If you like $450 million market cap like Cresco Labs (CRLBF), then you just gotta love their deal to acquire $586 million Origin House (ORHOF). Even if you know very little about either company, there is an opportunity to make a sizable investment return. Here is how.
On April 2, Cresco signed an agreement to acquire Origin, exchanging 0.8428 shares of CRLBF for each share of Origin. A shareholder vote is set for June. This is approximately three months before the deal closes.
A classic deal arbitrage strategy calls for investors to buy shares of Origin and sell short the equivalent amount of Cresco Labs. At the current Cresco price of approximately $12.31, the deal value for Origin is $10.00. However, the current Origin stock price is down around $9, or about 11 percent below the final value.
The key here is that investors will earn all of this in just about three months. That works out to an annualized return of 44 percent. Considering all things, where can you expect to earn 44 percent? Certainly not in the average stock or even in the sizzling hot market for cannabis stocks.
This is classic deal arbitrage but without the usual risks. Neither the price of Cresco nor Origin has reacted much since the announcement on Tuesday. That mitigates the risk, in the unlikely event, that the deal fails to get all necessary approvals.
Alternatively, if you like Cresco but are adverse to short selling, then you can take a different course. Simply buying Origin allows you to acquire Cresco at a discount. Nothing wrong with that approach either.
Remember you always have a third option: choose to ignore this idea entirely and do nothing. Before making any decisions, here are a few fundamental facts about each company.
Back on February 21, I authored an article, “Cresco Labs: Great financials and delicious Edibles”. With a title like that there should be no doubt about two things. I am a fan of Cresco Labs and I love delicious treats.
The company claims to be one of the largest, vertically-integrated multi-state cannabis operators. Their claim is based on operations so far in seven U.S. states (nothing in Canada). Naturally California is the target market and where the deal with Origin makes so much sense.
Cresco is something of a powerhouse in Florida with 30 dispensaries, but it has no stores in CA. They imagine themselves as the Proctor & Gamble of cannabis, creating THC and CBD brand names like Reserve by Cresco, Remedi, Mindy’s Artisanal Edibles, creatively packaged in color coded containers using catchy markers, including Rise, Refresh, and Rest.
If Cresco is to cannabis what P&G is to Tide detergent, then Origin House is The Coca Cola Company in the world of cannabis. Identifiable brands, of which there are 50+, include Chong’s Choice, Kings Garden, OMG Farms, and many more. Like just about everyone else, the goal is to achieve global dominance.
Until that day, the focus is heavily on California and creating strong brand names in the Golden State. This is where Origin has staked its claim. Over the past year, there have been four acquisitions that were entirely responsible for the $11 million in Origin revenues through the nine months ending last September.
Origin achievements are stronger on the production and distribution side. By the end of 2019 they expect to have 92,000 square feet of production to supply some 500 dispensary customers. When this total is added to the 250 claimed by Cresco, the distribution benefits of the deal make good sense.
An reasonable estimate of combined revenues over the last twelve months is over $50 million.
The numbers for 2019, of course, should be far higher. This places the combined company in the ranks of serious players.
Cresco has been profitable on it’s own, while Origin lost about $20 million on operations for their most recently reported third quarter. Before post merger cost reductions are announced, it is a safe bet the combined companies at the outset will lose money.
Most experienced cannabis investors have grown accustomed to short term operating losses, even though Cresco earnings have been an exception.
It is a positive offset to expected operating losses going forward that the combined balance sheet will show cash of somewhere between $150-$200 million, the result of both companies pursuing capital raising projects during 2018.
Don’t expect this to be the last deal; afterall, global dominance will take a lot more avenues of distribution. The cost of creating brand value is not cheap either. But unlike some deals, the management of Cresco was smart enough not to overpay for Origin. But that small premium represents an opportunity for investors.