There has been a significant uptick in mergers and acquisitions (M&A) activity in the burgeoning cannabis industry lately. This month, Canopy Growth announced plans to acquire Supreme Cannabis. And last year, Tilray (TLRY +0.00%) and Aphria (APHA +0.00%) made headlines when the two Canadian cannabis giants agreed to join forces.
However, I think there's an even better merger out there that offers investors greater potential returns. It involves Greenlane (GNLN 6.55%) and KushCo (KSHB +0.00%). Although they are smaller companies, that combination looks to be a smarter investment than the one involving Aphria and Tilray.
Image source: Getty Images.
There will be more growth opportunities available
Unlike Canopy Growth, Supreme Cannabis, Tilray, and Aphria, both Greenlane and KushCo are U.S.-based cannabis companies. And since they aren't pure-play marijuana producers, and simply provide the industry with ancillary products and services, they don't need to worry about the federal prohibition of pot in the U.S. Some of the products that the two companies sell are vaporizers, child-resistant packaging, consumption devices, and accessories. While they provide cannabis producers with necessary supplies to help sell their products, they aren't plant-touching businesses that will run into trouble with federal law.
Therefore, they can expand into any state where marijuana is legal and can also ship their products there. It may sound trivial, but for multistate operators in the U.S., it's a significant impediment that their products can't cross state lines. If they want to sell marijuana in a particular state, they also have to have operations there.
Canadian producers face even larger obstacles. They can't sell any non-hemp-based marijuana in the U.S. because those products wouldn't be able to cross the federal border (hemp was legalized under the 2018 Farm Bill). The Toronto Stock Exchange has also warned cannabis companies in the past about investing in an illicit U.S. pot market, and said that doing so could result in their shares being delisted. While there is a lot of excitement that the U.S. may legalize marijuana at the federal level and open up its doors to Canadian cannabis companies, there is no guarantee that it will happen anytime soon. Although President Joe Biden has shown interest in decriminalizing marijuana, completely legalizing it doesn't appear to be on his agenda.
For at least the near future, that means both Greenland and KushCo will have access to a much larger U.S. cannabis market. Research company BDSA projects that by 2025, the U.S. marijuana market will be worth $34.5 billion in 2025 and grow at a compound annual rate of 18% until then. The Canadian pot market will grow at a higher compound annual rate of 26%, but will only be worth $6.1 billion by then.
With New York and New Jersey recently legalizing marijuana, there will be more cannabis companies popping up and looking to take advantage of the industry's growth. And that in turn will likely create more demand for KushCo and Greenlane's products.
With a smaller market cap, there is more potential upside from the KushCo-Greenlane deal
KushCo and Greenlane have combined market caps of about $270 million while Tilray and Aphria's valuations are well above that at $3.4 billion and $5.1 billion, respectively. And while there is a gap in pro forma revenue between the two mergers, it is certainly not enough to justify such a large delta in valuations. When Tilray and Aphria announced their merger last year, their pro forma revenue for the past 12 months was $685 million. KushCo and Greenlane's pro forma sales of $250 million for 2020 is a little more than one-third of that.
The discrepancy in valuation becomes much more apparent when looking at the price-to-sales (P/S) ratios of all these companies:
APHA PS Ratio data by YCharts
While Aphria and Tilray are the more popular pot stocks, KushCo and Greenlane offer investors more value. The one disadvantage now for the merger of the U.S.-based companies is that they still struggle with profitability. In 2020, Greenlane reported an adjusted EBITDA loss of $24.4 million while KushCo incurred a loss of $0.2 million over its last two quarters. Both Tilray and Aphria have reported positive adjusted EBITDA in recent periods.
However, within two years of the transaction, KushCo and Greenlane expect to realize between $15 million to $20 million in annual run-rate cost synergies, which could be enough to get them to profitability. The companies expect the deal to close in either the second or third quarter of this year. The transaction involving Aphria and Tilray could come to a close as early as this month.
The KushCo-Greenlane merger is the better one to invest in today
If you're looking for value or just more attractive growth opportunities, you are better off investing in the KushCo-Greenlane merger as opposed to Aphria-Tilray. With cheaper valuations and more attractive markets to penetrate in the near future, KushCo-Greenlane looks more likely to produce top notch returns.
