The plan for Cresco Labs Inc. (CSE: CL; OTCQX: CRLBF) to acquire CannaRoyalty Corp. (CSE: OH, OTCQX: ORHOF), more commonly known by its d/b/a name Origin House, has cleared the final regulatory hurdle, but uncertainties remain.
Based on the language in the press release the parties now have some negotiating to do before a deal can be finalized.
Considering Cresco Labs stock is down 50% since the deal was announced in April, Origin House investors are selling the company for C$550 million instead of C$1.1 billion, or 50% less.
To handicap the outcome of this deal it helps to look at the negotiating positions of Origin House and Cresco.
Reasons the Deal Will Close
- Origin House is on the hook for a C$45 million breakup fee it can’t afford, giving it a weak negotiating position.
Origin House had $15 million of unrestricted cash as of June so even with the C$33 million debt deal in July and other borrowing, the quarterly cash burn of C$18 million means the cash balance will be far below C$45 million as of October.
So on the one hand Origin House stockholders are probably pissed they have to sell the company for 50% less money, but it is a far better outcome than pulling out of the deal and in the process bankrupting the company.
Better to walk away with C$550 million than nothing.
- Cresco is paying out the same number of shares regardless of the company’s stock price. If they liked Origin House’s assets then they should still like them now.
There is no reason on Cresco’s end to kill the deal because of stock price performance. They are still facing the same amount of share dilution as in April.
Reasons the Deal Won’t Close
- Origin House management is not too keen on giving up the company for 50% less than in April. They could potentially find a way to legally kill the deal while avoiding the breakup fee.
- Cresco could have found a better use for the shares earmarked for Origin House since the deal was announced in April.
- If Cresco can’t convince Origin House to accept a C$550 million valuation, there is nothing stopping them from walking away.
- If Cresco pays more than C$550 million for Origin House, they will have to increase the share payout, diluting shareholders further, something management may want to avoid.
Summing it Up
Looking at the puts and takes, we think the deal will ultimately close, but at a price closer to C$550 million than C$1.1 billion.
The breakup fee is too high for Origin House to walk away.
Also, if Cresco hasn’t walked away from the deal yet, especially after clearing the Department of Justice, we think it’s likely they do want the Origin House assets at the end of the day.
Now that the deal has made it past the Department of Justice gatekeepers, it’s all on the management teams to shake hands or go their separate ways.
Looking at the spread between the deal price and the current price, Origin House is trading 30% below where it should if the deal was 100% certain.
If the deal does close, current Origin House investors stand to make a quick 30%.
Based on the facts, we think buying Origin House stock at a 30% discount or higher offers a potentially attractive risk/reward for investors.
Potential Return for Origin House Investors if the Deal Closes
Details of the DOJ Response
An amended request for additional information was sent out from the U.S. Department of Justice (DOJ) Antitrust Division last month, which saw the timetable for the acquisition pushed forward.
Both companies submitted their responses last month, after which a mandatory waiting period was put into effect under the terms of the Hart-Scott-Rodino (HSR) Antitrust Improvements Act of 1976.
Now that the DOJ has not required any additional information from either company in regards to the acquisition, the waiting period has officially ended and the acquisition can move forward to its next phase.
Discussing the deal’s anticipated closing later this year, Origin House Chief Executive Officer Marc Lustig commented:
Cresco Labs buying out Origin House in a deal valued at over $1.1 billion will be one of the largest U.S. cannabis acquisitions since legalization began to arrive piecemeal state by state for both recreational and medical usage.
DOJ secondary requests for information and subsequent HSR waiting periods have been a frequent occurrence over the last year as cannabis entities have seen a number of acquisitions and mergers.
Harvest Health & Recreation, Inc. (CSE: HARV; OTCQX: HRVSF) is currently in the waiting period process before closing acquisitions of Falcon International Corp, CannaPharmacy Inc, and Verano Holdings LLC.
Rival U.S. producer MedMen Enterprises Inc. (CSE: MMEN; OTCQX: MMNFF) was going through an HSR waiting period last month for a planned buyout of PharmaCann, although that deal ultimately fell through and was cancelled earlier this month.
In other Cresco news, the company was just granted early adult use licensing for the upcoming recreational market due to open in Illinois starting Jan. 1, 2020.
The company has seen a major decline in its stock price since April, although Cresco does represent an anomaly in the cannabis industry as the stock is very close to its price from this same time last month, indicating prices may finally be stabilizing after a turbulent year.