RE:Carl and our discountThis is the longest answer of the questions but probably the closest question to yours. If you're asking why they're not 100% in tandem every single day then welcome to a stock market in general. 100 people could have 100 theories.
Q: Conversion ratio of 1 TLRY to 0.8381 APHA is really disappointing.It should be 1APHA to 0.8381 TLRY. Why you downgraded your own shareholders who stayed long with the company through short attack and pendamic? You know how hard it is to hold 10K shares $16 through this bad time? Almost 2 years! And now when time come to breath out of stress, you are disappointing again by approving this merger ratio.Really disappointing merger. Not by assets but by the conversion ratio. What are the factors that satisfy you to accept this ratio perticularly when APHA is performing wonderful by providing best earning report repeatedly? Please enlighten us.
A: General-independent3 thank you so much for asking this question. It didn’t get many upvotes and is buried at the bottom of the list of questions, but I am moving it to the top (to a deluxe apartment in the SKYYYY . . . if you didn’t get that reference, I am way too old!) because it is THE QUESTION I was hoping to get. It is the question we get the most to our investor email. I also think it is the most misunderstood part of the merger. So, I am choosing to answer it first. But before that I need to unpack it into the multiple questions it is: (i) I don’t like the exchange ratio, why wasn’t it flipped; (ii) this merger was a bad idea and as a shareholder my investment has downgraded as a result; and, (iii) why did Aphria decide to do this merger.
Part I – I don’t like the exchange ratio, why wasn’t it flipped?
This question is effectively rooted in the belief that share price is more important than market cap. And closely rooted to the belief that because an investor had a full share before the transaction but will not have a full share after the transaction, they are somehow disadvantaged (multiple investors have emailed us claiming this is the same as taking shares away from them). I know that share price is much easier to find but it isn’t nearly as relevant as market cap. Market cap establishes the value of the company or how big a pie the company is. Share price is just a function of how many pieces of the pie are available, so how big your piece of the pie is.
If two companies are worth $5 billion each and otherwise equal but one company has 5 billion shares and the other company has 100 million shares, that means company #1 has a share price of $1 and company #2 has a share price of $50. Just because company #2’s share price is $50, doesn’t mean that company #1’s share price should be $50 as well and could “moon” to that amount. That would make it worth $250 billion! They are both worth $5 billion.
When one company decides to buy another company with its shares, one of the most important negotiating points is how much dilution is there going to be in the new entity. This is determined by how much of the new company, each of the old company’s shareholders receives. This decision gets made based on several factors providing rough fence posts, including the respective market caps, cash provided to the combined entity, sales provided to the combined entity, assets provided to the combined, profits provided to the combined entity, future prospects to the combined entity, etc. Once the fence posts are established, a value in between them can be negotiated. In our case, after thoroughly exhaustive negotiating efforts it was determined that the appropriate split was 62/38. Once this value is known, the legal acquirer (in this case Tilray) is considered to be the fixed variable (their shareholders keep 1 share for each share they own). Given that Tilray had 165.4 million fully diluted outstanding shares at the time of the announcement, this translated to 38% of the combined entity. This math means that Aphria shareholders would get 62% of the fully diluted shares or 269.9 million fully diluted shares (165.4 million / .38 = 435.3 million total fully diluted shares less 165.4 million Tilray diluted shares = 269.9 million fully diluted shares for APHA holders). This figure is then compared to Aphria’s actual outstanding fully diluted shares of 322.0 million and we have to adjust those 322.0 million shares to down to equal 268.9 million (268.9 million / 322.0 million = 0.8381 – yes, I rounded, and it doesn’t exactly equal, but you should get the point).
So, what is the takeaway? 62% of the company is the most important variable, but the fact that the number of outstanding shares for Aphria exceeded the number of outstanding shares for Tilray played just as important part in the calculation. If shareholders really want APHA shareholders to get more than 1 share of TLRY, we could always do a share consolidation of 2:1 first. That would double the exchange ratio to 1.6762. It doesn’t change anything though. You are still getting 0.8381 shares for each share you own.
Before we look at your scenario of a flipped exchange ratio, I feel it is important for investors to understand all the various pieces of information reviewed in considering the appropriate allocation of ownership in the combined entity. There were reviews and analyses of (i) selected publicly-traded companies, including both cannabis and non-cannabis companies; (ii) Aphria’s discounted cash flow analysis; (iii) Tilray’s discounted cash flow analysis (in both cases as prepared by management and as adjusted by the other side); (iv) contribution analyses (sometimes referred to as “football field analysis”); (v) implied exchange ratio analyses; (vi) give & get value creation analyses; (vii) current trading metrics; (viii) historical trading price ranges; and, (ix) analyst share price targets. The amount of diligence and work done by both sides was significant.
Now let’s look at your scenario of a flipped exchange ratio and work our way back to the split in ownership.
In your scenario of 1 APHA share equals 0.8381 TLRY shares, 322.0 million fully diluted shares for APHA would be combined with 138.6 million fully diluted shares for TLRY (165.4 times 0.8381) resulting in 460.6 million fully diluted shares. Which results in APHA shareholders owning 70% and TLRY shareholders owning 30%.
Based on the market caps (what the investing universe believed APHA and TLRY were worth at the time), the split in market caps was roughly 67%/33%. But one of the most important things to remember when comparing market caps, is that by definition the market cap of a company is what investors believe it is worth in total, IF you own a minority interest. If you can own a controlling interest in a company, investors will pay a premium to acquire control. That means that the 33% needs to be increased and the ratio shifted to reflect the premium that the company who is being acquired demands in order to give you control of their company. That is how 33% moved to 38%. But more importantly, it is why you could never get a deal done where the 33% moved down to any number, let alone 30%, if the company was ceding control to the other entity.
It is also important to understand that in the period leading up to the announcement the 67%/33% ratio was moving up and down, sometimes by a point or two in a given day. Eventually, the two sides needed to pick an allocation then have it stick until the announcement.
Part II – The Merger was a Bad Idea and My Investment has been Downgraded
On December 15th, the day before we announced, APHA’s stock price closed at $8.12. On Friday, January 22nd, APHA’s stock price closed at $12.92. That is an ~60% increase in less than 40 days.
Part III – Why Did Aphria Decide to Do This Merger
We decided to combine APHA & TLRY because we believe that meaningful synergies are available to shareholders through cost leadership and scale in the Canadian cannabis market. It allows us to offer a full portfolio of brands (including 2.0 products) with a portfolio covering all market segments. In the US, SweetWater and Manitoba Harvest together represent over CAD$120 million in U.S. sales. More importantly, both brands provide leverageable opportunities to introduce our cannabis brands to different consumer markets in advance of federal legalization. In Europe, we will be able to take advantage of a rapidly emerging legal cannabis market through Europe’s largest GMP production footprint while taking advantage of our existing distribution system. Lastly, APHA & TLRY form a company that immediately becomes the international market leader making us more attractive to capital markets due to our scale, cost structure and the strategic opportunity to attract institutional and strategic partners.
In making this decision, APHA established an investment thesis with which to evaluate potential business opportunities, including: (i) meaningful synergies; (ii) improved strategic positioning for the US; (iii) maximizing opportunities globally; and, (iv) optimal positioning within capital markets. There was also consideration of the risks associated with any transaction, including (i) integration of two major corporations; (ii) likelihood of achievement of the projected synergies; and, (iv) the diversion that a major transaction creates for management. I believe that the TLRY+APHA combination achieves the investment thesis while protecting and minimizing the potential impact of the risks.