjusted operating margin.”
Canada Is Still Too Small

Apple Maps

That phrase is one I use a lot to describe the general environment of the Canadian cannabis companies. They have the early advantage due to Canada being the first country to adopt full legalization. Now they are joined only by NAFTA partner Mexico. Nothing substitutes for access to public markets, legal banking, transportation and insurance services.

But given the international regulatory environment, especially the very complicated one in the US, there is a lid on what these companies can do. Canada is very large geographically, but has only 38 million people, fewer than California. On top of that, recreational retail rollout has been very slow in the most populous provinces. But the experience of Alberta, the most libertarian province, shows that in a less restricted retail environment, legal recreational cannabis can do very well. Unfortunately, Alberta is also too small at 4 million people, about the size of the City of Los Angeles.

Medical, hemp and CBD are good markets that are helping to keep these companies afloat right now, and so they are very important. But they pale in comparison to the brass ring: the global recreational market, especially in the US and Europe. Since you are here reading this, I will assume that like me you can imagine a day where cannabis laws everywhere more resemble Canada’s, and now Mexico’s. But we are not there yet, and it is still in our imaginations.

Canada is the diving board, not the deep end of the pool. That’s the starting point for all analysis here. The most important factor for the future of all these companies are regulations outside their home territory, and that is something they have very little control over.

For a fuller discussion of all this, my January article on the merger contains a discussion of the threats and opportunities coming from the US for the Canadian cannabis companies.

Aphria Versus Tilray
Pretty soon after we saw the reports from the Canadian cannabis companies post-legalization, it became pretty clear that Aphria had chosen the right strategy and was executing well in a tough environment. At the time of legalization, it had one of the lowest market caps.

ChartData by YCharts
That of course changed quickly when everyone saw what happened next.

Aphria was much more choosy in the furious frenzy of asset acquisition and CapEx that preceded legalization. It did not burn through a ton of capital like Canopy Growth (CGC) or Tilray.
It is growing a high-quality product at low cost with a unique greenhouse design.
It has a portfolio of well-regarded brands.
Its CC Pharma purchase, a German medical distributor, has proven to be one of its most important in the short and medium term. This channel is both a great toehold in the EU and is producing a lot of revenue for them.
The others had moved too fast and were saddled with a ton of inventory and overproduction. Aphria had the opposite problem. Its superior product and branding had proven popular in the limited Canadian recreational and medical markets, and the CC Pharma unit was also doing a lot of volume right away. It wound up having to purchase wholesale cannabis at higher prices, as its own production came online slowly.

Now, while everyone else is reducing production, and relying more on the wholesale market, Aphria is going in the opposite direction and could soon also have a healthy wholesale business. This is one of the places the merger helps.

So, let’s look at Aphria and Tilray. Starting at the top:

ChartData by YCharts
This is two entirely different experiences post-legalization despite the fact that pre-legalization they raised similar amounts of capital: $654 million for Tilray, and $590 million for Aphria (cumulative cash flows from financing through December 2018). Just in this quick view we can easily see who is executing better from roughly the same starting point.

But let’s dig into those metrics. We are going to see two things:

In addition to selling more, Aphria is the far better operation.
Tilray trimmed operations considerably starting Q2 2020 to clean things up in preparation for a merger. And here we are.
First, we get rid of the Canadian non-cash line items for our adjusted gross margin.


Aphria not only sells more, but also keeps more of each sale. They also spend far less on customer acquisition.


In Q4 2019, Tilray was paying $2 in customer acquisition for every $1 of gross profit. Here’s also our first indication of Tilray’s drastic cost reductions starting Q2 2020. We see the same pattern in the office inefficiency metric:


Again, drastic swings on the Tilray line. Both these OpEx lines crashed in the end of 2020:


Adding it up, Aphria’s adjusted operating margin has been positive in the last two quarters, and even after the cuts to expenses, Tilray is at -22%.


Sometimes I look at these numbers and wonder if they are in the same business. But part of the reason I like this merger on balance is that the people who brought you the blue lines in these charts will be running the assets from the green lines. These are not bad assets, but they have been very poorly managed. If Aphria can bring Tilray’s operations up to its level of execution, that’s a big multiplier on what it is buying.

What Is It Buying?
This is the core of why I think this is a good merger for Aphria. Aphria took a go-slow approach, and implicit in that is saying “no” to things. This leaves it with important holes in its portfolio, and Tilray fills some of these.

Aphria focused on:

A unique greenhouse model with automation, employing best-practices from Canadian greenhouse growers of produce. The result is a highly regarded product at industry-leading low costs.
Brand differentiation.
European medical distribution, and production there to feed that channel. Importantly, two of its three facilities have EU best-practices certification, and the Tilray merger will add another in Portugal.
Licenses in other parts of Europe and Latin America for production, import, export, etc.
And that is really it. So despite the success of this core business, it leaves it with lots of holes.

Enough production to meet demand.
Recreational distribution in Canada. It has leaned on a deal with a large liquor distributor.
Hemp and CBD.
Cannabis 2.0 R&D and product development. It has focused here on vape pens and oil gel caps, which is the right short term decision.
No real US strategy outside of the Sweetwater acquisition.
Sweetwater is a US craft brewer that focuses its marketing around the “cannabis lifestyle.” Most of its brands have “420” in the name, and it has a line of hard seltzer with terpenes, which are the chemicals that give cannabis its unique scent and flavor. It also has a big annual music festival. The 2021 lineup includes Snoop Dogg, Phish frontman Trey Anastasio, Toots & The Maytals, and The Allman Betts Band.

I think this is a clever move. It is buying a small but profitable company, so it adds to its bottom line. It won't buy any US cannabis assets until it is taken off Schedule 1 at the Federal level, but this gives it a chance to introduce itself to future customers on a cultural level. But still, it does not provide the protection and opportunity in the US like Canopy has with their Acreage Holdings deal. Canopy remains the only one.

So what gets added with Tilray?

More production, including that Portugal facility. These will retrofit to the Aphria model.
Jumpstarting its Cannabis 2.0 efforts, especially Tilray's deal with AB InBev (BUD) to develop beverages with its Labatt’s brand. Tilray also brings baked goods and candies.
Hemp products come from cannabis strains with only trace amounts of the intoxicant chemicals and are legal throughout the US and much of the world. These are CBD, edible seeds, and industrial seeds and fibers. Tilray has been selling through its Manitoba Harvest Brand at major chains through the US, about 37% of Tilray’s revenue in 2020.
So this plugs up three of the five holes, but it still leaves it without Canadian recreational distribution, and a real US strategy. On balance, the companies fit more than they don’t.

These last two sections combined are the reasons why I like the merger. Tilray has a set of underperforming assets that also fill some of Aphria’s needs. If Aphria management can bring operations up to its level, it’s a big multiplier on the merger. But forgetting about that multiplier, let’s talk about why I believe Aphria is overpaying, but by less so than I believed three months ago, before we saw the fall quarters.

Comparative Valuations
Again, I’m looking for what questions I want answered:

What did the market think the companies were worth the day before the merger was announced?
What are the companies bringing in cash and cash-like line items?
What sort of liabilities are they bringing?
The answer to the first one is simple — the market caps at the close of trading on December 15.

The other two are trickier, because the executives who were negotiating the deals had more information than we did — what their balance sheets looked like at the end of their fall quarters, and how many shares they actually had outstanding, not what it said in their last report. So these fall quarter filings are key to our understanding about what they were looking at when they signed the agreement on December 15th.

So:

Cash+ = Cash, equivalents, receivables, prepaids and investments at the end of fall quarter.
Net Cash+ = Cash+ minus all liabilities.
EV+ = Market cap on close of trading on December 15 plus Net Cash+
Now knowing the correct share counts on deal day, Aphria shareholders will own 62.6% of the combined company, 1.68x the Tilray shareholders’ portion. But they will be bringing 68.2% of the combined EV+ to the deal. Based off the summer quarter numbers, it looked Aphria was bringing 76.7% of the combined EV+, a much worse deal for Aphria shareholders.

But in the fall, Tilray continued cleaning up its balance sheet along with its operations statement. The Sweetwater purchase sent Aphria’s balance sheet in the other direction. Both wound up with a lot more shares as a result, which was a wash in relation to each other. All this was known to both groups of executives. So whereas three months ago it looked like Aphria was overpaying by 22.4% based on the summer EV+ measure, now it looks much more modest at 8.8%. As I type this, the exchange rate is now 0.7927, up 1.2% from the rate in the agreement, so that only changes that to 8.7%.

So while I gave a very qualified thumbs up to the deal three months ago, I am more enthusiastic now that we know exactly what we are looking at.

The Long And The Short
The neutral rating on Aphria relates to the uncertainty surrounding the regulatory environment, especially in the US. Even if the Federal government were to take cannabis off Schedule 1, this still leaves a patchwork of state laws. Only 15 states representing about a third of the US population have laws like Canada’s, even after a clean sweep in the 2020 elections. The current laws also assume no interstate trade, and many enforce state autarky as a result. My previous article on the merger contains more detail on all this.

But I have been playing a spread trade since the deal's announcement. I hesitate to mention it, because both stocks are being batted around by Reddit users right now, and we know that can lead to increased volatility, so be very careful if you want to try it.

When the deal was announced, Tilray was underpriced relative to Aphria in my EV+ measurement so I did a long-Tilray/short-Aphria trade for a few weeks until the ratio of US prices Tilray:Aphria was closer to 1.4. But the new calculations from the fall reports put that closer to 1.2. Right now the ratio is 1.43. So since Tilray reported, I opened up a long-Aphria/short-Tilray trade until that ratio gets closer to 1.2, or Reddit makes the whole plan go sideways.

I’ll be back with updates as news warrants.

Disclosure: I am/we are long APHA. 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: Short TLRY in long-short spread trade.