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3 Possible Buyers of Troubled Pot Stock CannTrust Holdings

Sean Williams, The Motley Fool

It's very possible that in a decade we, as investors, will look back on the cannabis industry as the greatest growth opportunity of our generation. After producing a mere $3.4 billion in legal worldwide sales in 2014, legal marijuana revenue neared $11 billion in 2018, according to the duo of Arcview Market Research and BDS Analytics.

However, in a decade's time, growth is really expected to take off. With Canada legalizing recreational weed this past October, and favorability toward legalization growing in the U.S., one Wall Street firm believes global annual marijuana sales could hit $200 billion.

But as investors, we also understand that not every company in a fast-growing industry will necessarily be a winner. Just ask investors (such as Yours Truly) of Ontario-based CannTrust Holdings (NYSE: CTST), which has lost close to three-quarters of its value since late March.

A folded hundred dollar bill, with Ben Franklin's eyes peering through the folds.

Image source: Getty Images.

The CannTrust scandal, explained

Although there are a number of reasons CannTrust's stock sank during the second quarter, including wider-than-expected losses tied to its outdoor-grow production project, as well as a $170 million shelf offering that diluted existing shareholders, the real kick in the pants was the admission earlier this month that the company had blatantly violated cannabis growing regulations.

For those of you who may not have followed the story closely, CannTrust announced that it had been growing marijuana in five unlicensed rooms between October 2018 and March 2019 at its flagship Niagara facility in Pelham, Ontario. These rooms were subsequently licensed in April 2019. As a result of this admission, Health Canada is holding 5,200 kilos of inventory from these rooms, with CannTrust placing a hold on another 7,500 kilos being held at its Vaughan campus, for a total of 12,700 kilos. Not long thereafter, CannTrust announced that it had also ceased sale operations, putting the company's future at a total standstill until Health Canada issues its punishment.

There are a number of possible outcomes for CannTrust at this point. It could get an effective slap on the wrist with a 1 million Canadian dollar fine, or it could lose the 12,700 kilos in inventory. Another possibility is a temporary suspension of its cultivation license, or perhaps a complete revocation. Having what could be the third-largest producer subvert regulations is unprecedented, so it's really anyone's guess what happens at this point.

Three white knight suitors that could acquire CannTrust on the cheap

However, one idea I'd suggested shortly after the scandal was announced was the possibility of a lowball buyer emerging. On Thursday, BNNBloomberg in Canada announced that the hunt has begun for a possible white knight buyer of CannTrust -- the idea here being that an acquirer's license would not be revoked, thereby allowing CannTrust to continue its operations. Of course, buyers are likely to be hesitant of a purchase until the full scope of the penalty from Health Canada is known. 

With the understanding that this is completely hypothetical and no buyout may occur, here are three pot stocks that could be the perfect suitors to gobble up CannTrust at a depressed price.

An up-close view of a flowering cannabis plant growing in an indoor farm.

Image source: Getty Images.

Cronos Group

I've previously opined that one of the smartest ways Cronos Group (NASDAQ: CRON) could put its cash to work is by acquiring CannTrust. Since Cronos Group received a $1.8 billion equity investment from tobacco giant Altria for a 45% nondiluted stake in the company, it has more than enough capital to buy CannTrust as an all-cash or cash-and-stock deal.

Buying CannTrust would make sense in three respects for Cronos. First, CannTrust is one of four Canadian growers that has supply deals in all 10 Canadian provinces. Cronos isn't there yet, but could quickly buy its way into potentially lucrative supply deals by acquiring CannTrust.

Secondly, Cronos has a particularly strong focus among Canadian growers on the derivatives market. Of the 200,000 kilos to 300,000 kilos of peak annual output that CannTrust intends to grow, some 100,000 kilos to 200,000 kilos will be outdoor production. Outdoor marijuana typically isn't of the highest quality, and is thus perfect for extraction purposes. With Cronos having plenty of extraction deals set up, adding CannTrust could further cement Cronos Group's supply of cannabis for extraction purposes.

Lastly, don't overlook the fact that Cronos Group isn't a top 10 cannabis player, if royalty companies and joint ventures are considered. By purchasing CannTrust, Cronos Group's peak annual output would be among the top five in Canada and solidify it as a top-tier player.

A person holding a vial of cannabidiol oil in front of flowering cannabis plants.

Image source: Getty Images.

Green Growth Brands

Although I consider it the longest shot of the three to acquire CannTrust, Green Growth Brands (NASDAQOTH: GGBXF) could make for an interesting suitor, even though they both have almost identical market caps.

For those who may not recall, Green Growth Brands aggressively pursued Aphria (NYSE: APHA) at the beginning of the year after a short-seller report alleged fraud at Aphria in December. An internal review found that Aphria had not overpaid for its Latin American assets, as the report alleged, but it did uncover conflicts of interest that eventually led a few Aphria executives to step down, including longtime CEO Vic Neufeld. At one point, Aphria's share price had lost about three-quarters of its value from its 2018 high, with Green Growth seeking a hostile takeover of the company that eventually failed. What this tells me is that Green Growth Brands is eager to broaden its horizons and become a major grower, if the price is right.

Furthermore, Aphria and CannTrust share similarities in that they're both focused on derivative production. CannTrust's aforementioned outdoor grow will be predominantly used for extraction, which is right up Green Growth's alley. Remember, Green Growth plans to open 108 cannabidiol (CBD) shops in Simon Property Group malls and more than 70 CBD stores at shopping centers owned by Brookfield Properties, and has landed deals with a number of popular retail brands. CannTrust would give Green Growth an abundant source of CBD production.

The catch? Green Growth Brands announced a combination with MXY Holdings (also known as Moxie) for $310 million (mostly to be issued in common stock) a little over two weeks ago. It could be difficult, and very dilutive, for Green Growth to piggyback the CannTrust acquisition to its purchase of Moxie. But there are clear benefits to adding CannTrust to its portfolio, should it choose to do so. 

A black silhouette outline of the United States, partially filled in with baggies of cannabis, rolled joints, and a scale.

Image source: Getty Images.

Tilray

A third and final suitor that would make sense, and which also has the available capital like Cronos Group to make a deal happen, is Tilray (NASDAQ: TLRY).

For those of you who've followed Tilray since its initial public offering a year ago, you're aware it's been a wild ride. After listing at $17 and rocketing to $300 per share in less than two months, Tilray has come crashing back down to earth. The company's poor performance on the earnings front is a big reason why shares of the popular pot stock continue to deflate.

One of the biggest issues Tilray is contending with is a lack of cannabis to meet existing supply deals. Tilray has regularly had to purchase marijuana at the wholesale level in order to meet its supply deals and derivative needs, which is a big reason why its gross margin remains anemic at 20% and 23% over the past two quarters.

Further, Tilray's CEO, Brendan Kennedy, announced in March that the company would de-emphasize Canadian investments in favor of U.S. and European investments moving forward, which is expected to push the company's ability to generate a profit out another year. Yet, even with this statement from Kennedy, it could be difficult for Tilray to overlook the value in CannTrust's half-completed Niagara campus and 60,000-square-foot Vaughan facility, which are capable of 50,000 kilos of combined annual run rate production.

CannTrust also recently announced a hemp farming joint venture with Elk Grove in California, which would build on Tilray's ongoing push into the U.S. markets via the hemp industry. In effect, CannTrust would give Tilray access to added production, thus negating its need to buy wholesale and killing its margins, and builds on its U.S. presence.

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Sean Williams owns shares of CannTrust Holdings Inc. The Motley Fool recommends CannTrust Holdings Inc. The Motley Fool has a disclosure policy.