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Merger Arbitrage - Aphria Inc. and Tilray Inc.

January 3rd, 2021


Disclaimer: I don't own any positions in Aphria and Tilray anymore.

The stock is Aphria Inc. which is known to be one of the current market leaders in recreational and medicinal cannabis in Canada, currently expanding facilities to the US and Germany. Previously I've been bullish on the stock due to the incoming Biden administration which is seeming to be more friendly towards future cannabis regulation laws. Under Joe Biden’s Criminal Justice Policy it states "Decriminalize the use of cannabis and automatically expunge all prior cannabis use convictions. Biden believes no one should be in jail because of cannabis use. As president, he will decriminalize cannabis use and automatically expunge prior convictions. And, he will support the legalization of cannabis for medical purposes, leave decisions regarding legalization for recreational use up to the states, and reschedule cannabis as a Schedule II drug so researchers can study its positive and negative impacts.” With additional upcoming catalysts that are set to increase the price of APHA such as additional states legalizing, let me transition into the main part of this post which is the confirmed Aphria Inc. merger with Tilray.

Now, what the heck do I mean when I say "Merger Arbitrage". Well, Google defines it to be the subset of event-driven investing or trading that involves exploiting market inefficiencies before or after a merger. In layman's terms, it means that you are betting on the companies ability to close and eventually merge. As a trader, you possess the risk of the two stocks’ inability to merge whether that be from rejected contract negotiations or some other outside force vetoing the following merge. So quantitatively what is this risk you may ask?

When Tilray and Aphria merge on approx. in the early half of 2021, APHA shares will be converted to TLRY at a rate of 1 APHA to 0.8381 TLRY. Currently, during after-market hours, Aphria Inc. is trading at a price of $12.42 compared to Tilray Inc.’s price of $19.70. At the current conversion expressed from the merger, Aphria should be trading closer to $16.51 (19.7 x .8381 = 16.51). This current offset in pricing is known as the merger spread and it's directly related to the risk of the deal falling through (Essentially the approx. risk). This isn't free money any more than options are free money, you're being paid for the risk you're taking. That spread usually closes almost entirely by the time a merger is imminent.

Even with this risk, APHA is an extremely solid company that pre/post-merger will continue to dominate the industry. They are undervalued considering almost every other ticker is nowhere near profitable but Aphria has been consistently profitable and has exposure in Germany which is going to ramp up over the next few quarters. They also have one of the largest cash reserves which I believe they are hoarding in order to penetrate into the US market whenever they see an opportunity

While the US Market has gotten more efficient in the last decade, it's far from being a perfect market. The inefficiencies in the market allow for arbitrage opportunities, and, to a degree, that's what allows hedge funds to make profits consistently. Even if the merger doesn't go through which is pretty unlikely, Aphria is a solid company that will continue to dominate the cannabis market over the next 4 years at least.