It's been over 15 months since Canada legalized cannabis for recreational use, and while we still may be waiting on the rollout of the cannabis 2.0 market to get a full picture of where the market may go from here, it's fair to say that the first 15 months have been more than disappointing. This time last year, pot stocks were riding high on the crest of the "green rush," before it all went downhill before we could even blink.
Scandals at the top of the industry were the trigger for some steep declines over the summer months, while supply issues and a lack of retail visibility exacerbated an already beaten down market by the time winter rolled in. Due to the initial tide of optimism in the early days of legalization, many cannabis companies were pretty open-handed when it came to capital expenditure, building some massive facilities and throwing money around in an effort to grab up as large a market share as quickly as possible.
Now, those chickens have come home to roost, with stock prices sinking as growth capital goes up in smoke due to far lower-than-expected sales. Many pot producers are now cash-strapped and heavily indebted, and while the bigger names may have the reserves and backing to see out these initial growing pains, lower and mid-sized producers are facing the real possibility of buckling under the pressure. For some of the more vulnerable firms, the possibility of a merger or takeover from one of the market's heavyweights could be their only saving grace.
And that could spell good news for the market going forward. Irwin Simon, CEO of Aphria Inc (TSX:APHA) (NYSE:APHA), said that there are too many players in the Canadian cannabis industry relative to the amount of existing demand for the product. “I see a big, big opportunity within the cannabis industry,” Simon said. “There [are] a lot of companies out there today that have their challenges in regards to growth, products, cash, et cetera. And I think there’s going to be whether [you call it] a consolidation, a shakeout within the industry.”
So, broader market consolidation looks likely to become a common theme in 2020, but just which companies are the most likely to be bought out? Let's take a look:
1933 Industries (CSE:TGIF) (OTCQX:TGIFF)
The Vancouver-based pot firm looks like an excellent candidate for a takeover from one of the bigger players. At just C$59 million, its market cap is a fraction of the size of, say, Canopy Growth's (TSX:WEED) (NYSE:CGC) or even HEXO's (TSX:HEXO) (NYSE:HEXO), meaning a deal is unlikely to break the bank for either of these companies. That's not to say that there's little value in that; in fact, it's the opposite. 1933 owns every aspect of the supply chain, has majority holdings in two promising US firms, and it's highly focused on developing a really broad product portfolio, which could help a potential suitor in the 2.0 market.
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"1933 is set up in a way to supply a bigger brand that will generate revenue, has some good assets and will be a good partner for other marijuana companies," said Chris Parry, a Canadian-based consultant in technology, health care, and marijuana marketing.
The Green Organic Dutchman (TSX:TGOD) (OTCQX:TGODF)
TGOD is a prime example of a mid-tier cannabis company that burnt through capital in the early days of legalization and now finds itself on the brink. The company invested heavily in two sites at Ancaster and Valleyfield before running out of money to actually finish construction. This led TGOD to segment the construction of the Valleyfield facility and seek a sale-leaseback agreement on the Ancaster facility, but the damage had already been done to TGOD stock as it crashed from $5.50 last March, to just $0.72 today as rumors of bankruptcy began to circulate.
However, the company has positioned itself as a market leader in organic cannabis, for which there is a huge demand. Should one of the bigger names decide it wants an edge in the organic market, and with the added benefit of a vastly increasing production capacity, TGOD is an oven-ready pot stock that looks like good value for its C$225 million market cap.
The Takeaway
It looks increasingly likely that asset-heavy/cash-poor pot firms will need a marriage of convenience in the very near future. As the market takes shape and the industry heavyweights begin to size up the areas of the cannabis space that they may be able to take advantage of, there is a likelihood that they may turn to such smaller firms that have already made headwinds in those sectors. Expect cannabis consolidation to be a prominent theme in the coming weeks and months.
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