With Canada legalizing cannabis for recreational use in Canada in October, 2018 became a year of big deals in the sector.
In November, Constellation Brands — an international producer and marketer of beer, wine and spirits — increased its stake in Canopy Growth by an additional $4 billion (it had acquired a smaller stake earlier in the year). Two months earlier, Canopy had bought up Hiku Brands, parent company of Tokyo Smoke, for $250 million.
Aurora Cannabis, one of the world’s largest and fastest-growing cannabis companies, made two acquisitions: CanniMed Therapeutics for $1.23 billion and MedReleaf Corp. for US$2.5 billion. And in December the Altria Group, a tobacco company, bought a 45-per-cent stake in Canada’s Cronos Group for US$1.8 billion.
“It’s certainly a very exciting” period in M&A in the cannabis sector, says Patricia Olasker, a partner at Davies Ward Phillips & Vineberg LLP in Toronto, who led a team of legal advisors for Canopy Growth in the acquisition by Constellation Brands for MedReleaf shareholders in the purchase by Aurora Cannabis, and who advised the Cronos Group in the Altria deal.
“I think the challenges have been, because the big deals have had a US nexus, … a process in getting people on the other side of the border comfortable with our regulatory regime, and with the industry generally.” That has left a significant role for legal advisors in that respect, she says. And for the investment banking community in particular, as the mining sector “went into the toilet, the cannabis industry was born.”
The most interesting aspect of the past year has been the international aspect of cannabis M&A as more and more companies look to expand their footprint outside of Canada, says Ranjeev Dhillon, a partner and co-lead of McCarthy Tétrault LLP’s national Cannabis Law Group, based in Toronto. He sees a continuing trend in international deals with Canadian companies. “If you want to be a dominant player long-term, you need to look outside our borders.”
Donald Belovich, a partner in the Capital Markets, Securities and Mergers & Acquisitions Groups at Stikeman Elliott LLP in Toronto, who led the team representing CanniMed Therapeutics’ special committee of the board of directors in CanniMed’s purchase by Aurora, notes that Canada’s cannabis sector is equivalent in size to California’s cannabis marketplace. Canadian licensed producers are buying capacity and ancillary services, but are also looking elsewhere to grow their business markets.
“We’re seeing them overseas, … making acquisitions domestically and internationally,” Belovich says. “They’re realizing that to stay relevant and profitable, you need to do more than grow for Canada.”
Will 2019 bring the same blockbuster deals to the cannabis industry as 2018 did?
Olasker sees cannabis M&A as moving in waves. The first wave began in 2015, she says, and she believes “the consolidation wave … has come and gone.” The second wave, including the Aurora-MedReleaf deal that she advised on last year, involved deals in which shareholders took a key role in deciding whether companies they’d invested in were wholly or partly for sale.
The third wave, which Olasker sees as taking place now, involves activity that “is not Canadian buys Canadian, but non-industry player buys industry player.” This includes the Constellation-Canopy and Altria-Cronos Group deals, as well as Molson Coors Brewing Co.’s acquisition of The Hydropothecary Corporation last year.
“All these players are coming onto the Canadian stage and buying whole companies, or entering into a control-like relationship with the Canadian entities,” Olasker says. “That’s been interesting, and has delivered a lot of value into the hands of Canadian players.”
Dhillon predicts “a flurry of activity” in 2019, with, potentially, some blockbuster deals based on companies with good synergies joining forces. On the other side, he says, as the cannabis market starts to find its feet, “I think we’ll see some entities that don’t perform well being targets, and can be scooped up cheap,” made even easier since the cannabis sector has largely been funded with shares.
“I think in 2019 we will continue to see large amounts of activity, and it will outstrip 2018, quite frankly.”
Aurora Cannabis’s ultimately successful take-over of CanniMed Therapeutics, completed on May 2, was “a rollercoaster,” says Stikeman Elliott’s Belovich, who led the legal team for CanniMed. What started as a meat-and-potatoes M&A deal in terms of the acquisition became a hostile take-over bid by Aurora midway through, he says, and the deal also contained many “firsts.”
Not only was this deal the first high-profile M&A deal in the cannabis space, but also the first under Canada’s new take-over rules that took effect in 2016, which give companies more time to respond to unsolicited offers and find a higher bidder.
Then Constellation Brands made its investment in Canopy Growth, which raised the bar and saw lofty valuations, says Belovich. “The cannabis industry itself is [still] coming into its earnings,” he explains, “then Constellation comes in and resets the bar regarding value.” Regulatory proceedings, then a take-over bid by Aurora under the new regime, “and crazy volatility in the marketplace, and overnight, the value is swinging in the millions of dollars.”
At the end of the day, Aurora increased its bid significantly and put in some more cash in addition to shares. “The valuation and price was so compelling, that ultimately it was in the best interest of the shareholders,” says Belovich, and CanniMed’s board could approve the deal.
The Constellation deal had a significant impact on the Aurora-CanniMed transaction and others, he adds.
Emmanuel Pressman of Osler, Hoskin & Harcourt LLP’s Toronto office, who acted for Constellation Brands in its investment in Canopy Growth, explains the rationale behind the deal. Three years ago Constellation had sold its Canadian wine business to the Ontario Teachers’ Pension Plan, a deal “designed to unlock value and capitalize on investment, and reallocate resources” to its Mexican breweries, premium label spirits and other products. About a year later, “in what’s otherwise a slow-growth business,” Constellation started looking around and saw Canada’s growth in the cannabis sector. The first deal, a 9.9-per-cent investment for about $250 million, with the ability to get up to 20 per cent, was conducted, and a year after that decided to make a much more material and meaningful investment in the company: the controlling $4-billion investment.
Although Constellation was interested in Canopy Growth with a view to creating infused beverages and other edible products, “that’s not the only driver behind the investment,” says Pressman. “They were interested in exploring a new category that was a potential competitor to alcohol. The cannabis players are positioning themselves as a … threat to alcohol.”
Shifting trends in consumer habits, such as the move from drinking coffee to energy drinks among young people, forecasts a potential consumer shift to cannabis edibles, vaping and more.
“I think Constellation is an innovator in the alcoholic beverage sector,” says Pressman, “and they saw a once-in-a-century opportunity. They were very forward-looking in terms of understanding shifts in consumer behaviour.”
The Constellation-Canopy deal created much speculation that investment in the cannabis space by certain types of industries would be more likely to occur, Pressman says. “Alcohol and beverages, tobacco and pharma were the three big industrials that people had expected to be very focused and interested in the sector.” First came the deal by Constellation, an alcoholic beverages company, then the Altria tobacco (Marlborough brands) company and its investments in Cronos, and then pharma, through joint venture transactions with Tilray, a Canadian pharmaceutical and cannabis company incorporated in the United States with primary operations headquartered in British Columbia. “Now, you’ve got a closing of the circle, the trifecta of industries that have identified their horses and strategic investments.”
And Canada is the only market that’s available to US producers who want to raise capital, Pressman says. Although there are hundreds of profitable, revenue-generating US cannabis producers, cannabis remains a controlled substance and illegal under the US federal Controlled Substances Act, making it difficult for American cannabis producers to borrow money from traditional financial institutions, or to raise capital on federally regulated stock exchanges.
Because of Canada’s expertise in that market, its stock exchanges and capital markets can foster international cannabis players similar to the way they fostered international junior and mid-market exploration-stage and development-stage mining companies, he says. Cannabis producers today are contributing to robust Canadian capital markets, “and as that happens, that is also potentially going to feed and foster the Canadian M&A market.”
In December the proposed amendments to the federal Cannabis Act and the Cannabis Regulations were released. These proposed amendments to the Act and Regulations are anticipated to permit the legal sale of edibles, extracts and topicals containing cannabis by October 17, 2019.
Cannabidiol (CBD), a therapeutic cannabinoid which can be used topically, in an oil, has now been liberalized in the United States, which is ahead of Canada in that respect, Davies’ Olasker notes.
“I think we’re going to see … Canadians looking to buy US hemp assets” so they can produce CBD, she says. “For Canadian companies, the holy grail is really being able to get a footprint into the US. Some are already there, such as Tilray and Canopy.”
Olasker also sees conventional retailers moving into the cannabis space, and notes Tilray’s recent global revenue-sharing agreement with Authentic Brands, which owns the shoe-store chain Nine West, among other brands, to develop and market consumer cannabis brands. “A driver is that if you’re going to buy a foot cream, you might prefer that it say Nine West on it rather than XYZ Weed Co.,” she jokes; and as cannabis products move into the health-and-wellness sector, “this is normal retail play, and obviously it makes a ton of sense.”
Today, cannabis is “a lot more than the Grateful Dead and potheads,” says Belovich. Medical cannabis may be available through health-care benefits and a product such as CBD oil may be safer for use by the elderly, for example, than conventional drugs. THC and CBD are just two of 113 cannabinoids identified to date, which science can use to create “millions of combinations,” he says. “If you think of the whole science aspect, that’s hugely exciting.”