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Writedowns Are Likely for These 3 Marijuana Stocks

Acquisitions can be a double-edged sword for even the most popular pot stocks. Read More...

The marijuana industry is looking like it could be one of the greatest growth stories of our generation. Having long existed behind the scenes in the black market, the now-legal pot industry is budding, and it has quite the audience in Wall Street.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Last year, the global legal cannabis industry generated $12.2 billion in sales — and this is just the beginning. Depending on your preferred Wall Street investment firm, the legal pot industry is capable of between $50 billion and $75 billion in worldwide sales by the end of next decade, and perhaps $130 billion to $166 billion in peak yearly sales (although no specific time frame was provided).” data-reactid=”12″>Last year, the global legal cannabis industry generated $12.2 billion in sales — and this is just the beginning. Depending on your preferred Wall Street investment firm, the legal pot industry is capable of between $50 billion and $75 billion in worldwide sales by the end of next decade, and perhaps $130 billion to $166 billion in peak yearly sales (although no specific time frame was provided).

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Suffice it to say, it should surprise absolutely no one that pot stocks have been consolidating at an extraordinary rate of late. We've witnessed about a half-dozen major acquisitions among vertically integrated dispensary operators in the U.S. since October, as well as numerous buyouts by Canadian pot growers since the beginning of 2018, all in the hope of boosting their market share in the relatively nascent legal environment.” data-reactid=”13″>Suffice it to say, it should surprise absolutely no one that pot stocks have been consolidating at an extraordinary rate of late. We’ve witnessed about a half-dozen major acquisitions among vertically integrated dispensary operators in the U.S. since October, as well as numerous buyouts by Canadian pot growers since the beginning of 2018, all in the hope of boosting their market share in the relatively nascent legal environment.

An investor holding a magnifying glass over a company’s balance sheet.

Image source: Getty Images.

<h2 class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Acquisition activity has picked up, but so have writedowns ” data-reactid=”26″>Acquisition activity has picked up, but so have writedowns

While consolidation is absolutely necessary as a means to reduce long-term costs, improve pricing power, and bolster margins, there’s also a downside to early stage acquisitions. Namely, the buyers run the risk of grossly overpaying for the assets they’re acquiring.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="In December, Aphria (NYSE: APHA) was raked over the coals by investors after a damning short-seller report alleged that it had vastly overpaid for Latin American assets that it had acquired from SOL Global Investments. Although an independent committee eventually determined that Aphria had paid a reasonable amount for these assets, the company still wrote down 50 million Canadian dollars in carrying value for its Latin American assets in the third quarter, following an impairment test request from the Ontario Securities Commission. Aphria’s CA$50 million writedown equates to more than 25% of what it paid for these now-controversial Latin American assets.&nbsp;” data-reactid=”28″>In December, Aphria (NYSE: APHA) was raked over the coals by investors after a damning short-seller report alleged that it had vastly overpaid for Latin American assets that it had acquired from SOL Global Investments. Although an independent committee eventually determined that Aphria had paid a reasonable amount for these assets, the company still wrote down 50 million Canadian dollars in carrying value for its Latin American assets in the third quarter, following an impairment test request from the Ontario Securities Commission. Aphria’s CA$50 million writedown equates to more than 25% of what it paid for these now-controversial Latin American assets. 

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Aphra's not alone, either. Earlier this month, TILT Holdings (NASDAQOTH: SVVTF) reported its fourth-quarter and full-year results which were, no beating around the bush, awful. TILT, which performed a complex reverse four-way merger and listed its shares for public trading in December, wound up writing down $496.4 million in asset value, leading a full-year loss of $552.1 million. For context, that’s more than two times TILT’s current market cap.” data-reactid=”29″>Aphra’s not alone, either. Earlier this month, TILT Holdings (NASDAQOTH: SVVTF) reported its fourth-quarter and full-year results which were, no beating around the bush, awful. TILT, which performed a complex reverse four-way merger and listed its shares for public trading in December, wound up writing down $496.4 million in asset value, leading a full-year loss of $552.1 million. For context, that’s more than two times TILT’s current market cap.

The common characteristic of these companies is that they were carrying around a substantial amount of goodwill prior to their writedowns. Goodwill is the “premium” that acquirers are paying when purchasing another business, above and beyond tangible assets. Ideally, buyers will recoup this value through cost synergies and future growth derived from the acquired business — but this isn’t always the case. Sometimes, acquirers have to bite the bullet, admit they overpaid for or overvalued an asset, and take a sizable writedown.

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<h2 class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Writedowns could be in the cards for these pot stocks ” data-reactid=”47″>Writedowns could be in the cards for these pot stocks

In the marijuana industry, three companies stand out as the likeliest to take a writedown, based on their high percentage of goodwill relative to total assets.

<h2 class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Aurora Cannabis ” data-reactid=”49″>Aurora Cannabis

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Aurora Cannabis (NYSE: ACB), Canada’s projected leading pot producer, looks to have one of the highest probabilities of taking a writedown among all marijuana stocks. That’s because its capacity expansion strategy has been more reliant on acquisitions than its peers. Last year, it gobbled up MedReleaf for $2 billion, CanniMed Therapeutics for about $850 million, and ICC Labs for $200 million, with a $130 million purchase of Whistler Medical Marijuana earlier this year. All told, Aurora has made 15 acquisitions since August 2016.” data-reactid=”50″>Aurora Cannabis (NYSE: ACB), Canada’s projected leading pot producer, looks to have one of the highest probabilities of taking a writedown among all marijuana stocks. That’s because its capacity expansion strategy has been more reliant on acquisitions than its peers. Last year, it gobbled up MedReleaf for $2 billion, CanniMed Therapeutics for about $850 million, and ICC Labs for $200 million, with a $130 million purchase of Whistler Medical Marijuana earlier this year. All told, Aurora has made 15 acquisitions since August 2016.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Although these purchases have pushed Aurora's projected output to the front of the pack, it's come with a price. The company ended the fiscal second quarter (Dec. 31, 2018) with CA$3.06 billion in goodwill on its balance sheet, representing 63% of the company’s total assets. Aurora will, presumably, recoup some of this value (especially from MedReleaf) after it brings acquired cultivation capacity online. But recovering more than CA$3 billion in premium is going to be difficult for any company, let alone one in a relatively new industry that’s facing supply chain challenges in its home market.” data-reactid=”51″>Although these purchases have pushed Aurora’s projected output to the front of the pack, it’s come with a price. The company ended the fiscal second quarter (Dec. 31, 2018) with CA$3.06 billion in goodwill on its balance sheet, representing 63% of the company’s total assets. Aurora will, presumably, recoup some of this value (especially from MedReleaf) after it brings acquired cultivation capacity online. But recovering more than CA$3 billion in premium is going to be difficult for any company, let alone one in a relatively new industry that’s facing supply chain challenges in its home market.

The next couple of quarters will be particularly telling for Aurora. Ideally, investors would like to see a decline in goodwill as a percentage of total assets in the company’s fiscal third quarter report, which will be released later this week. But if history proves anything, nothing works “ideally” with Aurora Cannabis.

A person holding a vial and dropper full of cannabidiol oil in front a hemp plant.

Image source: Getty Images.

<h2 class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Medical Marijuana, Inc. ” data-reactid=”65″>Medical Marijuana, Inc.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="From the second-largest pot stock by market cap in Aurora to a veritable tiny tot, Medical Marijuana, Inc. (NASDAQOTH: MJNA) is another marijuana stock that could deliver a sizable writedown.” data-reactid=”66″>From the second-largest pot stock by market cap in Aurora to a veritable tiny tot, Medical Marijuana, Inc. (NASDAQOTH: MJNA) is another marijuana stock that could deliver a sizable writedown.

Medical Marijuana is actually the very first publicly traded pot stock, though it’s been relegated to the over-the-counter exchange for quite some time because of its extremely low share price. Today, the company is seeing a healthy uptick in revenue as sales of its hemp oil and cannabidiol-based products are finally starting to take off. The December passage of the Farm Bill, which waved the green flag on industrial hemp production and hemp derivatives, is a big reason for Medical Marijuana shareholders to be excited.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="But the flipside of this excitement is that Medical Marijuana’s balance sheet is a mess. Despite having nearly $93 million in total assets at the end of 2018, almost half ($45.4 million) was tied up in goodwill. It’s also worth mentioning that about $25 million of its assets are related to its investments, which have undergone some wild swings over the past three years. Unrealized losses led to an almost $190 million dollar adjustment on its investment value last year. Given Medical Marijuana’s long string of operating losses dating back to its inception, a writedown on some portion of its $45.4 million would come as no surprise to Yours Truly.” data-reactid=”68″>But the flipside of this excitement is that Medical Marijuana’s balance sheet is a mess. Despite having nearly $93 million in total assets at the end of 2018, almost half ($45.4 million) was tied up in goodwill. It’s also worth mentioning that about $25 million of its assets are related to its investments, which have undergone some wild swings over the past three years. Unrealized losses led to an almost $190 million dollar adjustment on its investment value last year. Given Medical Marijuana’s long string of operating losses dating back to its inception, a writedown on some portion of its $45.4 million would come as no surprise to Yours Truly.

Multiple clear jars packed to the brim with cannabis buds.

Image source: Getty Images.

<h2 class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Canopy Growth” data-reactid=”81″>Canopy Growth

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Last, but not least, the largest marijuana stock in the world, Canopy Growth (NYSE: CGC), could surprise investors at some point in the future with a sizable writedown.” data-reactid=”82″>Last, but not least, the largest marijuana stock in the world, Canopy Growth (NYSE: CGC), could surprise investors at some point in the future with a sizable writedown.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Canopy Growth may not be the serial acquirer that Aurora Cannabis is, but it may soon get there. With the November closure of a $4 billion equity investment from Modelo and Corona beer maker Constellation Brands, the company ended the fiscal third quarter (Dec. 31, 2018) with more than CA$4.9 billion in cash and cash equivalents (almost $3.7 billion). This cash represented the bulk of Canopy’s CA$8.64 billion in total assets.&nbsp;” data-reactid=”83″>Canopy Growth may not be the serial acquirer that Aurora Cannabis is, but it may soon get there. With the November closure of a $4 billion equity investment from Modelo and Corona beer maker Constellation Brands, the company ended the fiscal third quarter (Dec. 31, 2018) with more than CA$4.9 billion in cash and cash equivalents (almost $3.7 billion). This cash represented the bulk of Canopy’s CA$8.64 billion in total assets. 

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="But if not for this equity investment, Canopy's CA$1.82 billion in goodwill would have stood out like a sore thumb and comprised a large percentage of total assets — though not quite as high as Aurora. The thing is, with CA$4.9 billion in cash and cash equivalents, Canopy Growth plans to spend, spend, spend to boost its market share. Much of this spending will likely be on acquisitions, such as its contingent right deal to buy Acreage Holdings&nbsp;for $3.4 billion in a cash-and-stock if, and only if, the U.S. federal government legalizes marijuana. As Canopy gets more aggressive on the acquisition front, its goodwill may further increase, raising the possibility of a future writedown.” data-reactid=”84″>But if not for this equity investment, Canopy’s CA$1.82 billion in goodwill would have stood out like a sore thumb and comprised a large percentage of total assets — though not quite as high as Aurora. The thing is, with CA$4.9 billion in cash and cash equivalents, Canopy Growth plans to spend, spend, spend to boost its market share. Much of this spending will likely be on acquisitions, such as its contingent right deal to buy Acreage Holdings for $3.4 billion in a cash-and-stock if, and only if, the U.S. federal government legalizes marijuana. As Canopy gets more aggressive on the acquisition front, its goodwill may further increase, raising the possibility of a future writedown.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content=" More From The Motley Fool ” data-reactid=”85″> More From The Motley Fool

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.” data-reactid=”90″>Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.

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