On Dec. 16, Aphria and Tilray announced a merger to form the largest cannabis company in the world by revenue. As we said in our earlier note on speculation of the deal, we see a strong strategic rationale for the combined company, which will keep the Tilray name, including the ability to consolidate production in Canada, combine alcohol and CBD businesses in the United States in preparation for potential federal legalization, and the ability to combine efforts in Europe. We consider the target $100 million of cost synergies as achievable, as they represent just 9% of combined costs and overhead expenses, and we see significant low-hanging fruit.
In a reverse merger structure, Aphria shareholders will receive 0.8381 Tilray shares for each Aphria share, implying a 23% premium to Tilray’s share price before the announcement. Given relative sizes, Aphria shareholders will own about 60% of the combined company and get seven of the nine board seats. Tilray CEO and Chairman Brendan Kennedy will get one of Tilray’s two board seats, while Aphria CEO and Chairman Irwin Simon will keep both roles in the combined company.
We’ve updated our fair value estimates, increasing Aphria’s to $15 per share from $14.50, and Tilray’s to US$14 per share from US$10. Our no-moat ratings remain unchanged for both companies, reflecting low returns on capital in the near term based on the industry’s infancy. In addition, we’ve reduced Tilray’s uncertainty rating to very high, in line with most of the cannabis producers we cover, as the deal reduces the risk of value destruction from dilutive equity issuances.
We think the deal favors Tilray because of its 23% premium, and we saw greater upside in Aphria shares before the transaction. Aphria shares were down about 1% and Tilray shares were up 19%, the market confirming our view of Tilray’s lopsided share of the economics. Nevertheless, both stocks look attractive, trading in 4-star territory.
With the combined company holding about 17% share, the Canadian market remains largely fragmented, with more than 500 licensed producers. Aphria is the only Canadian producer we cover that has reached EBITDA profitability, and we think the fragmented market hasn’t helped. Further industry consolidation is likely and will help operators reach profitability faster as supply is rightsized. While we continue to see significant room for market growth, we think consolidation would help producers more rationally grow capacity in line with demand.
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