During the last year, the landscape of the Canadian cannabis industry has changed and valuations across the board have plunged (despite the opening of the cannabis 2.0 market). The speed of the decline is similar to that of the rally of the Canadian cannabis sector in 2018, and we believe that our readers need to be aware of the transition.

At the height of the Canadian cannabis industry, the 3 largest Canadian cannabis companies had a combined market cap of $50+ billion. For an industry that was generating less than $100 million of revenue, valuations were frothy and the expectations associated with the operators were not realistic.

Although we expect there to be a few winners in the Canadian cannabis market, most businesses will fail. Some of the operators that we believe could fail are considered to be industry leaders and this is a scary thought since the businesses have been able to raise more than $1 billion in aggregate.

Today, we want to highlight two Canadian cannabis producers that have not lived up to expectations. Although these high-profile operators have been able to raise several hundred million dollars, the businesses have failed to execute on major growth initiatives and have completed some acquisitions that were extremely overvalued.

Canadian cannabis producers Aurora Cannabis Inc. (ACB.TO) (ACB) and HEXO Corporation (HEXO.TO) (HEXO) are the businesses in question and we will explain why these companies may be in trouble in the near future.

Aurora Cannabis: A Hard Fall From Grace

Although Aurora Cannabis was once considered to be the main challenger to Canopy Growth (WEED.TO) (CGC), a lot has changed in the last two years and Aurora Cannabis is no longer considered to be a challenger to lower-profile Canadian cannabis producers.

There are a number of reasons that could explain the downfall of Aurora Cannabis, and we want to highlight these below:

1. Acquired CanniMed and MedReleaf for more than $7 billion (cash and stock) at the height of the market (from a valuation standpoint)
2. Spent hundreds of millions of dollars to construct massive state-of-the-art cultivation facilities in Canada that were shut down in 2020 due to a supply-demand imbalance in Canada and abroad
3. The European investments have not been the revenue generators that they were expected to be and Aurora also closed some of its facilities in Europe
4. The leverage to the Latin American market has not paid off as anticipated and the acquisition of Uruguay-based ICC Labs was completed for a large premium
5. From a balance sheet standpoint, Aurora Cannabis is not the company it once was and has been forced to take on debt capital. Previously, Aurora had no problem with raising capital by selling equity. In the future, the company will need to pay off the loan and the interest associated with it which could prove to be a challenge
6. Many of the executives who played a key role in turning Aurora into a multi-national operator from a small scale cannabis producer have left the company, and we have a lower conviction level in the current team

Where Will HEXO be a Year From Now

HEXO Corporation is another example of a Canadian cannabis producer that failed to live up to expectations. In late 2018, HEXO became one of the most talked about cannabis companies after it formed a strategic partnership with Molson Coors (TAP.CN). This development got the market very excited and many analysts started to compare HEXO with Canopy Growth.

Although the agreement was substantial, it was not nearly as significant as Canopy Growth’s arrangement that resulted in it being given $4 billion of capital. The relationship that HEXO has with Molson Coors did not require an investment and was simply a partnership. We believe that the expectations that were associated with the Molson Coors partnership were too high and are of the opinion that the market punished HEXO for the amount of time it took for the relationship to materialize.

A few months ago, HEXO and Molson Coors announced the formation of a joint venture to explore opportunities for non-alcohol hemp derived CBD beverages in Colorado. A few months later, the Canadian cannabis producer was granted a license amendment that included the area of the facility that is dedicated to the production of beverages. We are glad to see the relationship with Molson Coors advance and will monitor how it supports the business.

In 2018, HEXO jumped on the Canadian cannabis producer acquisition bandwagon and purchased Newstrike Brands for a massive premium. The reason why there was a premium associated with the acquisition is because CanniMed previously tried to acquire Newstrike in an attempt to fend off Aurora Cannabis’ takeover acquisition bid.

Following the completion of the Newstrike acquisition, we became increasing cautious with HEXO. Like Aurora Cannabis, HEXO was forced to close down production facilities and had to substantially decrease its cash burn. The Ontario facilities that were closed were once operated by Newstrike and the shutting down of the facilities did not come as a surprise to us.

HEXO recently laid off 10% of its staff and is working to generate positive cash flow and to operate profitably. Going forward, we continue to be cautious with HEXO and will monitor how the story evolves from here.