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Marijuana Merger Complete: Say Hello to the Newest Production Powerhouse

Sean Williams, The Motley Fool

Chances are that you'd struggle to find an industry that offers as robust a growth potential as the legal cannabis industry. According to Cowen Group, which is arguably the biggest cannabis cheerleader on Wall Street, global sales are on track to hit $75 billion by 2030. Since this revenue has to wind up somewhere, pot stocks have been skyrocketing lately.

But rapid growth is also encouraging consolidation in an industry that's currently overcrowded on the growing and retail side of the equation (at least in the U.S., with regard to retail). Nearly two weeks ago, on March 14, a marijuana merger closed that created a new production powerhouse that, in all likelihood, you've never heard of before.

Two businessmen in suits shaking hands as if in agreement.

Image source: Getty Images.

This under-the-radar cannabis merger is now complete

In mid-December, small-cap Aleafia Health (NASDAQOTH: ALEAF) announced that it would acquire rival Emblem for about 173 million Canadian dollars ($130 million) in an all-stock deal. Neither company had found itself in the spotlight before this merger announcement, because neither company is a pure-play grower in the traditional sense. Rather, these are two companies that operate medical health clinics and, secondarily, grow cannabis for sale to their patients.

The model itself is actually genius. Medical marijuana patients tend to be more willing to open their wallets for marijuana purchases, and are far more likely to buy high-margin alternative products, such as oils. More importantly, medical pot patients that are tied to a health clinic are likely to purchase cannabis from that clinic as well, creating a sense of brand loyalty that's tough to come by in the early stages of the legalization process in Canada.

With the deal now complete, and Emblem shareholders receiving 0.8377 shares of Aleafia Health's common stock in exchange for each share of Emblem stock that they owned, the combined entity has 40 health clinics and education centers that've seen approximately 60,000 patients to date. 

Potted cannabis plants growing indoors under special lighting.

Image source: Getty Images.

Say hello to a new top-tier grower

But perhaps more interestingly, this marijuana merger combines Aleafia Health's projected 98,000 kilograms in peak annual production with Emblem's 40,000 kilos in peak forecasted output. This 138,000 kilos of peak yield should slide the new Aleafia Health into the No. 7 spot in terms of Canada's largest marijuana producers, assuming the completion of HEXO's Newstrike Brands buyout and expected capacity expansion in Canada by Tilray. Should neither of these occur, Aleafia Health could crack the top five in terms of peak annual output.

The combination might also be attractive from a fundamental standpoint. No cannabis grower that'll produce in excess of 100,000 kilos annually has a market cap that's lower than the new Aleafia Health. For example, Tilray, which does have partnerships with Novartis' generic-drug subsidiary Sandoz and Anheuser-Busch InBev, as well as well-known medical pot brands in Canada, is currently on track for around 100,000 kilos in annual production with a market cap of close to $7 billion. Meanwhile, Aleafia Health could produce 138,000 kilos with a market cap of less than $500 million.

This high level of production and the loyalty associated with its health clinics might also lead to healthy margins and profitability sooner than later. The same can't be said for Tilray, which is expanding its capacity slower than many of its peers and is liable to lose money for the foreseeable future.

A television studio at the Nasdaq exchange, complete with a digital big board in the background.

Image source: Nasdaq.

What's next for Aleafia Health?

With the combination complete, Aleafia Health and Emblem will likely be working on cost synergies over the next 12 to 18 months given that their business models are similar. There will also be plenty of brand-building involved, as the duo aims to improve brand recognition outside of its health clinic and education center network.

However, the biggest step forward for Aleafia Health might just be uplisting to the Nasdaq, which it applied to do late last year. As a larger company (i.e., in terms of market cap), Aleafia should, presumably, have improved access to financing. All that's really missing is increased visibility and volume-based liquidity, which can be tough to come by on the over-the-counter (OTC) exchange. Plus, Wall Street firms aren't as willing to offer coverage or invest in OTC-listed stocks, especially those trading for less than $5 per share.

The hurdle for Aleafia Health is the company's microscopic share price. The company's stock has consistently traded below $2 a share for months, and even briefly flirted with sub-$1 territory in December. That's a problem because the Nasdaq has a strict minimum share requirement of $1 for listing. Additionally, some investment firms won't cover companies that have a share price of less than $5, which is considered "penny stock" territory. Aleafia could absolutely use the legitimacy and liquidity of uplisting to the Nasdaq, but it's low nominal share price is a problem. A reverse split would solve this problem, but reverse share splits are generally not viewed as a good thing by shareholders.

Long story short, there's a new name in the cannabis space that you should have on your radar. While far from risk-free, its sheer production potential relative to its current valuation makes it a pot stock you should be eyeing.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Anheuser-Busch InBev NV, HEXO, and Nasdaq. The Motley Fool has a disclosure policy.