Bluma Wellness (BMWLF) – Merger Arbitrage – 13% Upside

Current Price: $1.18

Offer Price: $1.34

Upside: 13%

Expected Closing: early Q2 2021

Press release and merger presentation

 

Cannabis merger with the target company in Florida. Similar strategic rationale and industry background aspects apply to those covered in the ongoing Liberty Health Sciences merger write-up.

One of the major cannabis multi-state operators Cresco Labs is acquiring a small Florida retail player Bluma Wellness. Consideration stands at 0.0859 Cresco shares and is subject to downside protection adjustments: if Cresco shares fall to the range of US$9.99 – US$7.00/share (currently at $15.70), consideration will be fixed to US$0.86/share. If Cresco’s share price falls below $7.00/share, the exchange ratio will be fixed at 0.1229 per Bluma share. Closing is expected at the beginning of Q2’21.

Given the size of the merger (US$170m) and Cresco’s absence in FL, regulatory approval should not be an issue (as further evidenced by the relatively short indicated closing time). 40% of Bluma shareholders are supporting the transaction. The price comes at around 12x+ estimated 2020 revenues of Bluma, which is definitely not a low valuation for a small cannabis player. Initial premium to pre-announcement price was 29% and now stands at 55%, which adds further confidence of a favorable shareholder vote.

Major risk is merger cancellation or terms amendment, especially, when the buyer has already terminated a number of other mergers. This might be partially responsible for the current spread. However, in my view previous terminations/term amendments were carried for legitimate reasons under specific market conditions (more info below). Bluma acquisition is different – market conditions are now very favorable and the strategic rationale is sound.

Overall, it seems very likely that the deal will close as expected, however, keep in mind that merger arbitrages in the cannabis industry are generally on the riskier side.

Cresco (listing in US with ticker CRLBF) borrow appears to be plentiful at a 3% annual fee (IB).

Keep in mind that BWEL-U.CN listing is in Canada, however, the share price is quoted in USD. Also the US listing BMWLF appears to be more liquid than the Canadian one.

 

Strategic rationale is sound

This acquisition is a pure land-grab deal, which will allow Cresco to secure a market presence in the 3rd largest US state (2nd largest with a green light for medical cannabis). This rationale was summarized well by the CEO of Ayr Strategies (Cresco peer, currently making a similar expansion into Florida):

FL is about a landgrab. If you think about it, most municipalities aren’t gonna allow 20 cannabis companies into their town. They’ve already started limiting the number of stores they actually want. […] If you’re not in certain municipalities, you’re probably never going to get there and that’s why it is crucial to do this transaction now.

The merger will enhance Cresco’s retail segment and add 7 new dispensaries to their current 20 stores. Blum is one of the fastest-growing new cannabis players in the market – it started operations a year ago and is expected to generate about $14m sales in 2020 (Q2 revenue growth was 190% QoQ, Q3 – 50% QoQ, Q4 growth is estimated to be over 120% QoQ). Moreover, Bluma is expecting to more than double their number of stores in the short-term (from 7 to 15).

Cresco has been eyeing Florida for quite a while now – it tried to enter this market in 2019 by acquiring VidaCann (private, 7 stores at the time) for $120m. However, due to certain market circumstances/structure of the merger (more details in the section below), the whole thing was called off and the company focused on its other segments instead (Illinois and Pennsylvania), while promising to come back to FL with a more capital efficient move:

We will continue to monitor Florida closely for opportunities to enter the market in a capital-efficient manner.

This time the situation is different – Cresco’s IL and PA segments have already been strengthened considerably, and the FL market appears to be more attractive than ever:

  • Since 2019 the number of registered patients that are allowed for cannabis treatment has more than doubled – from 200k to 465k. Also, further growth potential is substantial – registered patients constitute only 2.2% of the FL population, vs 3% in PA, 4% in AR, and 7% in IL.
  • In August 2020 FL legalized the use of cannabis edibles – a very favorable development for the FL cannabis industry. Edibles constitute a large portion of Cresco products offering.
  • The industry is experiencing significant tailwinds from the increased chances of legalization on the federal level – in the beginning of this year democrats won the elections in Georgia and secured a slim control in the senate. This increases the chances of passing the MORE Act, sponsored by VP Kamala Harris and passed by the House of Representatives in December to decriminalize recreational cannabis on the federal level. However, the act was voted down by Republicans, which used to have a majority in the senate. Now that Democrats have control again, the chance of legalization on a federal level has increased. Recently, Senate Majority Leader Chuch Schumer stated that he intends to push pot reform this year and make it a priority in the senate. As a result of these developments, US cannabis stocks have appreciated nearly 50%. Increased chance of federal legalization provides an additional incentive for major players to secure a presence in as many top states as possible.
  • Industry consolidation is already happening – in FL alone two relatively large mergers are currently ongoing (Liberty Health and AltMed). This provides even more pressure for Cresco to act quickly in order to secure a position in the state.
  • There is a limited number of potential acquisition targets in Florida. Aside from M&A, other ways of market entry are complicated due to the limited amount of licenses issued and various other requirements (e.g. vertical integration).

 

Cancellation/amendment risk

This is the major caveat for the transaction. Cresco has a history of flopping/amending transactions, however, in my view all of those happened for legitimate reasons, which are either not present in the current situation or not posing a big threat:

  • VidaCann – $120m cash/stock portion merger announced in March’19 and terminated in November’19. Cash portion was described as “heavy” – a significant part of the total consideration. The merger was canceled due to materially “changed market conditions” – the cannabis industry crash in mid-2019 (US cannabis ETF fell 50% from April’19 to Nov’19) and legalization of recreational cannabis in Illinois in mid- 2019 (one of the main Cresco’s markets) opening significant market opportunities there. Cresco also stated that the cash portion of the VidaCann merger consideration (the exact number not provided) was too heavy given the market circumstances and required capital relocation for the new opportunities:

    The structure of that was developed in January, really, of this year, when capital markets were different, before Illinois passing adult-use law. It was really a different scenario. […] Florida is a great state. It’s just — it’s a matter of prioritization, right timing, capital markets. We’ll continue to keep an eye on the state. […] We believe it’s in the best interest of our shareholders to re-allocate resources to these existing higher return opportunities with a view to looking for a more capital efficient way to enter the Florida market over the longer term. […] Primarily, VidaCann, the cash component of that consideration was a major driver of the decision.

  • Origin House – initially a $1.1bn merger with an all-stock consideration of 0.8428 Cresco shares for each Origin House share. It was announced in April’19 and then in November’19, the exchange ratio got adjusted to 0.7031, and a condition of Origin House raising C$40m before the closing was added. Target firm shareholders still voted in favor of the merger and it closed in the beginning of 2020. Similar reasons – the cannabis industry crash or “bubble pop” as it was called at the time, were behind this amendment.
  • Tryke Companies – $280m transaction announced in Sept’19. $55m of the consideration was supposed to be in cash. The merger was canceled in April’20 due to the COVID-19 outbreak, again noting the cash portion of the consideration and capital relocation needs.

In light of these cases, the current Bluma merger consideration being all-stock is an advantage.

As for another potential market crash – the whole industry is still riding the tailwinds from the increased chance of federal legalization. The merger is expected to close in 1.5-2 months, while the government will likely take much longer to take any decision on this front. So I expect the cannabis stock prices to stay elevated at least until the upcoming vote in the Senate this year.

 

Bluma Wellness

Bluma is a cannabis retailer operating in Florida. Previously it operated as a subsidiary of Canadian investment firm SOL Global Investments (ticker: SOL.CN, US$255m market cap) under the name of CannCure. SOL Global acquired CannCure in 2019 for $41m and made two further investments of $2m and $6.5m for a total of around $50m. In comparison, the current offer values the company for around $170m (EV). In May’20 CannCure conducted a reverse merger with a shell company Goldstream Minerals and changed the name to Bluma Wellness.

The company has acquired its first dispensary in FL at the end of 2019. By mid-2020 the number was expanded to 3 and currently Bluma owns 7 stores. Short term plan is to expand to 15 dispensaries.

 

Cresco
Cresco Labs is one the largest vertically integrated multi-state cannabis operators in US. It owns a dozen of different brands with a total of 350 products. The majority of its business is wholesale (62% of revenues) – Cresco sells to 700 dispensaries in the US. Additionally, it operates 20 retail dispensaries (38% of revenues) in 9 states, including 6 top states (7 with Bluma).

The company has made several acquisitions before. Recently it closed Verdant Creations (4 dispensaries in Ohio) for $2m, while the largest transaction up to date has been Origin House ($1.1bn initially, about $500m when it closed).

Cresco investor presentation.

4 COMMENTS

  1. valueactcapital

    In case of deal going through, the short Cresco/long Bluma pair is stand to make money in all scenarios, most when Cresco share px would fall to $7 (-54% vs current level), whilst the Bluma consideration would be fixed at $0.86 (-29%). Appreciate thats just theoretical at this stage, as Cresco share px unlikely to derate that much.

    So downside case really must be about deal cancellation, as pointed out in your note.
    How much would Bluma derate in such a scenario, hence asking for pre announcement px.
    How would Cresco react (the short leg)?

    Many thanks! Great note FWIW

    1
  2. Ilja

    Court approval for the Cresco Labs/Bluma Wellness merger has been received and only regulatory approval from Florida remains outstanding. The spread has been completely eliminated, so the idea is closed with 13% profit in 1.5 months.

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