MedReleaf Corp, Aurora Cannabis Exchange Ratio Price Forges New Highs

For spread/arb investors looking for a solid deal, MedReleaf Corp (TSE:LEAF) (OTCMKTS:MEDFF) may provide an intriguing opportunity. Exchange ratio price spreads—the difference in price between 3.575 Aurora Cannabis shares for every one LEAF share, pending shareholder approval—hit new wides today. This, despite the fact the acquirer stock has rallied heavily over the past couple of sessions. We explore.

To briefly recap, the exchange ratio spread between MedReleaf and Aurora Cannabis exists via merger plans announced on May 14. Aurora Cannabis agreed to purchase MedReleaf in an all-stock deal worth $3.2 billion fully diluted, whereby MedReleaf shareholders would receive 3.575 common shares of Aurora for each MedReleaf common share held, pending shareholder approval. At press time, each MedReleaf share was valued at approximately $29.44/share, based on the 20-day volume weighted average prices of Aurora and MedReleaf common shares on the Toronto Stock Exchange as of May 11, 2018.

However, the last six trading sessions have seen spreads blow out to new highs. This, despite Aurora Cannabis trading $0.31 higher (↑3.84%) post-deal (May 11 close to current)—presumably lessening the chances of a negative voting outcome.

As such, the widening gap doesn’t make much sense on the face of it. The exchange ratio price premium has increased from an already-substantial 11.82% at the close on May 14, to an astronomical 19.83% today. With Aurora closing at $8.38/share, MedReleaf shares should be theoretically valued at $29.96/share right now; instead, MedReleaf is trading at $25.00/share—almost five dollar below merger value.

This reality suggests one of two things: either investors believe the ACB-LEAF deal has a progressively lower chance of coming together, or that other unforeseen events are at play. If we assume nothing has deteriorated from the acquirer/acquired side, what could be causing the rise in premiums?

I believe the answer lies not in the fundamentals of the friendly merger, rather, the ability to borrow short the acquirer stock.

According to a December 2017 Toronto Star report, the annual interest rate to short Aurora, Aphria or MedReleaf is upward of 20-percent. These prohibitively expensive thresholds made cannabis stocks difficult to borrow, even as rocketing prices provided attractive shorting opportunities. Provided these same dynamics are at play, it would explain the large dichotomy between pricing spreads between ACB-LEAF today.

While it’s counter-intuitive to believe that one of the most liquid stocks on the TSX—an issue with 561 million shares outstanding—would be hard to borrow, it could explain why spreads are blowing out to extreme levels. Perhaps other factors are at play, but if they are, I’ve yet to find them.

Regardless, for well-endowed investors with capital and time to spare, there’s a potential 20-percent return (minus borrowing interest costs) sitting on the table. With Aurora Cannabis prices rebounding smartly over the last couple days, the smart money may begin circling the wagons (pending share availability).

Original article: MedReleaf Corp, Aurora Cannabis Exchange Ratio Price Forges New Highs

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