Will the Lexaria - Altria deal lead to an outright buyout?
QUESTION: “Exciting news from Lexaria (CSE: LXX) (OTCQX: LXRP) this week regarding Altria (NYSE: MO) and their research and development project. I see the initial $12 million as a “lease” on LXRP’s DehydraTECHTM technology to see if it really does what MO wants. I also think there is more to this than just cigarettes given MO's recent deal with Cronos (TSX: CRON) (NASDAQ: CRON). Do you think MO is positioning itself for edibles/CBD/drink infusions utilizing both CRON and LXRP? Do you see this deal between LXRP and MO leading to an outright buyout of LXRP or buying a large share of LXRP? I’m glad I've continued to hold LXRP on your advice.”
E.G. from the United States
ANSWER: Let’s begin with the basics. Recall that LXRP established subsidiaries last year to license out their technology into specific applications. So on LXRP’s side, the party to this transaction is Lexaria Nicotine, one of those subsidiaries. From MO’s side, the party is Altria Ventures that is described as an indirect subsidiary of MO that describes its approach as follows: “To be a collaborative, strategic investment partner to companies whose innovative technologies, processes and products complement and advance the Altria family of companies, help us seize new opportunities and deliver competitive advantages.” Sounds like Lexaria all right.
The agreement is, in brief, that Altria Ventures will invest $12 million into Lexaria Nicotine in stages as three milestones are met. I suspect you are correct in your question. The objective of the research will be to ensure the technology does what Altria wants and what they will need to get regulatory approvals, if any, with whatever commercial products they have in mind. Altria has invested $1 million and as they invest the remaining $11 million, they acquire additional interest in Lexaria Nicotine. When all $12 million has been invested, Lexaria Bioscience still controls ownership and the Board of Directors of Lexaria Nicotine.
The direct reward to LXRP comes in two possible ways. If MO begins to market products using DehydraTECHTM, LXRP begins to receive royalties. Remember MO sales are currently US $25 billion so the royalties could become significant over time. Alternatively, MO has an option to buy out Lexaria Nicotine at their option at a price based on an independent valuation that is satisfactory to both companies.
Assuming we get to this stage and MO is happy with what they’ve found, I believe they will want to buy out Lexaria Nicotine sooner rather than later. As MO products begin to sell with the new technology onboard, it will become clearer that the value is greater. So the “best” price from MO’s point of view will come sooner. From the LXRP’s shareholder’s point of view, they should be more or less indifferent to which of these two outcomes prevail from a strictly financial point of view. As is the case when selling an annuity for a lump sum, up front value, the valuation of Lexaria Nicotine will be not less than an estimate of the present value of future royalty payments. Some people may be more or less optimistic while others may prefer an income stream over a lump sum. But from a strictly financial perspective, the outcome should be close either way.
Does this open doors to other parts of MO’s empire? You certainly can’t rule that out. Altria is the world’s largest tobacco company, they have direct interests in beverages (wine) and a Board of Directors level connection to beer (AB Inbev, that is, Budwieser) and former ownership of Kraft plus their recent involvement in cannabis through Cronos and JUUL. I think it’s almost inconceivable this won’t go beyond tobacco/nicotine. The way I think of it is Lexaria’s first major partner is Altria. Lexaria’s second major partner might be Altria.
From Lexaria Bioscience’s perspective, this transaction does not contemplate a major investment by MO in LXRP. But that doesn’t mean it won’t happen. Remember this transaction involves the DehydraTECHTM technology for nicotine applications or as it says in the press release, oral nicotine applications. LXRP is free to pursue commercial applications in cannabis, NSAIDs (Non-Steroidal Anti-Inflammatory Drugs), vitamins and any other applications. So it is a completely non-dilutive transaction for shareholders. But we must never forget that Altria’s market cap is over $90 billion while Lexaria’s is around $125 million or about .001% of MO’s. So a larger financial move from Altria to Lexaria certainly could happen.
I agree with you that the real benefits to Lexaria come indirectly. First and foremost, this deal gives total credibility to LXRP management and their technology. I first reported on Lexaria on Seeking Alpha in November 2016. Since that time I have watched management struggle to swim against a tide of cynicism and skepticism. Some of the attacks were completely unjustified and, arguably, malicious. Other commentary was simply warning potential investors that there were risks involved because Lexaria was a small company and when I first wrote it up, the stock did not meet Seeking Alpha’s $1.00 per share threshold and the $100 million market cap requirement and it would be many months before it got there. So I started it as a Seeking Alpha blog report. I have done this subsequently when the same barriers exist for other companies I like a lot, most recently 1933 Industries (CSE: TGIF). But this transaction for Lexaria should quiet most of those critics. Altria is the world’s largest tobacco company so it isn’t easy for a still relatively small company like Lexaria to breakthrough. CEO Chris Bunka told me that since making initial contact with Altria some eight months ago, they have been professional, respectful and fair in understanding Lexaria’s objectives. In asking questions of Bunka and listening to his answers, I believe Altria will learn they have taken on a professional and loyal partner as well.
So while the big prize always remains a possibility, I expect some significant improvement in LXRP’s market penetration. For example, who in the cannabis industry wouldn’t be tempted to tie down the rights to use the DehydraTECHTM technology? And, as I said, after Altria became Lexaria’s first major partner, doesn’t it make sense that Lexaria’s second major partner might be Altria? And as your question implies, wouldn’t Cronos be a natural? Big pharma is a possibility now as well. There are probably many applications that go beyond NSAIDs and Viagra or Cialis.
When CRON announced Altria was investing US $1.8 billion in them, Cronos stock rallied and then fell back to a level consistent with where it had been trading before the report went public. At the time, I thought there’s something wrong here. CRON should be much higher. Unfortunately I didn’t know enough about CRON and I still kick myself for not taking a blind shot. However, that’s not my style. But when LXRP announced their Altria deal, the stock shot up and then sold off. LXRP is above where it was trading just before the transaction was announced but still well below the levels it was at before the deal was done.
Unlike CRON, I know LXRP well. I have been following and recommending it for over two years starting at around $.20 per share; I have met, interviewed and gotten to know Chris Bunka, CEO and John Docherty, President quite well and I understand and agree with the corporate strategy they are pursuing. This allows me to say now that Lexaria had its initial speculative jump up and has backed off, it is still far from reflecting the potential value of this association with Altria, in other words, I know LXRP enough to say now is the time to own this stock.