High Finance: What Makes a Good Acquisition Target?

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The cannabis industry is unique in many ways, but it still follows the same basic template every new industry follows as it evolves through four fundamental stages: introduction, growth, maturity, and decline. The cannabis industry currently sits somewhere between the growth and maturity stages, as big players are emerging, companies are establishing market share, and major corporations in adjacent industries (healthcare, pharmaceuticals, biotech) are coming into the market by snapping up acquisition targets or merging with companies that align with their interests.

Mergers and acquisitions (M&A) have been an ebb-and-flow affair over the past five years. Now, with investment capital flowing more freely than it has since 2018 and large multistate operators (MSOs) scaling up and branching out, M&A activity should accelerate as companies build their brand portfolios and compete for market share.


Market activity

In 2017, 163 mergers and acquisition deals totaled $1.9 billion. In 2018, 324 deals accounted for more than $7 billion. In 2019, as Canadian cannabis stocks crashed and investment capital dried up, only 249 deals took place; together, they were worth a total of about $5 billion. In 2020, the COVID-19 pandemic put the industry in a precarious spot. Fewer deals took place, totaling less than $1 billion. (Source: S&P Global Market Intelligence)

In 2021, some of the more notable acquisitions to date include:

  • Ireland-based Jazz Pharmaceuticals PLC (Nasdaq: JAZZ) acquired British pharma company GW Pharmaceuticals PLC (OTC: GWPRF) for $7.2 billion.
  • Trulieve Cannabis Corp. (OTC: TCNNF) acquired Harvest Health and Recreation for $2.1 billion.
  • Hexo Corp. (NYSE: HEXO) acquired Redecan for $768 million.
  • Green Thumb Industries (OTC: GTBIF) acquired New York’s Fiorello Pharmaceuticals in a $60-million cash-and-stock deal. GTI also acquired Virginia-based Dharma Pharmaceuticals for $80 million.
  • Curaleaf Holdings Inc. (OTC: CURLF) acquired Los Suenos Farms for $67 million.

Ayr Wellness (OTC: AYRWF) has been active in the M&A space since launching in 2017. The company targets distressed companies and brands that still have value but are short on cash or business savvy. Thus far, Ayr has obtained assets in Arizona, Massachusetts, Ohio, New Jersey, and Florida. According to Jamie Mendola, head of strategy and M&A, in 2018 and 2019 valuations were still high, as MSOs were “sort of running around with their heads cut off, trying to grow as fast as possible, as big as possible, and plant flags in a lot of different states. And the market was rewarding that at the time.”

When the landscape changed in 2019, investors and companies looking to scale across the United States hit the pause button. Now cannabis stocks and investor confidence are back on the upswing. Market revitalization has put companies like Ayr Wellness—along with MSOs looking to expand their reach and brand presence—in the mood to shop for new assets.

Target indicators

So what makes a good acquisition target?

“Maybe they were capital-constrained, or maybe they had a couple holes in their own execution capabilities, and perhaps they hadn’t invested as much as we have in brand development,” Mendola said. “So we can bring some of our brands to those states, and we’ve also done a good job of integration on the back-end technology, accounting systems, and standard operating procedures.”

Another key factor for MSOs and others with dollars to spend is the licensing structure in the states where acquisition targets exist. In most of the legacy markets on the West Coast, many licenses are available and the supply-demand equation is harder to predict or analyze. The long-established black market in these regions throws an X factor into competitive analysis. In the Midwest and on the East Coast, by contrast, both licenses and the black market are much more limited, which makes companies in states like New York, Illinois, Massachusetts, Pennsylvania, Maryland, and Michigan prime targets for M&A.

So, if your company is a smaller player or in a distressed position, how do you recognize a good suitor? 

“They want to pick a partner who they trust from a corporate governance perspective, from a capital markets perspective, from an operational perspective, and whose stock isn’t overvalued, so they can ride with one of the winners and ultimately get a lot more value than just the upfront headline value you’re giving to them on day one,” said Mendola.

One of the ways larger companies incentivize acquisition targets to make a deal is using “earnouts,” whereby an upfront payment is made to the seller, and then future payments are contingent on meeting specific milestones.

“Sometimes it’s saying, ‘Hey, we think we can help you grow your cultivation capacity and will actually help you fund that, because you don’t have the $15 million to do it. And then we’ll give you some portion of the upside, if it turns out to be really good,’” explained Mendola. “For us, we’re sort of risk-sharing with them and not paying for optimistic numbers that may not be hit. But if we can help catalyze that growth, whether it’s through our own value-add, bringing in brands, helping them expand dispensaries or cultivation facilities, that may be a way for them to unlock value that really helps. And then it’s a win-win for everybody involved.”

Looking ahead

Does all this mean there is no room in the industry for boutique brands and craft growers to survive as big fish swallow more and more smaller players? Not necessarily.

Reading between the lines, the message seems to be this: Sure, you can still build a craft business if you are content to operate in one state or region and have access to enough capital to stay afloat as you expand and scale operations. But if your company has grander aspirations and wants to have a brand presence across multiple states, the time may be coming to hitch your wagon to a star.