We have been short APHA for over a year on the Canadian Cannabis market's challenges and the company position. Since CEO Irwin Simon landed at APHA, he has updated thinking around how the company should operate and tried to get to a profitability position. Unfortunately, the APHA balance sheet continues to be a significant source of pain for shareholders. He has also said, the road to profitability will include reshaping the company to look more like a traditional CPG company. He desperately wants to enter the U.S. cannabis market, but he can't do it legally. Buying a regional craft beer company is his answer, and we are unimpressed by the move. To date, cannabis consumers don't seem to be taking to beverages as their preferred way to consume THC and everybody was in on THC beverages. Generally, the products are unappealing, and taste always seems to be an issue, which holds for Sweetwater 420. I had a SweetWater 420, and I still remember it as the worst beers I have had in years. I woke up with the taste still plaguing my mouth.
For the time being, the street will take this as a positive, but we remain skeptical that the company can get away from its Canadian roots overnight. Importantly, there is a case to be made that it could be 5-10 years before APHA can enter the US Cannabis market. By then, the APHA/Sweetwater combo will have lost significant ground to the current US operators.
Aphria announced that it would purchase SweetWater Brewing for $300M, including $50M of stock. The purchase will be accretive to 2020 results. The investment will give Aphria a brand in the U.S. that will help it launch a line of THC beverages in Canada. The acquisition price seems expensive based on comparable deals in the space at 13.5x 2019 EBITDA (12.5x LTM EBITDA) and 4.5x sales. SweetWater does have surprisingly attractive EBITDA margins at 33%, though (especially considering revenue of $256 per barrel or $.78 a bottle). If the business hits the 2023 earnout targets, the purchase price will increase another $66M, but the valuation would be 11x EBITDA. Boston Beer purchased Dogfish Head a year and a half ago for $300M when it was the 13th largest craft brewer. (The Dogfish Head co-founders received 406,000 shares as part of the acquisition, which would make the acquisition price $416M more at today's stock price.) Dogfish Head was expected to have sales of $120M on 300,000 barrels in the year it was acquired.
SweetWater is the 14th largest craft brewer in the U.S. at 261,000 barrels and $67M in revenue. The brewer is based in Atlanta and has distribution to 27 states. It does have a taproom, but the majority of its sales are through packaged goods stores. With its Atlanta base, SweetWater does have distribution on Delta flights, giving it more brand exposure. SweetWater says it is distributed through 29,000 off-premise locations and 10,000 restaurants and bars. The brewer has a unique series of beers dedicated to cannabis, with each beer made to harness the aroma, flavor, and vibes of a cannabis strain. The ingredients in the beer only lend to the smell and taste of cannabis without any THC. Early this year, SweetWater received a liquor license, presaging an entry into distilling.
We are not a fan of the acquisition for several reasons.
- Diversification is not what we think investors want from a cannabis company. Although Irwin Simon has said, he was interested in acquiring a CPG company.
- Aphria brings no experience to craft beer.
- What does the acquisition imply for the opportunities management sees in the core cannabis business?
- The craft beer industry is past its rapid growth stage, but the number of new start-ups increases even in a pandemic. There are few barriers to entry.
- It is essential to keep the founders involved in the business after the acquisition. SweetWater was founded 23 years ago.
- As Constellation Brands' acquisition of Ballast Point showed, the craft industry has increasingly favored local beers, not national brands. With the number of craft acquisitions Anheuser-Busch InBev and Molson Coors have made in the craft industry, tap handles available for non-local craft beers have become very competitive. It has become very competitive to get a distributor to focus on a craft brand further away from its base.
- It is very early to be focused on THC beverages, and a cannabis company does not need to acquire a brewer to develop one. SweetWater has a lot of experience making beer taste like cannabis strains; it does not have experience making beverages with THC. We think that it is two entirely different skill sets. (I still can't believe the first is a desirable skill set – see below.)
On a personal note, I had a SweetWater 420, and I still remember it as the worst beers I have had in years. I woke up with the taste still plaguing my mouth. It must not be for everyone.
