Alcanna (CLIQ.TO) – Merger Arbitrage – 10% Upside

Current Price: C$8.43

Offer Price: C$9.30

Upside: 10%

Expiration Date: Dec’21/early 2022

Press release

 

This is merger arbitrage in Canadian cannabis industry. Vertically integrated cannabis player Sundial Growers is acquiring liquor and cannabis retailer Alcanna. Consideration stands at 10.69 SNDL shares per CLIQ share. Plenty of borrow for hedging is available at a 10% rate (should net about 1% from the current spread). The combination offers a strong strategic rationale amidst the increasingly competitive cannabis retail market. The buyer is flush with liquidity and is pursuing growth through acquisitions strategy. Valuation wise it looks like SNDL is getting a bargain and is unlikely to walk away from the merger. Shareholder consent is expected given the support from the largest shareholder/activist – the combined stake together with management is 12%. The situation offers a relatively short timeline with an attractive IRR.

Downside to pre-announcement levels (trading update on the 15th of Sep) is about 11%. However, CLIQ stock started appreciating in the beginning of September, which forced the company to issue the trading update. Thus the downside in case transaction breaks could be larger. Moreover, Q3 reports of both firms are expected shortly – 11th Nov’21 for SNDL and 12th of Nov for CLIQ.

 

Shareholder Approval

The merger needs to be approved by 2/3rds of CLIQ shareholders. Rationale on why this is likely to pass is outlined below:

  • Press release states that management and certain other shareholders with a combined 12% stake support the transaction. Management by itself owns 4.2%. It is very likely that the other supporting shareholder is PointNorth – a special situation-focused activist with 3 board seats since mid-2017 (current CEO is their nominee as well). PointNorth reported a 10% stake in November 2016, when the company was trading around C$10.50-C$11/share and later reduced the stake to the current 7%. It’s very likely that it was PointNorth’s initiative to expand CLIQ into the Cannabis industry in 2018. The move clearly didn’t work out – after the Canadian cannabis crisis in 2019 the market still remains very saturated and oversupplied. With the largest shareholder/activist heading for the exits (at around breakeven/minor loss), other shareholders are likely to follow suit. The merger is still quite fresh and there have been no other reports of shareholder opposition yet. No shareholders own 10% or more.
  • CLIQ has recently completed tender offer for 10% of shares at a price range of C$7.55-$8.3. The tender was 2x oversubscribed and ended up priced at C$7.8. Current consideration provides a 19% premium to the final tender price.
  • Competition in the Canadian cannabis retail industry is increasing at a quick pace. This was recently highlighted by both CLIQ and SNDL (see quotes below). After Alberta’s retail cannabis market share cap lift last year, new stores have been springing up at an extremely fast rate – the number of licensed stores has already increased by 16% from this March (from 596 at the end of March to 691 currently). Ontario is also reportedly issuing around 30 new authorizations every week (in February there were 489 authorizations and now there are around 1180 + 150 waiting in line). If SNDL CEO is right and there will be attrition/bloodshed in the market shortly, CLIQ shareholders might benefit from the increased scale, synergies, potential Spiritleaf franchise expansion in the US, and strong financial position of SNDL. Significantly increased liquidity is a nice bonus too.

CLIQ Q2 MD&A:

Same-store cannabis sales does not provide a useful comparison between the current period and the prior comparative period due to the fact that cannabis retail is an emerging industry and there were a limited number of stores open in the Alberta market during the prior year period, whereas in 2021 the number of competitor stores has increased significantly year-over-year.

SNDL Q2 call:

Look, there’s no question that the retail landscape is highly competitive and we actually expect a significant amount of attrition in the space. So not all operators are going to be successful here. I think on one of our previous calls, we talked about hitting a saturation point in retail.

[…]

We expect significant consolidation and actually quite a bit of bloodshed in the retail segment in Canada. And so we are excited to be competing.

 

Regulatory Approvals

From the regulatory perspective, the only concerning thing re this merger seems to be a large market share in Alberta – 106 stores combined, which is 15% of the market licenses wise. 15% used to be market share cap in Alberta, however, this cap was lifted in Oct’20, thus regulatory pushback is unlikely.

The combined market share of authorized stores in Ontario should be around 4%.

 

Alcanna

CLIQ is the largest private liquor retailer in Canada with 171 stores (mostly in Alberta). Alcanna’s liquor operations are rather stable and profitable generating around $16.4m annual FCF (TTM).

In October 2018, the company started its own retail cannabis operations (Nova Cannabis), which was spun off in March’21 through a reverse takeover. CLIQ still retains a 63% stake in Nova Cannabis, which is now listed as NOVC.TO. Alcanna provides corporate management services to Nova for a fixed annual fee of C$1.25m. Nova is quickly growing its retail store count and currently has 62 locations, mostly in Alberta. The business focuses on the low-price value/discount market segment. The cannabis segment is still unprofitable and burns cash. CLIQ stock price has been pressured ever since the company has entered the cannabis business in 2018.

Both segments benefitted from the COVID-19 outbreak in 2020. CLIQ has redeemed all of its notes this year and doesn’t have debt anymore.

On SOTP basis liquor business looks cheap and suggests SNDL might be getting a bargain. CLIQ currently trades at C$268m EV, out of which C$120m is NOVA stake. This leaves the rest of the company (liquor+corporate) at C$148m. During H1’21 liquor segment generated EBITDA of C$54m (before remeasurements and provisions). Management states that this is up 10% vs 2019 levels and expects at least part of the COVID tailwinds to stay permanent. Assuming liquor segment run-rate EBITDA of C$50m and deducting C$20m in normalized corporate overhead (C$3m expenses in H1’21 were one-off), puts the remaining company ex. NOVA stake at 5x normalized run-rate EBITDA.

 

More background on CLIQ can be found in this VIC write-up here.

 

SNDL

SNDL is a failed cannabis cultivator, which over the years moved from wholesale to selling its own brands. The attempt to target all price segments ultimately failed to stop revenue decline. SNDL IPO’ed in August’19 at $13/share and had a bad run since then due to the Canadian cannabis crisis, high cash burn, COVID-19 outbreak, etc. However, this year proved to be extremely lucky as SNDL became one of the squeeze targets of Redditors/WSB and saw its share price skyrocket from US$0.60/share to US$3/share during the first two months of this year (has already returned to previous levels since then). Management used this opportunity to raise almost US$1bn in cash and now is aiming to use this cash to revive company’s growth. SNDL has already acquired one of the fastest-growing retail franchisors Inner Spirit Holdings (Spiritleaf brand) for around C$131m. The merger was covered on SSI.

Sundial has also created an investment division aiming to capitalize on various funding issues in the cannabis industry, which is still strongly overhung by regulatory restrictions. Recently SNDL has started a 50/50 JV with SunStream Bancorp to provide lending, equity, and hybrid funding to cannabis firms. The company intends to expand these operations internationally and will likely focus on the US market. As of Q2, SNDL injected C$253m in the JV and these investments have already generated c. 13% annualized returns. In the recent Q2 call, it was mentioned that the company has lined up C$1bn+ investments pipeline for the JV. Aside from the JV, SNDL intends to deploy cash on M&A and various minority ownership investments. The company still has C$743m of unrestricted cash balance (and no debt).

Recent Sundial Growers acquisitions:

  • Pathway RX (2019) – for around C$3m+ valuation.
  • Project Seed Topco (2019) – cash and stock for a combined $100m+ valuation.
  • The Valens Company (May 2021) – acquired 10% of the cannabis research and analysis company for nearly $2m.
  • Inner Spirit Holdings (July 2021) – merger with Canadian cannabis retailing franchise for C$131m in cash and stock.

 

Strategic rationale

The strategic rationale here is pretty straightforward – amidst a highly competitive market, SNDL is buying one of the leading (in terms of store count) low-price cannabis retailers in Alberta, which will increase the number of SNDL stores by 60%. Most of the locations of both firms are in Alberta and Ontario. SNDL’s cultivation capabilities should definitely add some synergies to Nova’s retail footprint. CLIQ has extensive 25-years of experience in the retail business (although mostly liquor) and SNDL expects to deploy their playbook of winning market share through lower margins/M&A. It also intends to use CLIQ’s management services platform (which it uses for Nova) for the recently acquired Spiritleaf stores. Overall, the buyer expects the synergies to add C$15m of additional annual EBITDA – quite significant as post-ISH merger, pro-forma SNDL should be generating something around C$5-10m annual EBITDA, whereas CLIQ’s cannabis segment is still operationally unprofitable.

Cashflows from CLIQ’s liquor business (C$16.4m TTM) will provide financial support for further consolidation/growth of the cannabis business and development of the investments business.

Overall, the risk of merger termination seems low.

Store locations of SNDL (Spiritleaf) and CLIQ (Nova Cannabis):

 

Risks

Despite the arguments outlined above, the spread likely exists due to the pending shareholder approval (on top of the usually larger spreads for merger arbitrages in the cannabis space). There are a few caveats worth mentioning.

Valuation of the liquor business at 5x normalized run-rate EBITDA seems quite low for a rather stable, cash flow generating business. For comparison, a much smaller and much more levered peer Rocky Mountain Liquor trades at 5.2x H1’21 run-rate EBITDA. Thus some shareholders might consider the offer price too low. However, merger support by the activist with 3 seats on the board and the absence of any other 10%+ holders limits the chances of shareholders opposing the merger.

Merger consideration is in Sundial stock. Since the initial Reddit-driven squeeze at the beginning of the year, SNDL volatility has been very limited, however, SNDL is still the 4th most widely held stock on Robinhood and there are still plenty of commenters trying to pump the stock on SA/Twitter/Stocktwits. Aside from hedging risks related to this, CLIQ shareholders might consider SNDL to be overvalued at current levels. SNDL trades at EV of around C$1bn, whereas its cannabis business is expected to generate pro-forma revenues of only C$80m (albeit Spiritleaf is growing rapidly). Investment business also focuses on the cannabis industry. SNDL management’s track record is questionable although cash raise during Reddit-driven squeeze was very timely.

And to finish with a positive – exposure to the U.S. federal legalization decision is limited as the merger will close before that. Even if some bad news is released until then, the effect might still be limited as SNDL has now entered the cannabis financing business, which should actually only benefit if the U.S. rejects legalization.

25 COMMENTS

  1. Terence

    SNDL, the buyer, surges 20% to $0.86, after strong Q3 and share repurchase. CLIQ.TO and its US OTC equivalent LQSIF, meanwhile rose only 10% to C$9.60 or US$7.70. This widens the arb spread from 12% to 22%.

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  2. Ilja

    Although SNDL results weren’t that great (except for the retail/ISH segment), its share price jumped 26% after the announcement. The stock is really volatile due to its retail investors’ base. The spread stands at 21%, however, I think it is now even more likely that the merger will close successfully. The biggest uncertainty was the shareholder approval and if SNDL share price remains elevated, I don’t think CLIQ’s shareholders will be able to refuse this kind of a premium. Of course, it is worth noting that the downside has also increased materially (SNDL will likely not fall to pre-announcement levels now). Overall, looks pretty interesting for a case that will close next month.

    SNDL Q3 results:
    – Cannabis revenues at $14.4m vs $9.2m in Q2’21. The increase was mostly due to the addition of ISH business (merger closed on the 21st of July). Ex. ISH revenues decreased.
    – ISH revenues were $6.1m looking quite strong given it was for less than half of the quarter. In comparison, Q1’21 was C$8.8m.
    – Investment and fee revenue $3.3m vs $5.7m in Q2’21.
    – Adj. EBITDA $10.5m (mostly driven by unrealized gains on marketable securities of $24m).
    – The company had $1.1bn of cash, marketable securities and long-term investments. Unrestricted cash was $571m.
    – CEO stated the expectation to generate positive FCF in 2022.
    – Additionally, SNDL announced open market buyback program for 5% of shares.

    Alcanna also issued a short PR on the Q3 results. Performance is going on a similar trend (lower than 2020, higher than pre-COVID):
    – Same-store liquor revenues C$145.4m – 5% lower YoY and 7% higher than the same quarter in 2019.
    – EBITDA C$10.4m vs C$13.9m in 2020 and C$7.2m in 2019.

    Nova Cannabis also announced positive Q3 results and share price went upwards. CLIQ’s stake is now worth just short of C$150m (almost half of CLIQ’s market cap).

    The merger is still expected to be completed in Q4’21.

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    1. snowball

      My guess is that the spread widening is not the result of higher (perceived) odd of deal breaking. But instead:
      (1) After run-up in both CLIQ and SNDL prices, higher downside loss in case the deal breaks.
      (2) Higher volatility of SNDL shares. I think there are are limited amount of arb capital pursuing this kind of cross-border small-cap all-share merger deals. Most of us probably have already hit position sizing limit when the spread was 10%.

      For those who hedged based on a fixed 1 CLIQ :10.69 SNDL ratio (effectively taking a net short position due to the 10% spread) instead of equal dollar amount, the run-up in prices also led to some additional MTM losses.

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  3. dt

    Shareholder meeting to vote on the merger is set for the 14th of Dec. Approval by 2/3 votes cast + simple majority of minority will be required. I expect this to pass.

    1. Terence

      When SNDL spiked up to >80c, Alcanna LQSIF rose only a little. Likewise, afterwards when SNDL returned to 75c, LQSIF is down only a little. Thus, spread over 20% back down to 9%. Seems as if Alcanna traders think SNDL should be at this lower level.

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  4. fmadzharov

    Are there any news on the merger, because I can see that the spread is widening again?

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    1. Ilja

      The current spread is just 1%-2% larger than the previous levels, of course, the remaining timeline is shorter now. The market is probably concerned about the overall decline of the cannabis industry due to uncertainty around US cannabis legalization. I don’t think that it will derail the current merger. CLIQ is a Canadian market play for SNDL and current uncertainties make little impact on the strategic benefits of this merger. Although, I guess CLIQ’s shareholder approval is a bit riskier now but is still likely to go through. The meeting will take place on the 14th of December.

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  5. rukun

    This spread is very technical –
    1) Brokers are giving you no margin on SNDL. So in addition to the long CLIQ capital, you have to commit all the short capital as well, which changes your return on capital calculation.
    2) The cost of borrow on SNDL, currently quoted b/w 5-6% (and associated borrow stresses) has to be baked in.
    3) Have to think through / hedge CAD/USD currency risk – currencies have been volatile w/recent Fed tapering talk
    4) Spread trades in points – the bid/ask in CLIQ itself maybe a point. Also w/ a 10.69x ratio, moves in SNDL amplify the spread

    But just to play devil’s advocate, and come up with a reasonable reason for a widening spread when we could get a close in a week:
    1) While a lot of the premium offered to CLIQ shareholders has gone out because of SNDL stock performance, CLIQ shareholders are still benefiting in that the adj. px of the stock would be lower than CAD $6.50 if no deal. With a 25% quorum and approval from 2/3rds of votes cast, the vote threshold is not very high. Worst case, you extend the special meeting w/a new record date that increases arb participation – but timing, esp. since you’re paying for SNDL borrow, is a risk.
    2) Regulatory timing is also a risk w/Ontario approval still pending. Low risk of regulatory issues, but just timing risk.

    All that said and considered, the spread continues to be attractive.

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  6. rd128

    I think Alcanna is too attractive and an important piece of Zach George’s strategy for SNDL. Quorum is 25%. They need 2/3 of votes cast in support and 50% of independent votes cast in support. SNDL revs are currently ~ $70mm. With Alcanna, he will add another $700mm in revs to the top line (w/NOVC consolidated). Post synergies, the companies should generate > $30mm in free cash, that’s a 6x post synergy free cash multiple if you ex-out the public market cap of NOVC.

    If he has to add $1 CAD per share to get it over the post with TD Waterhouse & Penderfund (10% in combined ownership), I think it would make sense for him to get it done. $1 CAD is an add’l $36mm CAD. He’s sitting on CAD $500mm cash. For the $15mm in synergies he’s expecting, and the potential to change the narrative on SNDL with one swoop, this is too compelling a transaction.

    Spread is at 15%.

    Note: Borrow in SNDL is quoted in the mid-teens.

    There’s a 12% voting agmt in place. 8.4% of whom are independent.

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  7. rd128

    They have enough proxies. A lot of shareholders came out against the deal, hard to tell how many, but enough not to meet approval by 66 2/3 of the votes cast.

    It’s a fair argument by shareholders. A lot of the premium offered is gone b/c of the performance in SNDL shares. There’s two questions now: (1) Can SNDL increase the cash consideration, and (2) can they get enough shareholders (there’s a wide range of shareholders / incentives from what I understand) to agree to the increased consideration. In the end, more cash consideration should be compelling…but given the shareholder mix, the outcome isn’t certain. The cost of borrowing SNDL shs is now in the low 20%s.

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  8. rd128

    The strategic drivers and cash accretion from this deal are very compelling. I continue to believe they’re going to try and do what they can to close this deal.

    GLTA

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  9. hta

    Deal has been revised to 8.85 shares SNDL plus $1.5 cash(Canadian). Meeting remains scheduled for tomorrow.

  10. dt

    Good news continues to pile in for SSI cases this year.

    We are closing Alcanna merger case before tomorrow’s meeting. Only 4% spread remains to revised consideration.

    The fact that consideration had to be revised so late into the process suggests that management did not believe there will be enough shareholder support. The revised consideration replaces only a small part of stock consideration into cash – not sure if that will actually make a difference. 4% spread is not worth this risk.

    Altogether 12% return (13% gross less 1% for borrow) in 1.5 months.

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    1. nostradamus

      I would assume they know they have the votes now, considering they upped the offer but didn’t postpone the meeting further. Most small retail votes would already have been placed long before the meeting.

      1. Terence

        Since the spread narrowed significantly on the news (15%? to 3%), the market apparently thinks they have the votes. Having said this, I still agree with DT closing the case since the spread is too low to justify taking any risks, especially if playing this arb unhedged.

  11. Terence

    DT, I cannot write comments under the topics “2021 end of year review” and the “Summaries and Updates”. Is this intentional?

    Below comment is intended under “2021 end of year review”:

    Monster year indeed: tracking portfolio up 54%, vs S&P500 up 28%.
    66 ideas: 32 with gains of +11% to 240%, 24 with -10% to +10% (minimal loss or gain), 10 with losses -11% to -68%.

    Among the 8 ideas which are most viewed and discussed (2 of the 10 in the two lists are overlaps), 5 are losses and 3 are gains (even when the number of winning ideas overwhelms the losing ones). I hope I’m wrong, but apparently SSI members are more interested in the few losing ideas than the many profitable ideas. One thing I am sure is that I myself is a very good example, having invested much more in the losing ideas (vs blindly following all SSI ideas and having a 54% gain). Note that this observation ignores weighing of investments, which may magnify gains/losses.

    Congratulations to SSI on year 2021, and keep up the good work in 2022!

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