Play Tilray Stock for the Aphria Stock Merger Arbitrage Opportunity

Aphria (NASDAQ:APHA) stockholders will vote April 16 on the mega-merger with its longtime Canadian cannabis-market competitor, Tilray (NASDAQ:TLRY). Since the merger announcement, TLRY stock and APHA shares have gone in different directions due to the merger arbitrage opportunity.

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When the Aphria-Tilray merger was announced back in mid-December, both pot stocks exploded.

In terms of revenue, the combination will create the biggest cannabis company in the world. So, the enthusiasm surrounding the merger makes sense.

In the year thus far, Aphria stock is up 135.3%, and TLRY gained 139.2%. Under the terms of the deal, Aphria stockholders will receive 62% of the combined entity.

Some made money by buying Aphria and shorting Tilray. However, at this point, the more interesting discussion is whether the combined entity will have the legs to run in an ailing industry.

It has been struggling due to the Canadian cannabis market going through an essential round of bubble bursting.

On that end, I believe the merger ultimately creates an interesting stock that has a much better chance of competing in the Canadian cannabis sector while keeping an eye on the U.S. market.

TLRY Stock Suffered With Cannabis Sector

Let’s face it. Before this merger was announced, both Tilray and the wider cannabis segment were suffering. Gross margin, operating margin, net margin, return on assets, return on equity, and ROIC is all in the red for TLRY.

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According to Refinitiv data, the Canadian pharmaceutical and cannabis company has disappointed Wall Street analysts’ consensus earnings estimates 10 times in the last 12 quarters. The company recently reported a negative EPS of 45 cents versus a consensus of negative 14.7, a miss of 206.1%.

There are some bright spots, though. For the full year 2020, total revenue jumped 26% to $210.5 million, driven by international medical revenue and growth in its Canadian adult-use business.

Out of the two companies, Aphria is clearly the better company on operating metrics. Sales rose 235.8% over the last five years at a compound annual growth rate (CAGR). Growth in the top line hasn’t translated to profitability as yet. But on every major operating metric, the company is doing better than Tilray.

APHA Stock Maintains Upper Hand

No surprises Aphria has the upper hand in this deal. Shareholders will get a total of 0.8381 shares of Tilray for each of their Aphria shares and control the combined entity.

Aphria’s and Tilray’s share prices will diverge in the run-up to the merger due to the market arbitrage opportunity. Basically, a market arbitrage opportunity is when you simultaneously buy and sell securities to take advantage of a price difference.

Usually, when a merger is announced, the target company’s share price rises. The opposite occurs in the case of the acquiring company. The acquiring company has to pay a premium to purchase the target company, often using debt to finance the acquisition.

Combined Entity Will Be a Strong European Player

After the merger, the surviving entity will become the biggest cannabis company globally in terms of revenue.

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Wider marijuana decriminalization in the U.S. is imminent. Democrats have unified control of the White House, Senate, and House for the first time since 2010.

At the moment, neither Aphria nor Tilray has a strong American presence. In contrast, the European medicinal cannabis market and the Canadian recreational market represent the company’s strongest market segments.

That’s not to say it couldn’t make a splash in the U.S., though. With greater size and scale, it can make further inroads into the American market since that is the major lifeline for most cannabis aspirants at the moment.

Although it’s fairly large, the Canadian market doesn’t hold a candle to the California weed industry, let alone the entire U.S.

Hence, the foray into America is a given, and with the combination, the merged entity has a better chance of performing well in the market.

Bottom Line on Tilray Stock

For now, investors should keep taking advantage of the arbitrage opportunity. In the last three months alone, shares have increased by 90%. During the same time, Tilray stock is up 74.7%. The divergence will increase as we move closer to the merger.

If you are bullish on the merger, you can hold onto APHA stock post the combination. But I would take my profits after the merger closes and wait for a couple of earnings reports before deciding to put your capital back into the company.

On the date of publication, Faizan Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. Faizan has several years of experience analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio. 

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