For a long time, Aphria (NASDAQ:APHA) was overshadowed by its rivals Canopy Growth and Aurora Cannabis. That’s changed. Aphria is now arguably at the center of attention in the Canadian cannabis industry, thanks to its pending merger with Tilray (NASDAQ:TLRY). Aphria’s shares are up over 180% so far this year.
But neither the attention nor the tremendous gains are good reasons to buy the marijuana stock. Here’s the most compelling reason to buy Aphria right now.
An A for arbitrage
Arbitrage usually involves taking advantage of a price difference of a given stock (or other investment) between multiple markets. But every now and then, an opportunity for a different kind of arbitrage arises. That’s what’s happened with the merger of Aphria and Tilray.
First of all, this merger isn’t one of equals. Aphria is, without question, the dominant company in the deal. Its shareholders will control around 62% of the combined company, and its chairman and CEO Irwin Simon will retain his current roles in the new entity. Aphria will also hold seven of the nine spots on the board of directors.
More important for potentially buying Aphria stock, though, are the specific terms of the merger. Aphria shareholders will receive 0.8381 shares of Tilray for each of their Aphria shares. Tilray shareholders will keep the current shares.
Currently, Aphria is trading at close to 0.73 times Tilray’s share price. The single most compelling reason to buy Aphria stock right now is that this ratio absolutely must increase to the 0.8381 ratio included in the merger agreement.
But just buying Aphria stock by itself isn’t enough to effectively capitalize on the merger arbitrage opportunity. There are three ways that the ratio between Aphria’s and Tilray’s share prices could get to the agreement ratio:
- Aphria stock could rise
- Tilray stock could fall
- Both of the above could occur
The best way to take advantage of the current pricing discrepancy is to buy Aphria and short Tilray. You won’t make a huge profit, but arbitrage can be the closest to a sure thing you’ll find with investing.
Are there other reasons to consider buying Aphria that don’t involve arbitrage? Sure.
For one thing, the company is set to soon become the biggest cannabis company in the world based on revenue after the Tilray merger closes. This large scale could be important as the main players compete for market share in a rapidly expanding global cannabis market.
Aphria, which will operate under the Tilray name after the transaction wraps up, will hold the leading market share in the Canadian retail cannabis market. Although this market has faced headwinds, the reopening of the economy amid the easing of COVID-19 restrictions should fuel stronger growth going forward.
The combination of Aphria and Tilray will also establish a formidable competitor in European medical-cannabis markets. Aphria’s CC Pharma is already a leading medical-cannabis distributor in Germany. Tilray operates a large-scale cannabis-production operation in Portugal.
Of course, the biggest prize is the U.S. cannabis market. Both Aphria and Tilray already have U.S. operations, albeit not in cannabis. Aphria recently acquired SweetWater Brewing, a craft-beer maker that focuses on cannabis lifestyle brands. Tilray owns Manitoba Harvest, the largest hemp foods producer. The combined company will look to leverage these existing businesses to enter the U.S. cannabis market as soon as they’re legally allowed to do so.
Not so compelling
Should investors rush out to buy Aphria stock? I don’t think so.
My view is that the U.S. market will determine which cannabis companies have staying power. However, I’m not convinced that Aphria, as it stands now or after it merges with Tilray, will be among the biggest winners in the U.S.
The CEOs of both companies confidently predict full legalization of marijuana within the next two or three years. Although I think marijuana decriminalization is likely within the next year, I don’t look for full federal legalization anytime soon.
Even if the “new” Tilray (which, again, will be more Aphria than Tilray) is able to enter the U.S. market, my hunch is that the established multistate cannabis operators will have a major competitive advantage. Manitoba Harvest and SweetWater Brewing aren’t the strongest launching pads for moving into the U.S. cannabis market.
I’ll readily admit that Aphria could deliver solid returns for investors even after the arbitrage opportunity goes away. However, I think there are other cannabis stocks that are even better picks for investors right now.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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