With its wildcatter approach to capital raising, hastily assembled governance, and well-backed, motivated buyers, people have been expecting the cannabis industry to be a magnet for activism for as long as it has existed.
This week’s announcement by Marcato Capital Management that it intends to vote against Acreage Holdings’ sale to Canopy Growth may not be the first such campaign, but it could be a sign of how these will play out in the future.
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This is the second part of a short series on Michael J. Mauboussin's research document reflecting on 30 years of Wall Street analysis published in 2016. Q3 2020 hedge fund letters, conferences and more The document outlined Mauboussin's observations of successful investors throughout his three decades on the Street. This article starts at point six. Read More
Until now, M&A in the cannabis sector had been difficult to predict or influence. Riposte Capital pushed for the sale of Hexo in September. I understand it has since exited the stock, likely turning a healthy profit without effecting the merger it sought. On the short side, rumors of a takeover bid for Aphria Inc (NYSE:APHA) ended a campaign by Quintessential Capital Management and Hindenburg Investment Research.
Nonetheless, fortune has favored the brave. Aurora Cannabis built itself into a player serious enough to lure Trian Partners' Nelson Peltz as an adviser by interrupting a takeover bid for CanniMed in early 2018. Backed by Constellation Brands, Canopy has become the most valuable weed company in the world, giving it a powerful currency for acquisitions.
Key to Marcato’s complaint is that Acreage, which only listed in November, is selling itself cheap. That may seem odd for a $3.4 billion deal based on 2018 sales of $21 million but as Mick McGuire’s firm points out, Canopy’s enterprise value is a "highly speculative" 178 times its expected revenues for 2020, while the Acreage acquisition is priced at less than 21 times on the same metric.
Adding to the insult, Acreage shareholders will receive a down payment of just $300 million in return for giving Canopy an option to exchange each Acreage share for 0.58 Canopy shares. The fact that the deal will only be consummated if the U.S. legalizes cannabis on a federal level in the next seven years means Acreage shareholders are taking a big, almost unhedgeable gamble, Marcato says.
Although Marcato isn’t soliciting against the deal, it has called on the company to go back to the drawing board and conduct a full strategic review. Acreage’s board, which includes former U.S. Speaker John Boehner, former Massachusetts Governor Bill Weld, and former Canadian Prime Minister Brian Mulroney, is not likely to appreciate being second-guessed. With Acreage’s shareholder circular going out on Monday and the meeting likely to be held on June 19, the window for a change in the shareholder base or for another bidder to enter the fray is short.
More conventional shareholder activism could have a future in cannabis too, although valuations are generally too high to provide a strong argument for throwing out incumbents. Aphria's run-in with short sellers led to the appointment of a credible independent chair, which helped it conduct a review of the claims against it and see off an unsolicited takeover bid. Its stock more than recovered (at least until last month’s earnings report), proving good governance can have benefits all around.
Sachem Head Capital Management is gearing up for its first-ever proxy fight, at Dallas, Texas-based construction firm Eagle Materials. The activist wants the company to consider a breakup and doesn’t trust the board, which announced a strategic review last month, to do the job properly. Eagle doesn’t plan to discuss the review until it is finished but it will face considerable time pressure given the annual meeting is likely to be held in August.
Also requiring a decision is the question of who will fill the board seat vacated by Dave Powers, who retired as CEO in April. Michael Haack took up the top job at the end of a lengthy planned transition but has not yet joined the board. Eagle might be tempted to duck the fight and put Haack on the board later; the other two members of the class of directors up for election this year are hardly ossified, having served for just one and two terms respectively.
Quote of the week comes from EQT’s board, which sent a stinging letter to Toby Rice, one of two brothers trying to replace three-quarters of its directors. As well as accusing the activist of planning to install his wife and former baseball coach – who were executives at Rice Energy – at EQT, the company pointed out that he served as CEO of Rice prior to its initial public offering (IPO), leading to this stinger:
"The fact that you were replaced as the CEO at the time of the IPO speaks volumes, and we are not aware of anything that would cause us to reach a different conclusion than your own family members."