Hexo Corp. is buying rival cannabis producer Zenabis Global Inc. in a $235 million all-stock deal that will position the Ottawa-based company as one of the biggest Canadian pot firms by sales. 

The deal will give Hexo a significant boost in cultivation capacity, adding 111,000 kilograms of cannabis production to its operations, while securing a footprint in the nascent European medical market. 

It is also 2021’s first major M&A deal in the pot sector, coming a couple of months after Aphria Inc. and Tilray Inc. announced plans to merge. Analysts expect more consolidation to take place in the Canadian cannabis sector this year as struggling companies are could be snapped up to stem mounting losses. 

Hexo Chief Executive Officer Sebastien St-Louis said in an interview that the deal will ensure the company will remain one of the lowest-cost cannabis producers in Canada. The cannabis grown at Zenabis' indoor production facility will be earmarked for the company's "super-premium" products, he added. 

"Hexo was well on its way to challenge for a top-three spot in Canada, but with Zenabis, when you add the revenue together, we're bigger than Aurora [Cannabis] by a significant margin," St-Louis said.  

St-Louis said Hexo's balance sheet will be able to withstand any scrutiny for a deal that would add a sizable amount of production to the company's operations, despite the glut of unsaleable products in Canada. Analysts expect Hexo to deliver positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in its upcoming quarter for the first time. 

"When you look at the inventory we have, when you look at the assets and goodwill; there's no depreciable capital base to challenge our [earnings-per-share], even when compared to the top names in the space," he said. 

Hexo said in a release it has identified about $20 million in savings within the first year of the deal closing. Zenabis shareholders will receive 0.01772 of a Hexo share in exchange for each share they own, a ratio that reflects a 19-per-cent premium to the company's shares over a 20-day average. ​

The deal may also provide some relief to Zenabis shareholders who have seen the company's valuation plummet as much as 98 per cent since trading at all-time highs in late 2018. Since then, Zenabis has gone through four CEOs and reported over $61 million in impairment charges related to several small acquisitions and inventory write-offs. Zenabis booked a net loss of $127 million in its most recent fiscal year.

"They've made a lot of deals that that were opportunistic given the fact that they’re cash strapped," St-Louis said. "Those deals that put a lot of pressure on their stock and created a ton of uncertainty."

The tie-up with Zenabis could also see Hexo ship cannabis-infused beverages to Europe via its joint venture with Molson Coors Beverage Co. Zenabis owns a subsidiary in Malta that recently received European Union Good Manufacturing Practices (EU-GMP) certification, allowing the company to ship medical cannabis products to the European market. 

St-Louis expects to see more consolidation in the Canadian cannabis industry this year and says he is seeking "creative opportunities" to position Hexo as one of the top two companies in the recreational sector. He said he's also eyeing developments in the U.S. for a potential entry point into that market. 

"We look for low cost operators but there's certainly not a lot of those," he said. "In fact, [Zenabis] is pretty much the last one off the market. So, we're certainly more focused on what's going to be happening in the U.S." 

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