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This major Canadian cannabis company is finally getting a foothold in the U.S.

May 24, 2020, 2:00 PM UTC

Aurora Cannabis is staking a claim stateside.

The Canadian cannabis heavy hitter announced an all-stock acquisition of U.S. CBD company Reliva last week, which marks Aurora’s first big foray into the enticing U.S. market. But it comes at a time when industrywide bearishness has led many stocks to dramatically sell off—including Aurora, which has shed nearly 90% of its market cap in the past year.

The pros of the deal are obvious: “It’s immediate access into the world’s largest cannabinoid market,” and “delivers a key aspect of our reset plan,” Aurora executive chairman and interim CEO Michael Singer told CNBC Wednesday. The company’s stock popped over 30% on Thursday.

Back in September, Fortune reported Aurora was still looking for a strategic entry into the lucrative U.S. market, as many of its competitors like Canopy Growth had secured partnerships with titans like Constellation Brands. While this deal lets Aurora tap into the growing CBD market in the U.S., it still lacks a strategic investor to help it weather industrywide cash burn problems.

In fact, according to Morningstar’s Kristoffer Inton, “the deal doesn’t change what Aurora needs to and continues to focus on, which is dealing with this whole market cash burn,” he tells Fortune. Still, he believes “it’s a good asset to add to the company because U.S. CBD is a growing market.” (In fact, Brightfield Group, a research firm, estimates U.S. retail CBD sales could soar to as much as $24 billion in 2025.)

Aurora paid $40 million in stock for Reliva, which is one of the top sellers of hemp-derived CBD-infused drinks, creams, gummies, and more in the U.S. at over 20,000 retail locations and online. The deal closed in late May.

Cowen analyst Vivien Azer describes the “logical” deal as Aurora’s “long-awaited” entry into the U.S. at the heels of competitors like Tilray and Canopy. On the upside, the company says the Reliva deal will be “immediately accretive to Aurora on an adjusted Ebitda basis,” and analysts like Inton note the fact that Reliva is already positive adjusted Ebitda “is a good thing considering Aurora’s Canadian [business] isn’t positive Ebitda yet.” Plus, Reliva has no debt, and the deal structure allows Aurora to protect its own cash (yet Inton suggests Reliva is likely “still free cash flow negative,” and some analysts question how profitable the company is on a standard accounting basis).

Azer likes the deal for a couple of key reasons: “By acquiring a CBD company, [Aurora] has the ability to start building its infrastructure out to capitalize on the potential for 1) a more benign FDA environment on CBD and 2) THC legislation that makes it federally permissible to operate domestically,” she wrote in a note Thursday. (CBD is the nonpsychoactive component of marijuana, while THC is the component that gets you high.)

However, for Morningstar’s Inton, “I would point out to people that think this [Reliva deal] turns into a launching pad for eventual U.S. THC that it’s not necessarily the case,” he says. Reliva’s big distribution is in convenience stores, like Circle K, and Inton suggests, “I really, really doubt that even in the next 10 to 20 years, you’ll be able to find THC at a gas station. It’s always going to be controlled via dispensary,” he says. “Going into the U.S. CBD is not the same as going into U.S. THC.”

Yet it’s the U.S. THC market that many analysts suggest will be a more lucrative, bigger opportunity for cannabis companies. CBD, meanwhile, is growing fast in the U.S, but “it’s also supercompetitive,” says Inton. Plus, those like MKM Partners’ Bill Kirk have concerns about declining CBD prices in the U.S. amid questions about and restrictions on edible CBD from the FDA: “U.S. CBD has been under a lot of commoditized pressure,” Kirk recently told CNBC.

And while analysts believe Reliva looks like a good asset for Aurora, those like Inton and Kirk point out that shares of Aurora are getting highly diluted (the company paid for the acquisition in all stock and has had to raise equity to cover expenses). At the stock’s current battered levels, “it was another equity issuance at a low price,” Inton points out. In fact, Jefferies downgraded the stock on Friday, with analyst Owen Bennett noting that “the CBD space is experiencing significant headwinds currently,” and “further dilution at a questionable multiple…has been a criticism of the past.”

Problems on the home front

Meanwhile, although the deal provides Aurora a much-desired footprint in the U.S., the company still faces a multitude of problems on the home front in Canada.

“The bigger focus and concern should still be to right-size the Canadian operations,” Inton says, referring to how Canadian companies have struggled to find the right product mix and have been weighed down by cash-burning expenses tied to the growth they expected that has proved lackluster. “During the rest of the year…what everyone is still going to be looking for is how much progress Aurora is making in terms of shrinking that cash burn.”

Indeed, the sector en masse has been pummeled, as investors sold out of cannabis stocks late last year in what many industry experts called a “bubble that burst.” A slew of missed earnings, regulatory troubles, and lackluster sales in Canada have left many cannabis companies like Aurora struggling to achieve the promising growth they once touted.

Yet it seems investors are slightly more optimistic about Aurora now, as the stock popped over 100% since the company reported better than expected earnings for its third fiscal quarter on May 14—an “encouraging sign, for a change,” Cantor Fitzgerald’s Pablo Zuanic said in a note. The company said it’s now shooting for a positive adjusted Ebitda in the first quarter of 2021, and for Cowen’s Azer, the deal gives Aurora “additional cushion to meet its targets.”

While Aurora’s stock has seen a bit of a recovery in recent weeks, up over 80% in the past month, it’s still miles off its 2019 highs.

A new deal may bring promising growth in the U.S. CBD market, but Morningstar’s Inton maintains that stemming cash burn is “the No. 1 priority for Aurora.”

Update: This article has been updated to reflect that the Aurora Cannabis-Reliva deal closed.

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