As the cannabis industry adapts to its new regulatory environment following the DEA's announcement it would move to reschedule cannabis, a recent report from Viridian Capital Advisors suggests a significant uptick in mergers and acquisitions (M&A) activity is on the horizon.

Increased Benefits For Tier 1 Mult-State Operators

The analysis highlights a crucial trend in the valuation gap between Tier 1 multi-state operators (MSOs) and smaller entities, which has widened to a three-year high.

Ordered by market capitalization, tier 1 MSOs include Curaleaf Holdings (OTC:CURLF) at $4.15 billion, Green Thumb Industries (OTC:GTBIF) at $2.98 billion, Trulieve Cannabis (OTC:TCNNF) at $2.10 billion, and Cresco Labs (OTC:CRLBF) at $718.51 million, among others.

This disparity means that M&A has become increasingly accretive for larger companies. In simpler terms, larger companies can now achieve more growth through acquisitions than before, as they can purchase other companies at relatively lower prices compared to their market value.

Capital Cost Dynamics Alter Bargaining Power

The report also indicates a growing differential in the cost of capital, which is beginning to favor the larger, publicly traded Tier 1 MSOs.

This means these companies now face lower costs when raising funds compared to their smaller, often privately-held, counterparts. This financial leverage shifts the bargaining power significantly towards the larger MSOs, making it easier for them to pursue and close deals.

According to Viridian, these dynamics are setting the stage for a robust period of consolidation in the industry, particularly as smaller competitors, worn by prolonged market battles, look increasingly to exit.

The report also notes the second half of 2024 and the beginning of 2025 are expected to witness a notable rise in M&A activities, fueled by the strategic use of elevated public company stock prices and healthier cash balances.

Viridian's chart illustrates a notable decline in M&A activity within the cultivation and retail sector in the first half of 2021, shown by the green bar indicating a decrease in total transaction value. This downturn was largely influenced by falling equity prices, as indicated by the orange line representing the MSOs ETF price and a tightening of capital markets, which led MSOs to conserve cash rather than pursue expansion. However, the report suggests an impending reversal of this trend.

Shift Towards Equity In Deals

Amid a slow climb in equity prices due to the anticipation of Schedule 3, larger companies are finding it more advantageous to use their stock as currency for acquisitions rather than raising new capital through markets.

This shift is largely due to the sluggish pace of banking reforms and legislative updates, making cash harder and more expensive to obtain. As a result, the report notes equity, not cash, is becoming the preferred method for financing M&A activities.

Pro Tip

Companies may opt to use equity over cash for mergers and acquisitions to leverage high stock prices, preserving cash for operational needs and mitigating new debt risks. The optimal time for equity-financed M&A is typically when a company's stock price is robust, coinciding with favorable market conditions or positive industry news that boosts investor confidence.

However, this method can lead to shareholder equity dilution if not managed carefully, potentially causing a drop in stock price if the market perceives the issuance as excessive. Issuing new shares increases the total shares available, enhancing liquidity and potentially attracting more investors, although it risks negative perceptions affecting stock value.

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If you're interested in gaining a deeper understanding of cannabis mergers and acquisitions and their impact on investment opportunities, don't miss the opportunity to join us at the 19th Benzinga Cannabis Capital Conference in Chicago this October 8-9. Engage with top executives, investors, policymakers, and advocates to explore the future of the industry. Secure your tickets now before prices increase by following this link.