TLRY - Tilray Acquires HEXO On The Cheap In Surprise Move

2023-04-15 09:30:00 ET

Summary

• Tilray is acquiring HEXO in an all-stock deal valued at $56 million.
• The transaction presents a salvo for HEXO whose liquidity as of the end of its last reported quarter presented a cash run rate of not more than six months.
• Net income and operating cash flows for the larger company will remain negative even with cost savings synergies of up to $25 million.

Tilray (TLRY) is acquiring HEXO Corp (HEXO) in an all-stock deal that will see HEXO shareholders receive 0.4352 of a share of Tilray for each HEXO share held. This is essentially at an implied purchase price of US$1.25 per share against Tilray's 60-day volume weighted average price as of April 5, 2023. Hence, whilst Tilray will be exercising a US$173 million HEXO convertible note, the all-share transaction essentially values HEXO at around US$56 million, below its market cap immediately prior to the deal being announced. What's Tilray getting for US$56 million? A struggling Ottawa-based cannabis company that realized a 54% revenue decline for its last reported fiscal 2023 second quarter covering the three months until the end of January.

However, the deal is somewhat transformative and will see Tilray achieve around US$25 million in cost-saving synergies from a consolidation of HEXO's production, manufacturing, and broader operating structure. It will also increase Tilray's market share of the Canadian adult-use cannabis market to 12.9%, a 480 basis points move. Tilray will have the dominant market share across core cannabis adult-use categories from concentrates and topicals to flowers. Tilray will also expand its brand portfolio to include Redecan and Bake Sale.

Consolidation Of An Industry Under Stress

The move by Tilray continues what's been a year of consolidation of the North American cannabis industry as the somewhat still nascent industry which previously faced a wall of investor euphoria and enthusiasm has had expectations rocked by what now seems to be structural unprofitability. Cannabis prices continue to drop just as inflation and rising interest rates work to disrupt the operating structure of cannabis producers and retailers. I believe the deal presents a salvo for HEXO with the company's cash and equivalents falling to US$26.1 million as of the end of its last reported quarter, down sequentially from $57.6 million in the prior quarter. Hence, whilst HEXO reported its first earnings period of positive net income, around US$500k, the company still burnt through a large amount of its cash pile to create a run rate that was less than two quarters.

It was either a $56 million buyout or the specter of bankruptcy with HEXO already previously flirting with being delisted by Nasdaq after falling below its minimum listing requirement. To be clear here, HEXO was down 85% over the last year, its shares outstanding had ballooned to 44 million, up 73% from 25.4 million in the year-ago comp. The company had cumulative cash outflows from operations of $36.4 million over the last four quarters and revenue was essentially cut in half on the back of depressed cannabis prices as the Canadian adult-use cannabis market continues to face oversupply and black market headwinds. The current phase of North American cannabis can be characterized by brutal Darwism as a liquidity crunch on the back of rising interest rates and tepid investor sentiment has starved companies of liquidity, materially raised the risk of bankruptcy, and left weaker more poorly capitalized players fully exposed to buyouts.

A Salvo For HEXO And Possible Upside For Tilray

Whilst around 67% of HEXO's shareholders still have to approve the deal, Tilray expects it to go through with the alternative likely being worse for HEXO's shareholders. Indeed, the acquisition price being below HEXO's immediate market price possibly highlights the urgency of the situation HEXO faced. The current bear market cannot last forever and Tilray's HEXO buyout creates latent potential from a larger company with a stronger market share.

Bears would of course flag Tilray's cash burn from operations of $18.6 million for its last reported fiscal 2023 third quarter covering the three months until the end of February. This came against revenue of $145.59 million , a 4.1% decline from the year-ago quarter and a miss by $4.54 million on consensus estimates. Tilray did record its 16th consecutive quarter of positive adjusted EBITDA. This was at $14 million for the quarter to support what Tilray expects will be adjusted EBITDA of between $60 million to $66 million for the full year, a 30% increase from the prior year.

Critically, Tilray ended the quarter with a cash and marketable securities position of $408.3 million, $129 million from the year-ago comp. The company also reiterated expectations to deliver positive free cash flow from its operating segments by the summer of this year. Whilst Tilray will face difficulties in achieving this with cannabis prices down more than 40% in Canada, the company's craft beverages continue to be a bright spot with Montauk becoming the fastest-selling craft beer brand in New York. I'd wait for the company to reach positive operating cash flow before considering a position with the risk of underperformance still high as cannabis remains volatile.

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