Is Aphria Inc The Front-Runner In The Molson Coors Sweepstakes?

Benjamin A. Smith
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Late in the Friday afternoon trading sessions, a very material press release was floated that could portend dramatic impact for Aphria Inc (TSE:APH) (OTCMKTS:APHQF) (FRA:10E) or a plethora of potential suitors. It appears that Big Alcohol is angling to enter the cannabis space in a big way. We brake down the details of the release, and analyze our perceived front-runners in talks which should have a transcendent effect on the sector.

At approximately 2:00pm on June 22, a major network business outlet disseminated that Molson Coors Brewing Company—the giant multi-national brewing conglomerate—was in serious and ongoing talks with several Canadian-based cannabis LPs to invest and collaborate on future cannabis-infused beverages. This gambit is undoubtedly in response to Molson’s flagging global sales, and previous declaration that cannabis was a major “risk factor” in the company’s annual financial report.

Facing an unstoppable declining growth paradigm, Molson has decided to take action. The company has reportedly spent the past six months engaged with at least four separate cannabis companies—two of which are said to be Aphria and Aurora Cannabis Inc. The other two suitors were not disclosed, but we have our suspicions.

With that top-line summary of events in hand, we put our qualitative analyst hats on and attempted to decipher which cannabis LPs make the most sense in any prospective Molson Coors partnership. Ultimately, we narrowed the field down to two likely candidates—and the rest of the field.

Aphria Inc.

In my judgement, Aphria has pole-position in current partnership discussions. The reasoning just fits from a quantitative and circumstantial perspective, dating back to the company’s June 6th $225 million bought deal financing.

Beyond the extra capacity increase at Aphria Diamond, the financing’s other stated objective was to construct a state-of-the-art Extraction Center of Excellence. Aphria even dedicated a separate press release singling out the $55 million capital project, to be equipped to conduct a wide range of cannabis extractions, including C02, butane and ethanol, and produce world-class cannabis concentrates, including fractionated distillates.

Upon completion, the facility would be among the most advanced cannabis extraction labs in the world—ideal for research and development capabilities for the emerging beverage-infusion industry. It’s hard to imagine Aphria dedicating this many resources on money-losing R&D operations instead of revenue-reoccurring grow capacity unless there wasn’t a specific plan in place.

Secondly, there’s the more circumstantial—yet relevant—’where there’s smoke there’s fire’ scenario.

Consider that on June 6, Aphria was halted due to their impending bought deal announcement (stock halts on such circumstances are exceedingly rare, however large). Coincidentally, so was Molson Coors on the flimsy excuse that the company remained “committed” to its 2018 guidance ranges. Since when do Fortune 500 company shares get halted on such yawning pretext? Did Aphria and Molson Coors come to a last-minute decision to hold off on announcing a partnership until royal assent was officially granted?

Furthermore, just nine days later, Aphria announced former Molson Coors and current industry executive Joel Toguri as Vice President of Sales effective on June 18, 2018. While they could have simply wanted the best candidate for the position—irrespective of industry type—the move seemed to imply a targeted motive behind it. 

Additionally, consider Moors Coors (NYSE:TAP) robust stock performance since the time of Aphria’s $225 million bought deal. The stock has appreciated around ↑13.99% since June 6—well beyond any of its industry peers. TAP has only incurred two losing sessions over the last thirteen; this, coming off it’s worst aggregate percentage swing losses since 2009.

Whether this performance is simply a fortuitous oversold bounce, or insiders purchasing shares anticipating a significant catalyst on the horizon, we cannot say. But the smoke billowing from under the blanket is unmistakable.

If quantitative evidence is your bag, there’s plenty of that also. Aphria will be churning out 240,000 kg annually by next summer, has significant (or imminent) grow operations in both Europe and South America. The later locations are important future target markets for Molson Coors.

Also consider that Aphria is poised to become the lowest cost LP in the industry. CEO Vic Neufeld is on record estimating cost-per-gram will brake below $0.70/g once full production takes place. Most other qualifying LPs are closer to $0.80-0.95 range.

Such cost certainty gives Aphria an important cost advantage, where input costs largely drive unit margin expansion or contraction. So does its international supply pipeline, located in and around Molson’s other targeted geographic zones. Aphria looks to be among the few LPs that can satisfy confidence that both cost certainty and supply will remain constant.

In light of all this evidence and source disclosures that Aphria in among the leading candidates at the table, it’s difficult to bet against their chances of closing.

The Hydropothecary Corp.

In my judgement, the other potential suitor is a name not mentioned in BNN Bloomberg’s catalyzing article—Hydropothecary. We actually laid out the case on May 21, in a well-received piece that remains just as relevant today. Thus, the following verbiage will focus on a top-line summary of key synergies between a potential partnership. For more in-depth description, please read the original article.

To summarize, there are several elements which could drive Molson Coors to stake a position in Hydropothecary.

The first is culture. Both companies are cut from the same cloth in terms of business genesis in the province of Quebec; both have significant francophone-origin employees and operating history.

The second is logistics. The second reason is logistics. Hydropothecary’s  primary 250,000 square foot grow facility is strategically located in the center of the prime southern Ontario-Quebec City corridor, in Gatineau, Quebec. Once the 1 million sq. ft. expansion is complete in December 2018, the facility will yield 108,000 kg/annually—ample for the company to fulfill it’s 35,000kg/annum supply deal with SAQ and service the R&D requirements of Molson’s product designs.

The third reason is product quality. If Molson Coors is looking for a “high quality product that isn’t going to embarrass them”, Hydropothecary certainly fits the bill. Both companies would be on the same wavelength in terms of cannabis onset/offset design and product innovation. The company is on record stating elucidating its hyper-focused on creating a product which maintain rapid onset effects, as well as a predictable (and short) offset to baseline. These qualities are exactly what Molson Coors will be seeking in any cannabis-infused product—although that’s hardly an industry secret at this juncture. Watch (starting at around 4:00).

The Hydropothecary Corporation CEO Sebastien St. Louis talks about the company’s “Holy Grail” driving focus and forward-thinking consumer product development

In the end, it just might come down to what Molson Coors values most. If it’s seeking the absolute lowest input costs, presumed international supply, scale, and forward visibility, Aphria likely wins out. Molson’s does have brewery presence in Ontario and a corporate office in Toronto, so the logistics of a potential partnership doesn’t disfavor Aphria either.

However, if culture, investment bang for the buck (HEXO is around 2.5x less expensive on a market cap basis) and recreational product innovation/synergies are the primary focus point, Hydropthecary might have a shot—presuming they were in the race all along. Remember, it will be many months before any such cannabis-infused product becomes commercially available in Canada. There’s plenty of time for Hydropothecary to enter international markets and establish grow operations to service Molson Coors future needs—even if that road map is currently muddled.

The Darkhorses

Aurora Cannabis Inc., Green Organic Dutchman Holdings Ltd., Canopy Growth Corp. (conflict of interest with Constellation Brands Inc.?)

– All have limiting factors hindering a potential Molson Coors partnership. Aurora seemingly doesn’t offer comparable value to TAP shareholders. With the float about to balloon to close to 1 billion shares, a significant stake will be hard to afford for the relatively cash-strapped company. Of course, they could issue more shares in the capital markets, but why would they? Almost all of Aurora’s recent acquisitions or partnerships have focused on procuring medical assets. A large swing to recreational R&D seems out of range and concentration, although nobody should ever count the company out.

TGOD is making hay in the extractions business but doesn’t offer the type of production scale or cost structure that makes sense. The company is also known for its premium organic growing business model, which doesn’t lend itself to low input costs.

Final Thoughts

While BNN Bloomberg’s sources cited that “deal could be announced before the end of the year”, this conclusion strikes me as odd. Why float this press release on a Friday afternoon, the day after Bill C-45 received royal assent if talks weren’t at a very advanced stage? This isn’t the type of release that’s thrown out there for public consumption by accident, and with a trigger-point months away.

Also, we posit that Molson Coors disadvantages itself the longer it waits on the sidelines. We understand that corporate decisions of this magnitude with international conglomerates generally move slowly. But with legal & legislative risks largely removed from the equation—and with its stock up ↑18.26% from its disastrous May 2 earnings release low—now may be the time to put shareholder capital to work. They’ve already been conducting due diligence for six months; what left is there to analyze?

Waiting only forestalls the considerable task of bringing a commercially viable product to market before their competitors. And there’s a lot to think about: the solubility challenge of water-phobic CBD/THC concentrates; the natural separation of ingredients upon storage (shelf life); the thousands of trials needed to get taste and texture just right; engineering a proper onset/offset time between contrasting active ingredient characteristics; and of course, the product-specific Health Canada approvals that will be required after once become legal in late 2019.

In short, there’s an abundance of hoops to work through before a viable commercial beverage is born. By waiting any longer than it needs to, Molson Coors puts a potentially lucrative first-in advantage at risk. Becoming the first commercial brewer to come to market and establishing an brand recognition should generate an immense marketing and branding advantage that would be difficult for competitors to overcome.

Such power-positioning shouldn’t be squandered—especially with Bill C-45 and market trends so well-telegraphed in advanced. Consumer trends are very well understood at this juncture, and the conclusions are obvious. There are very few disqualifying surprises left, presumably.

Thus, we expect a partnership announcement sooner rather than later. Perhaps Molson Coors have already decided, and the trial balloon press release was just one last chance to give pundits and stakeholders their say. Perhaps they are just gauging the public’s temperature, similar to what government’s do when they contemplate initiating innovative new policies. Only insiders know for sure.

But for investors of Aphria, The Hydropothercary and the darkhorses, the Molson Coors sweepstakes must sadly conclude with only one happy ending.

Benjamin A. Smith

Benjamin A. Smith

Ben is a research analyst and capital markets professional with nearly 20 years of experience. His areas of expertise are broad-based, and include extensive knowledge of macro economics, stock/derivative trading, commodity complexes, cryptocurrencies and technical/quant analysis. He also maintains an particular affinity for U.S. politics and the macro-regulatory environment facing...
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