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Smoldering cannabis in front of Canadian flag

Slow burn: Cannabis sector may be ready for market consolidation

Monday, February 01, 2021 @ 2:24 PM | By Brandon Schupp and Nader Hasan


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Brandon Schupp
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Nader Hasan
Mergers and acquisitions (M&A) activity slowed significantly during the first half of 2020 as the COVID-19 pandemic impacted capital markets, but the second half of the year saw a surge in M&A activity that is expected to continue into 2021. One industry that may be particularly well primed for M&A activity in 2021 is the cannabis industry, where market consolidation is already underway.

The cannabis industry has long been expected to undergo significant market consolidation. Even prior to the legalization of recreational cannabis in Canada, research by Ernst & Young indicated that some industry executives believed that consolidation was inevitable and would leave only a few large players to operate in the post-legalization cannabis market. As of this writing, however, there are still a large number of licensed cannabis producers in Canada.

One factor that has likely contributed to the delay in market consolidation has been the unpredictable valuations of Canadian cannabis companies. When the Canadian government was preparing to legalize recreational cannabis in 2018, valuations of Canadian cannabis producers soared. However, these lofty valuations trended downward almost immediately following legalization, due at least in part to insufficient supply and government regulations that slowed the rollout of retailers. By the end of the first year following legalization, investors in Canada’s 10 largest cannabis producers had yielded an average negative return of more than 50 per cent.

This unpredictability surrounding the valuations of cannabis companies created a more difficult environment for deal-makers in 2019, and M&A activity in the cannabis sector slowed significantly relative to 2018. Then, the COVID-19 pandemic and the resulting economic challenges brought M&A activity in the cannabis industry to a virtual standstill in the first half of 2020.

An additional factor which may have had a cooling impact on M&A activity was the elimination of Ontario’s lottery system for awarding cannabis retail licences. Following legalization, Ontario used a lottery system to award a limited number of licences to operate retail cannabis stores. The resulting difficulty in entering the market drove some M&A activity, as buyers sought to gain market share by acquiring existing retail operations. However, the lottery system was eliminated in 2020 in favour of allowing prospective retailers to apply for licences on a first-come-first-served basis. The elimination of this barrier to entering the market may have reduced the incentive for prospective retailers to acquire existing businesses.

However, it appears that the lull in M&A activity in the cannabis sector may be reaching an end. Following the recent announcement that two Canadian cannabis producers (Aphria Inc. and Tilray Inc.) will merge to form the world’s largest producer, some analysts are predicting that the transaction will kick off a cascade of M&A activity as other producers make deals in order to remain competitive. Market consolidation could be further fuelled as share prices of cannabis producers recover from the low points seen during the peak of the pandemic, allowing deal makers more flexibility in negotiating and closing transactions. Finally, some have suggested that the election of Joe Biden — and the increased prospect of legalization in the U.S. — may further drive M&A in the cannabis sector as Canadian producers seek to gain market share in the U.S. recreational market.  

For all of these reasons, it appears that the Canadian cannabis sector may be primed for M&A activity in 2021.

Brandon Schupp is an associate with Norton Rose Fulbright with a focus on securities, mergers and acquisitions, corporate governance and shareholder activism. Nader Hasan is an associate in the M&A and securities group and a member of the Canadian special situations team at the firm.

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