The marijuana industry is going through a tough year and glitzy mega-deals are probably behind us, for now. But the situation isn’t a total buzzkill. The consolidation of distressed assets presents investment opportunities.

Cannabis companies are picking up inexpensive assets through mergers and acquisitions (M&A), a trend that will bolster the overall industry and create profits for investors who target takeovers.

Pot stocks are generally in a slump, but analysts predict that in the coming months, we’ll witness robust cannabis M&A activity, with the overall value of transactions in 2023 topping the $3.2 billion posted in 2022.

Instead of the multi-billion-dollar deals that grabbed headlines in the past, we’ll see a slew of smaller transactions, many initiated by failing cannabis companies that seek an exit and larger well-capitalized firms that want quick entry to new markets. Purchasing distressed assets at discounted prices is becoming an expeditious way for financially sound cannabis companies to expand.

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Yes, it’s been challenging for marijuana investors so far in 2023, due to higher interest rates, recession worries, elevated inflation, the failure of legalization efforts in Congress, increased competition, and falling prices for weed. Although state legalization efforts have been successful, it’s been dispiriting to see much-ballyhooed efforts at the federal level fizzle out.

But here’s the silver lining: we’re on the cusp of an explosion in distressed M&A and restructuring, throughout the U.S. and Canada.

For insights into how to profit from M&A activity in any sector, I interviewed my colleague Nathan Slaughter (pictured), chief investment strategist of Takeover Trader. The following is a condensed transcript of our discussion.

Is it possible to “reverse engineer” the deal-making process, to get ahead of the curve?

Yes, that’s exactly what I do. I’ve examined countless takeovers over the years, looking for commonalities. I’ve also been in on more than my fair share of these deals. And while there is no such thing as a crystal ball in the investment world, I’ve noticed a few recurring patterns.

Just as meteorologists are trained to spot wind shear and other telltale signs of an imminent tornado, there is a specific set of conditions that often precede a takeover announcement.

What are the criteria with the most predictive power? I assume that visible growth prospects are near the top the list.

Yes, it takes growth to placate investors. Companies that don’t deliver often see their shares languish. Unfortunately, finding new growth avenues isn’t always easy, particularly for mature businesses, and when the stock market is in a slump.

Acquisitions can be the surest growth catalyst, and there are a lot of larger, older companies out there in need of propulsion.

I also look for achievable synergies. In fact, synergy is what justifies the sometimes exorbitant price tag to make these deals happen. That’s how management sells it to voting shareholders.

When two businesses get married, they no longer need separate headquarters. Combining into one organization provides an opportunity to eliminate or downsize overlapping administrative functions, sell off redundant assets, and take other steps to streamline expenses.

Those cost savings are called synergies. And the bigger the scale, the more they add up. In most cases, the two companies joining will become more profitable together than they were apart. It’s a classic case of 2 + 2 = 5.

Mergers can bring about other benefits, such as supply chain efficiencies or debt refinancing. Supply chain streamlining is all the more important these days, as we witnessed from the bottlenecks in global distribution networks caused by the Russia-Ukraine war and the pandemic.

These efficiencies can expand margins and squeeze more profit from every dollar of sales. But the most impactful mergers can boost sales as well, delivering synergies on both the top and bottom lines.

When an innovative company with great ideas joins forces with a more established player with global distribution capabilities, it can be a beautiful thing. The greater the potential synergies, the more accretive a takeover can be to cash flows, and thus the more attractive to acquirers.

Enhanced pricing power is probably a big plus, especially during this era of elevated inflation.

That’s true. Corporate profit margins right now are under enormous pressure from rising inflation and supply chain hassles.

But even in the best of times, every business wants to increase product prices and boost profit margins. It’s a calculated trade-off, because doing so can scare away customers, shrink market share, and bite into volume.

How does competitiveness factor into your equation?

If you’re a Star Trek fan, you’re probably familiar with the Borg, the fearsome cybernetic creatures that take over entire races. With every assimilation, the Borg not only remove a potential enemy, but they also absorb the unique strengths of that conquered race.

Over time, they become increasingly formidable. The Borg’s motto is: “Resistance is futile.” The business world is no different.

Microsoft (NSDQ: MSFT) didn’t reach $198.3 billion in annual sales all on its own. PowerPoint, for instance, came from the purchase of a company called Forethought back in the 1980s. Over the years, Microsoft has gobbled up more than 200 smaller competitors, absorbing their assets (and their customers). More recently, it has hunted down Nuance for $20 billion and ZeniMax for $7.6 billion.

The same dynamic applies to other tech juggernauts such as Apple (NSDQ: AAPL) and Google parent Alphabet (NSDQ: GOOGL). It always pays to be on the lookout for situations where deep-pocketed companies can turn dangerous potential enemies into valuable allies.

Editor’s Note: Now that the bear market is behind us, companies are flush with cash and eager to fuel growth. That means we’re likely to see a wave of deals in the coming months, in not just the marijuana industry but throughout a wide range of sectors.

At Takeover Trader, my colleague Nathan Slaughter has the knack for pinpointing potential takeover deals that provide a windfall for early investors. Want to get in on his next big trade? Click here for details.

John Persinos is the editorial director of Investing Daily.

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