EY Expert: New Metrics in Cannabis to Dictate M&A Activity

The evolution of merger and acquisition (M&A) priorities in the cannabis industry is unveiling moving targets for companies and investors, according to one business expert.

In an interview with the Investing News Network (INN), Ashley Chiu, cannabis strategy advisor with EY Canada, discussed the state of M&A in the cannabis industry, touching on what kind of acquisitions companies are looking for right now and how a US entry could end up looking for Canadian players.

Overall one takeaway was clear: As players take the current financial conditions into account, the days of careless spending from big-name cannabis operations seem to be dwindling.

Chiu said capacity and low costs for producers, which were previously among the most desirable characteristics in the Canadian cannabis sector, have lost weight in comparison to value, quality and the price point of products heading into the market.

“You’re starting to see a lot of companies really reassess their capacity needs, looking at their international operations, trying to understand which markets are developed far enough for them to really make a meaningful presence,” Chiu said.

The expert thinks the difficulties in the financial landscape at the moment could push some of the smaller cannabis names in the public markets towards mergers as a way to strengthen their position.

“I think there might be some mid-tiers that are going to look at merging with each other to see if they have complementary assets and synergies that ultimately make the company better when they’re combined,” EY Canada’s Chiu commented.

International opportunities for Canadian companies

Even before the coronavirus pandemic threw the capital markets upside down, cannabis names in Canada were already scaling back bold international expansion plans.

Chiu said key advanced markets like Israel and Germany are still intriguing for various companies, but now entries or evolutions in presence for market participants that are already established may come by way of partnerships rather than outright acquisitions.

When asked about whether Canadian names may enter the US market at some point, Chiu told INN she is encouraged by the potential for reform in the country, but at the moment the only option she has seen is in the hemp businesses conducted by some Canadian producers.

Hemp-derived cannabidiol (CBD) has seen an explosion of interest in the US recently thanks to a technicality that makes it legal in the country.

However, the US Food and Drug Administration has failed to deliver specific guidelines for the compound and its products. At the same time, the drug agency has issued warnings to manufacturers for promoting false claims attached to CBD products.

Despite the potential that hemp-derived CBD holds in the eyes of many experts, Chiu said the US market is extremely complicated given the regulatory uncertainty and the fragmented status of the space.

“Without clear regulation, I think that environment becomes really difficult to operate in,” Chiu said.

Where are the Fortune 500 cannabis deals?

Long-term cannabis investors will remember rumors that the likes of PepsiCo (NASDAQ:PEP) and even The Coca-Cola Company (NYSE:KO) were exploring acquisitions of Canadian producers.

While a select group of large corporations have made entries, such as Constellation Brands (NYSE:STZ) and Altria (NYSE:MO), the expected stream of Fortune 500-like companies coming in with fast and splashy cannabis entries didn’t really take place.

Chiu said in the early days of cannabis investment there was a big question around the benefits of being a first mover from the perspective of big outsider companies.

As the industry stands now, with all the challenges it has gone through, Chiu said she is encouraged by the next stage of entries.

“The next entry will be a lot more meaningful and a lot more targeted now that we know there is that second mover advantage,” the EY Canada expert told INN.

“I would say that I do think that there will be more entries from these adjacent players, the more well-capitalized, more mature, more established companies, but it’s really going to take more milestones I think that we need to hit before that happens.”

What could drive cannabis M&A in Canada

When discussing the interest in acquisitions and what could motivate a deal in cannabis right now, Chiu said while intellectual property (IP) or brand-based transactions could still be key, it’s important to consider the power of both an IP option or any given brand.

“Looking across the industry right now, I think there are a few companies that have been able to continue to build their brand and create that value for their consumers,” Chiu told INN.

However, that can’t be said for all marijuana companies. A recent report from the Brightfield Group confirmed what many Canadian cannabis market observers have been thinking, which is that brands are not really creating relationships with consumers just yet.

After surveying 3,000 Canadian consumers, the group showed that no brand obtained more than 41 percent recognition. Most did not even break through over 15 percent.

“When product options increase and brand awareness remains low, consumers get confused. They can get decision fatigue when they do not see a product that aligns with their complex purchasing decisions,” the Brightfield Group said in its report.

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Securities Disclosure: I, Bryan Mc Govern, hold no direct investment interest in any company mentioned in this article.

Editorial Disclosure: The Investing News Network does not guarantee the accuracy or thoroughness of the information reported in the interviews it conducts. The opinions expressed in these interviews do not reflect the opinions of the Investing News Network and do not constitute investment advice. All readers are encouraged to perform their own due diligence.