Emblem (EMC.V) – Merger Arbitrage – 16% Upside

Current Price – C$1.03

Acquisition Price – C$1.19

Upside – 16%

Expiration Date – TBD

Merger Announcement and Presentation

This idea was shared by Ilja.

 

This is a C$170m Canadian cannabis industry all stock merger.

The main concern is Emblem’s shareholder approval. The requirement is two thirds of total votes in favor + a majority of disinterested shareholders. There is some noise  that the merger consideration of 0.8377 ALEF shares is insufficient, however the support of management (holds 12% and has already entered into the agreement to vote in favor) and expected support of old Emblem shareholders (according to my calculations should hold c. 35%) makes it more likely that this transaction will close successfully.

Downside to unaffected price is 10%. Aleafia borrow is available and cheap.

Shareholder meeting has not been set yet.

 

Background

Aleafia is a C$225m medical-cannabis focused company that operates 22 clinics across the country, servicing 60,000 patients, but does not have recreational cannabis licence yet.

Emblem is a 2x smaller company, that has not performed so well despite the boom in Canada’s cannabis industry and having both medical and recreational licenses.

Both companies are trading at similar extremely high revenue multiples in line with the rest of Cannabis industry: Aleafia – 49x, Emblem – 41x. The combined company will also be quite cashed up with C$70m. Rationale for the merger is clearly lined out in the presentation and includes higher scale, easier access and lower cost of capital, combined entity being one of the top Canadian producers and premium valuation due to larger size.

Emblem is one of six licensed producers with a supply agreement with Shoppers Drug Mart, which has been approved by Health Canada to sell medicinal cannabis online, thus the acquisition would provide Aleafia national medical distribution. The deal also gives Aleafia a window into the international market through Emblem’s joint venture with German pharmaceutical wholesaler Acnos Pharma GmbH.

 

Arguments against successful merger closure

• The industry itself is very risky and the bubble might burst before the deal gets closed resulting in material losses. Both companies are trading at similarly high revenue multiples: Aleafia – 49x, Emblem – 41x (not so much lower).

• Retail shareholders are really dissatisfied with the deal and have expressed that in Twitter comments very clearly. The main argument is that Emblem’s share price is at its historical lows and is actually considerably lower than the numerous private placements done during 2016-2018 (at prices of C$1.15-C$2.05 per unit). Many commentators are saying they will vote against.

• Aleafia’s founder and chairman Julian Fantino has colorful history. Despite his work experience as police officer and politician, he was involved in numerous scandals and controversies. Nonetheless, no accusations were turned into charges.

• Aleafia is a young company and does not have any previous acquisition experience or track record yet.

 

Arguments in favor of successful merger closure

• 16% spread, with only 10% downside to unaffected prices.

• Aleafia has a decent team, with its founder/chairman being a somewhat influential figure in Canada and CFO coming from TMX Group (C$4bn company which manages Toronto Stock Exchange) with the experience of VP and Head of Finance.

• Most importantly, Alefia will get an entry into recreational cannabis market by getting Emblem’s license.

• So far despite high number of M&A transaction in cannabis market, it is hard to find an unsuccessful deal. It seems that just about any mergers and even way bigger ones are closing without any problems.

 

Emblem shareholders

Currently the company has 123m shares and I believe that a third of that is held by the old Emblem shareholders (unless these sold out in the open market).

On 2016 Dec 5th Emblem has closed their reverse merger with Saber Capital and got their listing. Out of 65m shares that the company had right after the merger, only 4m came from Saber capital. Simultaneously with the reverse merger the company issued 18m shares at C$1.15 in private placement, which leaves that about 43m were in the hands of old Emblem shareholders.

Since the reverse merger Emblem has carried out 3 private placements at these prices:

• 2017 January – issued 4m at C$3.63 (+ 0.5 warrant with C$4.75 exercise price)

• 2017 November – almost 8m at C$1.75 (+ 1 warrant with C$2.15 exercise price)

• 2018 February – 14m at C$2.05 (+ 1 warrant with C$2.7 exercise price)

It also seems that no large insider transactions were done since the merger with Saber, so I think that the old shareholder structure should be more or less the same and most likely they are going to vote for the acquisition as the management (holds 12%) has agreed to support this deal. Thus if my assumptions are correct, almost 50% of the vote should already be in the bag.