Coca-Cola Will Enter the Cannabis Market

BNN Bloomberg broke a story on Monday reporting that Coca-Cola is in advanced talks to create infused beverages with the third-largest licensed producer, Aurora Cannabis.

What is especially interesting about the tie up is that it’s rumoured to focus on infused beverages in the “recovery category”, drinks infused with cannabidiol only, or CBD, the active ingredient known to reduce inflammation and pain.

Beverage deals in the cannabis space so far (Miller Coors, Constellation Brands) are focusing on THC-infused drinks meant to give consumers the characteristic marijuana buzz from a smoke-free product.

In Grizzle’s opinion, the medical qualities of CBD will open up a much larger market opportunity over time compared to the smaller THC market focused on getting consumers high.

CBD derived from hemp is much cheaper and easier to grow than traditional cannabis strains and currently commands similar retail prices.

Market Impact

The deal is far from certain with Coca-Cola issuing the following statement:

We have no interest in marijuana or cannabis. Along with many others in the beverage industry, we are closely watching the growth of non-psychoactive CBD as an ingredient in functional wellness beverages around the world. The space is evolving quickly. No decisions have been made at this time. 

Not to mention Aurora is far from cheap, trading at a 30% premium to the group.

Regardless of the rumours, the eventual entrance of a global consumer giant like Coca-Cola into the cannabis market will add an air of legitimacy that even Constellation Brands can’t match.

If an industry heavyweight like Coca-Cola is willing to risk its reputation and create cannabis-derived products, the list of companies that are likely looking to buy into the sector is hundreds deep and will stoke continued M&A upside to licensed producers who are still independent.

Packaged food, beer, wine, liquor, water, the list goes on; if you operate in these product categories you are looking to jump start growth with cannabis.

 

Not a Slam Dunk for Aurora

Aurora’s stock will no doubt be up for the day on this news, but the structure of a potential deal will speak volumes about how outsiders view cannabis valuations.

HEXO was up 13% on the day the Molson JV was announced, however the stock gave up all of those gains over the next two weeks. The market does not like minimum commitment deals.

Any deal should be judged on a scale where the Constellation-Canopy deal is at the top and HEXO-Molson is at the bottom.

If Coca-Cola is willing to pay cash for a direct equity stake in Aurora, similar to how Constellation Brands invested in Canopy Growth, it signals that outsiders view cannabis valuations as reasonable.

However, if the deal is a joint venture, similar to the Molson and HEXO tie up, it signals Coca-Cola is non-committal and does not want to risk a loss of capital.

If the deal is structured as a JV, as we expect due to valuation, Aurora may have handicapped the stock in a rush to announce a deal with a global giant.

In the stock market, when you do low value partnerships you effectively take yourself off the market.

Cannabis is a high growth industry and when outsiders are circling looking to dance do you want to be married or do you want to be single and ready to mingle for as long as possible.

We think the answer is self explanatory.

 

Aphria Talks Broke Down Because Aphria Drives a Hard Bargain

The BNN article also quoted a source saying Coca-Cola was in talks with other players, specifically Aphria, but the talks did not progress.

Investors may remember Molson also held talks with Aphria this summer but eventually moved on to HEXO.

So what happened?

Knowing the management team, we think Aphria likely walked away from both deals due to deal terms and a structure that was unfavourable for investors (already vindicated by the wishy-washy HEXO deal).

The Aphria management team has shown time and time again that they are shrewd operators who try to squeeze the most value out of every partnership they sign.

They are likely holding out for an acquirer who is willing to buy the company outright or put a significant amount of capital and intellectual property into any partnership.

As owners of Aphria, at this early stage of cannabis M&A when potential buyers outnumber sellers, we think waiting for the perfect deal will be a profitable strategy for all stakeholders.

 

Only Three Solid Pure Play Targets Left

With Canopy Growth and HEXO likely off the market and Aurora soon to follow, the potential list of pure-play cannabis players is shrinking by the day.

If corporations want to get into cannabis, we think there are only three strong options left that remain priced at reasonable multiples of cashflow.

Aphria (TSE: APH)

Aphria has a global reach with cultivation assets, distribution partnerships, and retail brands spread all over North America, South America, Europe, and Asia.

Aphria is the only way an outside company could gain immediate access to a deep product development pipeline, global distribution, and high growth retail brands all at once.

Not to mention Aphria trades at a 35% discount to the average group multiple, has the lowest cost structure in the industry, and is run by the best cannabis management team in the business in our view.

CannTrust (TSE: TRST)

CannTrust just makes sense as a beverage play, possessing the deepest product pipeline and the most experience processing and selling high quality cannabis oil, the main ingredient in an infused beverage.

CannTrust is one of the first Canadian companies to receive infused beverage patents for their brewBudz line of coffee pods and possess patent-pending technology created specifically for dissolving cannabis oil into all types of beverages.

CannTrust trades at a 50% discount to the group and presents a clean way to buy into the infused beverage market for an acquirer.

Organigram (CVE: OGI)

Organigram is another clean pure play cannabis grower trading at a deep discount to peers like Canopy, Aurora and Tilray.

Organigram trades at a 50% market discount and has the second lowest cost structure in the industry behind Aphria.

Supply agreements are signed with four provinces and sales channels are established into Europe and Australia.

To an acquirer, Organigram is a discounted way to buy a reliable source of cannabis along with the distribution infrastructure to sell future cannabis products to consumers globally.