Consolidation in the cannabis industry is inevitable. As long as marijuana remains federally illegal in the U.S. and cannabis companies need to expand via acquisition to penetrate more states, marijuana businesses will continue to join forces. One deal that investors will want to pay close attention to right now involves cannabis producer TerrAscend's (TRSSF +4.72%) acquisition of Gage Growth (GAEG.F +0.00%), a Michigan-based marijuana company.
The two businesses announced the deal on Sept. 1, and the combined entity could become one of the top multistate operators in the country. Here's why you should consider putting TerrAscend's stock in your portfolio in light of this news.
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The business will be in five key U.S. marijuana markets
TerrAscend currently has operations in Canada and is active in four U.S. states -- California, Maryland, New Jersey, and Pennsylvania. But only one of those states, California, has a recreational market that's up and running. While New Jersey has approved adult-use marijuana, sales there may not commence until next year. The acquisition of Gage, which operates in Michigan, will give TerrAscend another top marijuana market in its portfolio that is fully legal and open for business. In 2020, Michigan generated just under $1 billion in cannabis sales, slightly below Illinois' tally. Both states were among the top 10 in revenue for cannabis last year.
Combined, the two businesses expect to have 34 stores open this year spanning five states. The bulk of those stores, 20 in all, will be through Gage's operations in Michigan.
It could generate well over $300 million in revenue next year
When Gage reported its second-quarter earnings on Aug. 24 (for the period ending June 30), sales of $26.4 million represented a record high for the business and an increase of more than 130% year over year. Its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) came in at a loss of $1.9 million, which was better than the $3.8 million loss it incurred a quarter earlier. A key reason for that improvement is that the company's gross margin has been rising thanks to its premium flower products, which Gage says sold for a 46% higher price in July than the state average.
For the same three-month period, TerrAscend reported sales of $58.7 million, up 72% from the prior-year period. And its adjusted EBITDA of $24.3 million was nearly triple the $8.4 million profit the company posted a year ago. With combined sales of more than $85 million, that creates at an annual run rate of more than $340 million once the transaction closes. But that number will surely be a lot higher next year from not just organic growth but also the opening of the recreational market in New Jersey.
With plenty of cash, more M&A could be on the horizon
As of the end of June, TerrAscend reported a cash balance of $154 million for what it says is to "support future growth initiatives." Gage, meanwhile, reported $32.8 million in cash. While that isn't going to give the new entity the resources to buy a large MSO, it can certainly help with its expansion efforts into other states. And what's important is that neither business is burning through tons of cash. In its most recent quarter, Gage used up $3 million to fund its day-to-day operations. And TerrAscend is coming off a third straight period during which its cash from operations was positive.
Although in this transaction, TerrAscend is funding the purchase through shares, for larger acquisitions, a cash-and-stock deal could be more optimal, as it will limit the number of shares the cannabis company needs to issue. And that means less dilution for shareholders.
Should you buy TerrAscend before the deal closes?
The companies expect the acquisition to be done in the first half of next year.
And while there's lots of promise here, investors may want to hold off on pulling the trigger just yet. In its Q2 results, TerrAscend withdrew its guidance for the year and hinted that some tough quarters may be ahead because of construction and expansion efforts in Pennsylvania that it says will affect the quality of its products there. And in New Jersey, it will also face headwinds as it focuses more on retail rather than wholesale, which is likely to lead to a lag in getting revenue to the income statement. As a result, it's possible TerrAscend's stock could decline further in the months ahead -- in just the past three months, its shares are already down more than 40%, far worse than the Horizons Marijuana Life Sciences ETF that's fallen just 23% during that time.
If you're looking for a deal, the best route may be to wait at least until TerrAscend releases its next quarterly results and to see if the headwinds have gone away, as there could still be much more bearishness in the short term. But for the long haul, this could be a promising cannabis stock to hold, given its strong financials and strategic presence in some of the top marijuana markets in the country.
