3 Takeaways From Aphria Inc (TSE:APHA) Divestiture of Liberty Health Sciences

Benjamin A. Smith
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In a stunning turn of events this evening, Aphria Inc (TSE:APHA) (NYSE:APHA) (FRA:10E) has divested their entire interest in Liberty Health Sciences (LHS). The maneuver represents a poignant conclusion to a sticky investment first cemented via Aphria’s $25 million investment in LHS almost two years ago.

The action was initiated by Aphria’s independent members of its Board of Directors. They unanimously approved the early termination and liquidation of a promissory note, option and other agreements related to the company’s previously announced divestment on Liberty Health Sciences on September 6, 2018.

That agreement granted Aphria a five-year promissory note due September 6, 2023—bearing interest at 12% per annum—in exchange for relinquishing control to 64,118,462 LHS shares to the new purchasers. The shares were to be held in escrow for five years until such time as: 1) the promissory note was repaid; 2) Aphria exercised their option to re-acquire the shares upon cannabis attaining legal status on the federal level.

With today’s announcement, neither of those options will come to pass. In fact, Aphria took a “penalty” for exiting the arrangement, receiving $47.4 million of the $59.1 million in LHS shares originally placed in escrow (ex-advising fees). The Leamington-based licensed producer has an opportunity to “earn” the extra $10 million back if Liberty buyers monetize the shares underlying the terminated option within six months.

With its 3.4 times cumulative return on investment in Liberty Health Sciences, Aphria walks away with more than a sound investment. Below are three key takeaways from the disunion, which is sure to have a material effect on LHS’s stock price (in particular) this morning.

Aphria Continues Shedding Past Ties

With this move, it becomes ever more clear that Aphria is shedding past associations. Since the Special Committee was formed on December 6, 2018, the company has parted ways with no less than four material parties.

If you recall, Aphria was a founding investor in Liberty Health Sciences—the brainchild of a three-way amalgamation between SecureCom Mobile Inc. and DFMMJ Investments Ltd.—in April 2017. In connection with the business combination, Aphria plunked down aggregate gross proceeds of $25 million in DFMMJ, thus becoming a pivotal player in the new entity.

However, DFMMJ Investments was also an entity founded and controlled by the Delavaco Group, lead by then Chief Investment Operator and Director Andy DeFrancesco. Mr. Defrancesco was recently in the limelight following Hindenburg Research’s nasty short-seller report focusing on LATAM assets, to which he was inextricably connected. Aphria proceeded to lose over $1.2 billion in market capitalization in the days following the report, after being accused of purchasing over-inflated assets from third party purveyors. The report has since been largely debunked.

Andy also had deep ties with the Serruya Family, having done investment banking and strategic advisor work for the Serruya’s in the past. In 2005, Mr. DeFrancesco went on to become Chief Investment Officer of the Serruya Family Office, which led to his roles in Epsilon Energy. In 2013, Mr. DeFrancesco & the Delavaco Group—along with Serruya Private Equity—injected $6.2 millions founding investment in Aphria.

The Serruya Family are currently the largest shareholder in Liberty Health Sciences.

As we can see, the connections between LHS, Andy DeFrancesco, Aphria’s founding investment and the Serruya family run deep. By severing this connection, Aphria essentially relinquishes some of its past, while realizing a sizable gain on its balance sheet.

Whether distancing itself from its past purveyors was a primary goal is unclear. But given that LHS is yet another disassociation Aphria has chosen to pursue, the evidence is starting to mount.

Passive Interest Means Little Control

Once upon a time, Aphria’s stake in Liberty Health Sciences was quite significant. In fact, Aphria held primary control in the combined entity upon the business combination (LHS) being formed (37.56%). That qualified as an active minority interest (20-50% ownership), in which the stakeholder has the ability to materially influence the majority enterprise.

(SecureCom Mobile and DFMMJ Investments Announce Definitive Agreement for Business Combination…, April 4, 2017)

But through bought deals, acquisitions, and share divestitures, Aphria’s stake had been declining. Even with 64.2 million shares placed in escrow in September, the company’s overall stake became a passive minority interest—defined as owning less than 20% equity in the majority entity—thus giving Aphria little say on LHS affairs.

With minimal ability to exert influence, and U.S. cannabis legalization perhaps not slated until after the next presidential election, Aphria’s stake in LHS was really one of passive investor—or “non-essential holding” in company parlance. Thus, it seems that the Board of Directors viewed the investment as trapped equity in a company it wasn’t destined to control anyway.

Such investments are always at risk of the chopping block once greater priorities are identified.

Does LHS Becomes A Potential Acquisition Target?

A potential winner in this scenario could be Liberty Health Sciences, which presumably becomes an acquisition target now that the specter of foreign LP control has been removed.

Why? Because LHS is the fourth biggest player in a state with an exploding medical patient roster. According to the OMMU, the number of active medical cannabis patients has nearly tripled, from 56,537 to 159,107 between December 1, 2017 and December 1, 2018. Dry flower and equivalent sales totaled well over $325 million in the first nine months of 2018, up considerably from an estimated $20-$40 million in 2017. The state’s high senior population—among the fastest segment of cannabis users—and snowbird population makes Florida a high per capita medical cannabis user state. The company also has burgeoning operations in Massachusetts and Ohio.

Whether other friendlies step up is pure supposition at this point. LHS is among the cheapest significant public or private Florida acquisition options, with Trulieve Cannabis and Curaleaf Holdings well into 10-figure market capitalizations. Even private Surterra Wellnesswith 23 dispensary locations in-state—is surely within 10-digit market cap territory should it decide to go public. Either way, Aphria’s exit opens the possibility that another player may attempt to pony-up to jump into a very important medical market.

Midas Letter will be following this narrative closely in the weeks and months ahead.

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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