Aphria has been signaling their intention to acquire a Consumer Packaged Goods company that was not tied into Cannabis for several quarters.  They did that with this acquisition, but from going through Sweetwater’s website they are very much (but not wholly) branded to cannabis. (From perusing their website, fishing is more prominent to cannabis in their branding.)

420 Extra Pale Ale, Hop Hash, Jack Herer Harvest Ale, Mango Kush Wheat Ale, Trainwreck Double IPA, Dank Tank Series Fresh Sticky Nugs, amongst other non-cannabis labels in the portfolio.  They even have a very large 420 annual concert weekend that draws 100,000 a day in Atlanta, Georgia.

Aphria will be paying USD $300 million of which $100 million is term debt, $150 Million cash and $50 million in shares.  There is a possible further $66 million earnout by 2023 if EBITDA (currently $22 million) gets to $30 million. 

This is a not a standalone “we are entering craft beer” play, but they will use Sweetwater to enter CBD (hemp not cannabis for now) in beverages and then THC as it becomes permissible across the USA.  Their only brewery is in Georgia, which is not a legal THC cannabis state, and THC cannot travel across state lines.

Sweetwater sells in 27 US states, predominantly in southern US with a view to expanding to Northeast and Northwest via increase distribution channels.  These expansions were put on hold when covid struck.

Will THC be sold where liquor and beer are retailed?  Will venues in the US allow THC and CBD beverages and other formats?  The good news is this transaction does not rely on those to be answered “Yes” for it to be accretive, but the opportunity is there.  The 27-state distribution infrastructure can likely accommodate dispensary deliveries if eventually allowed. Can it also allow for no beverage formats? I assume there is some synergies.

As a finance guy, I am pretty agnostic about brands until the synergies/leverage prove out, and as a cannabis watcher, beverages really fail to excite me.  I am not sold on cannabis beverages gaining a large market share of the cannabis market in the next 3 years.  So, the fact that this transaction is EBITDA and EPS accretive resonates with me.   The fact that Sweetwater are increasing (annualized from Aug 2020 eight months) EBITDA (+4%) on a decrease in sales (-10%) despite covid is quite surprising given their own restaurant venue and many others venues have been impacted by covid (I have asked for a sales split between venue and home consumption, but that would be selective disclosure.  Hoping Carl incorporates that on the go forward in MDAs). Sporting a 40% EBITDA to sales percentage is encouraging, as is the reported lack of annual capital spend required to expand production.

I have been told that the multiple of 12.5X EBITDA purchase price is the lowest in the past 7 years in an acquisition in the craft beer industry.  I would reckon there was a covid discount.

I was thinking the transaction might have been conditional on the US election results, but CEO Simon indicated that he does not invest based on politics. 

As we have seen with Aphria in Canada, their brands are a large part of the discussion of their operational success.  They intend to both bring Sweetwater beer into Canada but also leverage Sweetwater in the US to be able to introduce their Riff, Solei, and Good Supply brands into the US consciousness before THC opens across the USA.

If I must list in ordinal manner the benefits of the transactions: 1) Accretive, 2a) Brands and 2b) Distribution … would be my call.  Why Distribution last? Again, CBD and THC beverages are not a major revenue source in any mature cannabis market. This is not CC Pharma, as that did not have the upside branding element Sweetwater possesses.

Canopy is looking to build out Biosteel recovery beverages in the US and Canada, alongside Acreage making Tweed beverages in Illinois and California for those respective markets.  That was a $48 million price tag for 70% of Biosteel with a lot of new promotional expenses with the signing of athletes and more recently the Dallas Mavericks.  Canopy have never indicated sales levels from Biosteel, but I would hazard a guess that they are very much south of Sweetwater, and Biosteel is licensing out beverage bottling whereas Sweetwater is in-house presently.

Which strategy is better?  Time will tell.  Canopy has the cash and luxury of building out the brand over time.  Aphria could not take a similar route without a lot more cash on hand. 

Constellation will provide Canopy with all the distribution and branding they can muster in the USA. Where the strategies diverge is that Aphria will leverage in from Beer and Setlzer, whereas Canopy is looking to presently build brands from ground up on cannabis.  Those existing Constellation brands will likely not make the leap until the US allows cannabis country wide, whereas Aphria has purchased a brewer that has incorporated cannabis in their branding already.  Constellation could develop a cannabis themed alcohol brand but that makes little sense if they believe that the USA opens in 2021-22.

Is this a good spend of USD 300 million?  Again, time will tell.  But I cannot see how it could be worse than Cronos USD 300 million for Lord Jones (Under USD 2 million in Q sales and operational losses of $12 million in today’s earnings release), or LATAM or NUUVERRA acquisitions by Aphria.  This is a tangible accretive acquisition with potential synergistic outcomes.  The success of the acquisition does not exclusively depend on execution on branding into cannabis products and to eventually leverage CDB/THC beverages and the underlying distribution to show the upside.

The preceding is the opinion of the author and is in no way intended to be a recommendation to buy or sell any security or derivative. The author has a position in Aphria and will not start one or divest in the next five days. The author has no position in any of the other mentioned companies and will not start one or divest in the next five days.