The cannabis industry is firing up, and so are these pot stocks. But should you pause before you decide to cash in on the short-term gains?

Sushree

Mergers and acquisitions (M&A) are always exciting news. But the temperature has really been dialed up on the upcoming mega-merger between two big Canadian cannabis players, Aphria (NASDAQ:APHA) and Tilray (NASDAQ:TLRY). Since marijuana sales have skyrocketed amid the pandemic, the sector is the talk of the town. The expectation surrounding the new entity captured investors attention even more, elevating the stock prices of both Aphria and Tilray this year. So far in 2021, Tilrays stock has gained 227%, while Aphria has surged 180%. The industry benchmark, the Horizons Marijuana Life Sciences ETF, has gained 63% over the same time frame.

Investors sure did enjoy solid gains from the recent surge, and are expecting even more upside. In my opinion, selling Aphria or Tilrays shares to enjoy short-term returns is not the best option right now. Heres why, if you have the time to wait, holding on for the long haul is the wiser move.

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Image source: Getty Images.

Aphria holds all the cards in this merger

Currently, investors are keen to cash in on the Aphria-Tilray merger arbitrage opportunity. A merger arbitrage occurs when the stock price of the target company trades below the proposed acquisition price, mostly because of uncertainty around whether the deal will succeed or fall through. This price difference allows investors to buy the stock of the target company at a discount and make profits when the merger is completed.

According to the merger agreement, while the combined entity will operate under the Tilray name, Aphria shareholders will own 62% of the new company. 

But the most important point to note is that each Aphria shareholder will get 0.8381 shares of Tilray. Meanwhile, Tilrays shareholders will have no change in their holdings.

Currently, Tilrays shares are trading higher than Aphrias. So, buying Aphria now and shorting Tilray is a good short-term bet for making a profit when the merger completes. Shorting Tilray shares allows investors to borrow and sell the stock now, and then buy the stock later to return it to the lender. In this way, the investor is essentially betting that the stock price will sink, allowing them to make a profit from the difference between the buying price and the selling price.

But there are also risks to an arbitrage -- like if the merger doesnt go through, the share price will drop. Additionally, if more people opt to take advantage of the arbitrage, the opportunity might vanish altogether. However, there is another way to make money out of this merger deal (if you have the patience). 

Aphria and Tilray are playing the long game

No doubt, the arbitrage opportunity creates a short-term advantage until the merger closes. But stock investments are almost always fruitful when played out for the long run.

Cannabis is an evolving, quickly growing industry. The global cannabis market is expected to grow at a compound annual growth rate (CAGR) of around 17.8% to be worth $65.1 billion by 2027. Knowing this, I think its smart to invest in a growing pot stock and hold it for the long term in order to reap all the possible benefits. 

Through this merger, both expect cost synergies of around 100 million Canadian dollars. Cost synergies are the cost reduction arising out of a merger as each company has a chance of using the others efficiencies, such as growth strategies, the scale of operations, competitive innovative products, and high-class production facilities to generate more revenue and profits.

Both Aphria and Tilray already have strong footings in Canada. Aphria has a good hold in the European medical cannabis market, thanks to its German subsidiary, CC Pharma. It earns around 98% of its distribution revenue from it. Coupled with Tilrays operations in Portugal, the new entity can easily make its mark in Europe.

Until now, Canopy Growth (NASDAQ:CGC) has been boasting its progress with cannabis derivatives, particularly the beverage segment. Cannabis beverages are one kind of cannabis derivative -- others include vapes, chocolates, edibles, and concentrates -- which Canada legalized in October 2019. But with the acquisition of American craft beer maker SweetWater Brewing, Aphria can give Canopy a run for its money in this segment, while also growing its revenue.

Aphria saw 33% year-over-year revenue growth in revenue to CA$160.5 million in the second quarter of fiscal 2021, ended Nov. 30, 2020. This is excluding revenue from SweetWater. In its recent fourth quarter of 2020, ended Dec. 31, 2020, Tilray saw its revenue jump 20.5% to CA$74.4 million. Tilray also now has a new agreement to distribute its medical cannabis product in the U.K. and New Zealand.

Furthermore, if U.S. legalization happens over the next two to three years, a bigger, stronger company with access to more resources, a strong balance sheet, and a partner like SweetWater will be better poised to make a mark in the growing U.S. cannabis industry. Tilray already has some cannabis derivatives in its product portfolio, which it will be able to launch in the U.S. market. The U.S. legal cannabis market could grow at a compound annual growth rate (CAGR) of 21% to value more than $41 billion by 2025.

TLRY

TLRY data by YCharts

Risk remains 

Bear in mind that a merger involves a lot of risks and complications. It could be a long time before the deal successfully creates a bigger, more profitable business. But considering the rate at which the marijuana industry is charging ahead, it shouldnt be too far from now that investors start to see the benefits of the combined marijuana company.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Sushree Mohanty has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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