Shares of Canopy Growth Corp. dipped Thursday morning on news that it had entered into a $435-million stock and cash deal to acquire the Supreme Cannabis Co. Inc., paying a 66-per-cent premium over Supreme’s Wednesday closing stock price.
Supreme’s shares shot up by roughly 50 per cent to $0.40 in morning trading on the TSX after the announcement. At Wednesday’s closing stock price of 26 cents, Supreme had a market value of approximately $145-million.
The deal will see Supreme’s shareholders receive 0.01165872 of a Canopy common share and $0.0001 in cash in exchange for each Supreme share held.
Supreme is a mid-sized, Toronto-based pot company with production facilities in Kincardine, Ont. Its most prominent brand is 7ACRES, which has almost consistently been one of the top 10 best-selling premium cannabis products in the country. Canopy has long struggled to make a significant dent in the premium flower market. The company says this acquisition will expand its recreational market share to about 13.6 per cent.
“Consumers want choice, and we only have one brand right now – DOJA cannabis – sitting in the premium space. This was an opportunity to bring in a set of brands to Canopy that help us have the right brand proposition across the value spectrum for consumers,” Canopy chief executive officer David Klein said in an interview.
Supreme’s business strategy had for years focused on tapping into the so-called weed connoisseur market, selling premium cannabis for above-market prices. But the Canadian pot industry experienced a severe oversupply problem for most of late 2019 and 2020, forcing most producers to drastically slash their prices, leaving Supreme in an uncompetitive position.
From the end of its fiscal year in June, 2019, to June, 2020, its revenue tumbled by more than 50 per cent, resulting in significant layoffs and massive changes at the executive level. Supreme’s sales have since significantly increased, due in part to the overall increase in sales of cannabis countrywide during the COVID-19 pandemic.
For the quarter ended Dec. 31, 2020, the company generated revenue of $18.3-million, a 55-per-cent jump from the previous quarter. John Fowler, the founder of Supreme, who was terminated by the company at the end of 2019 and no longer holds any equity, told The Globe that the acquisition was a “validation” of the quality of the brand he created.
Canopy spent much of 2020 slashing costs, shuttering seven production facilities in Canada and exiting a hemp farming operation in Springfield, N.Y.
Last month, the Smiths Falls, Ont.-based company took out a US$750-million loan from private equity group King Street Capital Management LP, and analysts speculated it was priming itself to make a significant acquisition.
Canopy still has $2.5-billion in cash, which Mr. Klein says the company plans to use to solidify its presence in the American market, when it is legally permissible to do so. Cannabis is legal in most U.S. states, but still illegal at the federal level.
Despite acquiring Supreme at a premium, the terms of the deal appear “accretive” to Canopy, given its premium trading multiples relative to peers, Douglas Miehm, an analyst at RBC Capital Markets, wrote in a Thursday morning note to clients. “We view this as slightly positive for Canopy shares,” Mr. Miehm added.
Graeme Kreindler, a cannabis analyst at boutique investment dealer Eight Capital, said the deal makes sense for Canopy in part because good cannabis products have been hard to come by and that is something companies want to fix. “That’s why you see more M&A activity or rationale for M&A activity stemming from that,” Mr. Kreindler added.
There has been significant consolidation in the pot sector of late. In February, Quebec-based Hexo Corp. acquired competitor Zenabis Global Inc. Last December, two of the biggest pot companies, Tilray Inc. and Aphria Inc., announced a merger.
This deal, if approved by shareholders and regulators, is expected to close in June. Cassels Brock & Blackwell LLP is advising Canopy on the transaction, while BMO Capital Markets and Hyperion Capital are advising Supreme. Borden Ladner Gervais LLP is acting as legal counsel to Supreme.