Deal marks the end of the line as an independent entity for the Gatineau firm that was launched in 2013 under the name Hydropothecary and later became the subject of an award-winning book that chronicled the lives of founders Adam Miron and Sebastien St-Louis.
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Gatineau-based pot firm Hexo’s acquisition by larger competitor Tilray Brands is part of an “inevitable” trend of consolidation in a legal cannabis industry that’s still maturing, experts say. Tilray, the southern Ontario company behind brands such as Broken Coast, RIFF, Solei and Good Supply, announced Monday it is buying Hexo in an all-share deal valued at US$56 million. Assuming it gains the required 66 per cent approval from Hexo shareholders, the transaction is expected to close in June. It will mark the end of the line as an independent entity for the Gatineau firm that was launched in 2013 under the name Hydropothecary and later became the subject of an award-winning book, Billion-Dollar Start-up, that chronicled the lives of founders Adam Miron and Sebastien St-Louis. The arrangement structured as a merger builds on a strategic alliance the two companies struck a year ago, after Tilray acquired US$193 million in senior secured convertible notes originally issued by Hexo to HT Investments MA LLC. Hexo hoped last year’s agreement would help kickstart its turnaround and strengthen its balance sheet following years of multimillion-dollar losses that saw the firm nearly lose its Nasdaq listing and cycle through a series of CEOs in the wake of St-Louis’ departure in the fall of 2021. But the firm continued to struggle amid growing price compression in a sector that still faces stiff competition from the black market. A 2021 PricewaterhouseCoopers LLP review of the business showed that Hexo “did not maintain, in all material respects, effective internal control over financial reporting” and several factors “raise substantial doubt about its ability to continue as a going concern.” A series of aggressive cost-cutting measures, including layoffs and plant closures, helped Hexo reduce its net loss to $11.1 million in the second quarter, compared with $690.3 million a year earlier. But sales at the company behind brands such as 48North, Redecan and Original Stash kept heading in the wrong direction. Hexo reported revenue of $24.2 million in the second quarter, down 54 per cent from a year earlier, which it attributed to decreased market share and performance in Ontario, Alberta and Quebec. As losses mounted, a committee of independent directors formed by Hexo’s board to review a potential merger with Tilray ultimately concluded there was “no viable strategic, corporate or financing alternative available,” the company said Monday in a news release. Ian Lee, an associate professor at Carleton University’s Sprott School of Business, said the merger comes as little surprise in Canada’s “hypercompetitive” legal pot industry, in which an estimated 1,000 legal producers are jockeying for market share. “We’re now seeing the consolidation of the market,” Lee said. “I think it was inevitable.” Lee cited a number of factors for the cannabis industry’s ongoing financial woes. Noting a 2021 Canadian Institute for Health Information study that found that fewer than a quarter of adult Canadians used cannabis in the previous 12 months, he said most pot producers made “wildly optimistic” projections about the potential size of the legal cannabis market. Cannabis consumers spent about $4.5 billion on regulated adult-use products last year, according to Statistics Canada. While that was up nearly 18 per cent over 2021, sales of pot products were dwarfed by the $26.1 billion worth of alcohol sold in stores and businesses between April 1, 2021 and March 31, 2022. “The core of users is much smaller than many people thought,” Lee explained. Cannabis still isn’t as socially acceptable as drinking alcohol, he added, noting that smoking bans in public places make pot products much harder to consume in settings like bars. “That social norm or behaviour isn’t there,” he said. “You can’t go into a bar and say instead of going for a drink we’ll smoke some joints. The market will grow, but I just cannot see it ever rivalling alcohol of any kind.” Hexo’s decline helps illustrate “the magnitude of the overshoot, and now markets are correcting,” Lee added. Michael Armstrong, a professor of operations research at Brock University who studies the cannabis industry, agrees there are too many producers for the size of the Canadian market. He said the wave of mergers and acquisitions is likely to continue as pot companies look to achieve greater economies of scale and save money on administrative costs. “It’s not the beer industry, where you’ve got two or three big producers,” Armstrong said. “It’s still very fragmented.” Like Armstrong, Tilray chief executive Irwin Simon blamed some of the sector’s struggles on the high number of licensed producers. He also cited other factors, including the slow move in the U.S. toward federal legalization and “exorbitant” excise taxes that amount to $1 per gram on dry cannabis flower. While licensed pot producers were hoping the federal government would reduce excise taxes in last month’s budget, that didn’t happen. At the same time, the feds cut a planned 6.3 per cent hike in the alcohol excise tax to two per cent. “The alcohol industry probably has a much bigger lobbying power than the cannabis industry,” Armstrong noted. But Simon and other cannabis executives say the biggest hurdle facing the cannabis industry is a series of deep price drops. Statistics Canada said recently a gram of legal cannabis cost $10.29 on average in 2019, the year after recreational cannabis was legalized in Canada (more recent prices were not available). At that time, a gram of weed bought through the illicit market cost $5.96. Legal weed prices have fallen dramatically in recent years, with the Ontario Cannabis Store advertising several brands of flower for between $3.50 and $4.50 in recent months. “No one wins in a price war,” Hexo chief executive Charlie Bowman told industry analysts last month. “A lot of the especially smaller independent retailers are bleeding from a standpoint of just the plethora of retailers that are on the market right now and undercutting one another.” Meanwhile, legal producers must compete with the illicit market. According to the Ontario Cannabis Store, the illicit market made up 43 per cent of Ontario’s cannabis market in March 2021 – down from 75 per cent in June 2020, but still a hefty chunk of total sales. Producers hoping that foreign markets will open up lucrative new revenue streams might want to rethink their strategy, at least in the short term, Armstrong said. Federal legislation legalizing cannabis products across all 50 U.S. states “does not look at all imminent,” he said. “Even when it does happen, the Americans have a lot of cannabis companies there already,” Armstrong added. “There are lots of maybes, but no guarantee of financial success there.” Over time, as smaller producers get swallowed up or die, the market will find an equilibrium, with the strongest, most profitable companies left standing, Lee predicted. Consolidation “is a good thing, not a bad thing, to make the industry sustainable,” he concluded. Armstrong agreed. “There will be a solid future for some of the producers,” he said. “In Canada, we’re in a big experiment called cannabis legalization. We’ve gone through the big initial growth phase. Now we’re in that young adult phase; we’re trying to figure out what life is going to be like. “We’re trying to figure out what that stable level is and I don’t think we’re there yet, either on the production side or the retail side.” – With files from the Canadian Press