Hexo Makes Opportunistic Purchase in Canadian Cannabis Market

Hexo (NYSE:HEXO) should report results for its fiscal Q2 ending Jan. 31 within the next month. Hopefully, this will show that the Canadian cannabis distribution company can reach profitability at least on an adjusted EBITDA basis. As I wrote in my last article, HEXO stock may not rise substantially until that happens.

Dollar cut out in the shape of a marijuana leaf
Source: Shutterstock

However, until that happens, it seems that Hexo management has found a way to get profitable without necessarily doing it organically. On Feb. 16 the company announced a definitive agreement to purchase another Canadian cannabis company which is EBITDA profitable. The deal to buy Zenabis Global (TSE:ZENA) is an all-share purchase worth about 235 million CAD.

As a result, and maybe in anticipation of it, ZENA stock has skyrocketed. Since February 2020, it has moved up 37% to 18 cents CAD per share. But not to worry. HEXO stock is up as well.

For example, year-to-date HEXO stock is up over 115%. Hopefully, this is a signal from insiders who are buying knowing that the company is now profitable.

What Hexo Gets With Zenabis Global

First of all, Zenabis produces significantly more cannabis than Hexo. Zenabis has two facilities, one in the eastern side of Canada and the other in the west in British Columbia. The combined present capacity is 110,400 kg of dried cannabis.

By contrast, in its fiscal Q1 ending Oct. 31, Hexo produced 17,462 kg of cannabis, which puts it on an annual run-rate of 69,848 kg. This is seen on page 18 of its financial statements. This means that the combined company will have a total capacity of 180,248 kg, or 258% greater than Hexo presently has.

Revenue will jump significantly as well. For example, in Hexo’s latest quarter ending Oct. 31, it had 29.468 million CAD in revenue. Zenabis made $23.7 million CAD net revenue. Therefore, the total run-rate revenue will be 53.17 million CAD, which represents an 80% gain for Hexo.

But more importantly, as I mentioned above, Zenabis is now profitable on an adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) basis, whereas Hexo is not. Zenabis has now had three full quarters of adjusted EBITDA profits, based on slide 17 of its most recent presentation. The most recent quarter showed 3.5 million CAD in adjusted EBITDA profits at Zenabis, whereas Hexo had a loss of 419,000 CAD last quarter.

Hexo said on page 20 of its financial statements that it expects to be profitable for the quarter ending Jan. 31 on an adjusted EBITDA basis. Assuming it makes 1.5 million CAD in adjusted EBITDA, the combined company will have quarterly profits of 5.0 million in adjusted EBITDA or 20 million CAD annually.

That leaves HEXO stock in a relatively attractive position.

Valuing HEXO Stock

The purchase announcement indicates that Hexo’s all-stock purchase of Zenabis is at $235 million. (I take that to mean 235 million in Canadian dollars as both companies report their financials in Canadian dollars.)

It also looks like the purchase price will be after Zenabis completes the sale of a facility for 24 million CAD. This will leave Zenabis with about 40 million in net debt. Therefore the enterprise value of the purchase is 275 million CAD, or $217 million in U.S. dollars.

Zenabis produces 53.17 million CAD annually in revenue and 3.5 million CAD quarterly in adjusted EBITDA, or 14 million annually. Therefore, the purchase is being done at about 5 times sales (i.e., 275 million CAD in EV and 53 million CAD in sales). In addition, the EV-to-EBITDA multiple will be 19.6 times, just below 20 times.

The Deal Looks Good for Hexo Stock Owners

This will help HEXO stock’s valuation a little bit. For example, right now HEXO has an EV of about $860 million, assuming about $51 million in net cash and a $911 million market cap. Its sales are about 120 million CAD annually, or $95 million in U.S. dollars. Therefore, its EV-to-sales ratio is 9 times (i.e., $860 million divided by $95 million). Buying Zenabis at a much lower 5 times sales will help improve its overall valuation.

The combined valuation will give HEXO a lower EV-to-sales valuation as a result. For example, since Zenabis has about $31 million in net debt after its upcoming asset sale the combined market value will be about $1.096 billion (including the additional shares issued to Zenabis).

The new EV will be $1.076 billion (i.e., $860 million Hexo plus $217 million Zenabis). The combined sales will be about $137 million, giving the combined company and EV-to-sales of 7.85 times. In other words, Hexo’s EV-to-sales ratio falls from 9 times to 7.85 or so. These are rough estimates only, but it shows that the transaction is likely to be a good deal of HEXO stock.

In addition, both companies are likely to be profitable now on an adjusted EBITDA basis. Moreover, the two have identified 20 million CAD in planned synergies within one year. Therefore, the Zenabis deal looks like a good one for Hexo shareholders.

On the date of publication, Mark R. Hake does not hold a long or short position in any stock or security mentioned in this article.

Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.

Article printed from InvestorPlace Media, https://investorplace.com/2021/02/hexo-stock-will-gain-from-the-zenabis-deal-from-acqusition-synergies/.

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