The Sniff Test: The Aphria ‘hostile’ takeover offer is littered with red flags

Aphria Inc. has been accused by a short seller of being part of a vast network of reverse mergers and marijuana-focused acquisitions meant to enrich insiders at the expense of shareholders.

Aphria has not adequately addressed those claims. But now, a related company that just completed a reverse merger last month is attempting to acquire Aphria in a deal that could protect those same investors while not helping other shareholders.

On Thursday evening, Green Growth Brands Ltd.

GGBXF, +3.14%

publicly announced an all-stock bid for Aphria

APHA, +12.39%

APHA, +12.55%

that it said would value the Canadian pot producer at more than $2 billion. Getting to that $2 billion figure requires some fancy math: Green Growth values its own shares at C$7 apiece, even though they only topped C$5 a share on the Canadian Securities Exchange for the first time Friday morning.

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Executives from the two companies had a “friendly” meeting Thursday, at which Green Growth laid out its proposal and attempted to secure an exclusive deal, Chief Executive Peter Horvath told MarketWatch in an interview Thursday, though he framed the bid as hostile. “I guess it’s technically a hostile takeover,” Horvath said.

Green Growth and Aphria have a pretty long, and friendly, history for any genuine hostility to have sprung up now. The major backer of Green Growth, the billionaire Schottenstein family, partnered with Aphria on a bid to run a medical-marijuana dispensary in the Schottensteins’ home state of Ohio in 2017. The two companies also reportedly share some players, such as Aphria board member and former Green Growth board member Shawn Dym, as short seller Hindenburg Research pointed out in a post Friday morning.

Earlier research on Aphria by Hindenburg and Quintessential Capital Management caused a major drop in the company’s share price, but management has barely addressed any of the specific accusations the trader makes. Aphria is reportedly looking to fire its longtime law firm Stikeman Elliot, which was responsible for advising Aphria on several questionable asset purchases highlighted by the short seller

Aphria also may have given a clue about what was found in an internal investigation by removing Chief Executive Vic Neufeld — a major target of the short seller’s theory — from the chairman role in a little-noticed announcement that hit directly after Green Growth publicly announced its bid, timing that could lead one to believe that the two actions were coordinated to lessen the impact of the second. Neufeld sits on the advisory board of Green Acre Capital, which took more than C$30 million from Aphria in the fiscal first quarter and is an investor in Green Growth, through one of its funds.

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Aphria addressed this relationship directly in a statement Friday morning that said the bid “significantly undervalues the company” and that the proposed transaction carried considerable risks for shareholders. Aphria acknowledged the Green Growth investment made by Green Acre, and said the independent committee evaluating the takeover bid has no ties to either Green Growth or Green Acre.

While Green Growth’s bid could shore up Aphria’s valuation, it is still worrisome for any major investors who still hold stakes in Aphria. Green Growth went public through a reverse merger on the CSE less than two months ago — it is even listed on that exchange by the equity’s former name, Xanthic BioPharma Inc. — and an acquisition would, in the near term, force the combined entity to trade on that second-tier Canadian exchange and over-the-counter markets instead of the current homes for Aphria shares, the Toronto Stock Exchange and the New York Stock Exchange. Green Growth posted modest revenue of roughly $1 million on losses of about half that amount in the most recently reported quarter, and had zero revenue in the same quarter the year before.

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A switch to the CSE would mean many large institutional investors would not be able to own Aphria stock. As MarketWatch has reported, the CSE is not liquid enough to handle large trades, yet has flourished among U.S.-based pot businesses in the past couple of years, as no major exchanges would accept listings by companies that openly break federal law. And, it’s an open question as to how U.S. investors will be able to take shares in Green Growth, because it will be violating federal law.

All of these complications point to a deal that is unlikely to, and perhaps should not, be completed. If Aphria is legit, it is worth more than Green Growth is offering; if there are major ethical problems within the company, a related-party transaction would only temporarily paper over them. But in the long run, they would remain. Either way, this bid does not seem to be a reason for Aphria’s stock to head higher.

Aphria shares did gain Friday. U.S.-listed shares rose 12.4% on the day, while the TSX-listed stock increased 12.6%. The entire sector seemed to benefit as the week’s trading closed: U.S.-listed shares of Tilray Inc.

TLRY, +5.73%

bounced 5.7% higher, Aurora Cannabis Inc.

ACB, +2.55%

ACB, +4.71%

added 2.6%, Canopy Growth Corp. increased in value by 2.1%

CGC, +2.09%

WEED, +2.19%

and Cronos Group Inc.

CRON, +0.97%

CRON, +1.36%

gained 1%. The ETFMG Alternative Harvest ETF

MJ, +4.18%

 , which tracks marijuana-related stocks, advanced 4.2% on the day.

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