The marijuana industry has had nothing short of a groundbreaking year. In October, following years of promises from Prime Minister Justin Trudeau and months of debate in the Senate, Canada officially opened its doors to recreational marijuana. With nine decades of adult-use prohibition now over, Canadian pot companies are expected to see billions of dollars in added annual sales flow in by the early part of the next decade.
It’s also been a year for record deal making in the marijuana industry. Pretty much every top-10 deal by market value has occurred since the year began.
Brand-name companies are intrigued by the marijuana industry
More recently, we’ve begun to see real interest by brand-name companies in the beverage, pharmaceutical, and tobacco industries in what’s now a legitimate cannabis industry.
It all began on Aug. 1, when Molson Coors Brewing announced a joint venture with Quebec-based HEXO to develop and market cannabis-infused beverages. What made this partnership so interesting is that infused beverages aren’t yet legal in Canada — Parliament is widely expected to increase weed consumption options next summer — and HEXO wasn’t really on any pundits’ lists as a possible partner. Nevertheless, HEXO’s peak production potential of 108,000 kilograms, along with Molson Coors’ deep pockets and ability to move into new markets, makes this an intriguing pairing.
Just two weeks later, Corona and Modelo beer maker Constellation Brands (NYSE:STZ) made what would be the largest equity investment in marijuana history in Canopy Growth. When it closed, the 104.5 million shares Constellation acquired worked out to a $4 billion investment in Canopy, giving it a 37% stake. Inclusive of the 139.7 million warrants Constellation also received, it could up its stake in the largest publicly traded pot stock by market cap to more than 50% if exercised. The duo will not only work on new products, but it’s expected that Constellation will aid Canopy’s push into overseas markets.
And then, of course, the latest whopper of a deal: Altria (NYSE:MO), the company behind the premium Marlboro cigarette brand in the U.S., announced a $1.8 billion equity investment in Cronos Group (NASDAQ:CRON) this past Friday.
Altria’s smoking-hot deal with Cronos Group
Word of a possible tie-up between Altria and Cronos Group had hit the newswires a few days prior, according to a Bloomberg report. Altria has been looking for ways to reignite its growth engine as demand for traditional tobacco products continues to weaken in the United States. In 2017, adult cigarette-smoking rates had declined to an all-time low of 14%, meaning Altria has had to use price increases, internal cost-cutting, and the addictive aspect of nicotine to drive top-line and bottom-line growth.
For Altria, using some of its operating cash flow to invest in the high-growth marijuana industry looks like a no-brainer. With the electronic-cigarette movement not yielding the growth that the tobacco industry initially expected, alternatives for new sales channels have remained few and far between.
Plus, Altria, like Constellation Brands, received warrants from its equity investment that could allow the company to up its stake in Cronos to more than 55% if exercised.
As for Cronos Group, it gets much-needed capital that it can use to expand its operations to overseas markets. Shareholders are bound to be happy, because turning to bought-deal offerings is somewhat commonplace for pot stocks. Without the need for immediate capital, concerns about large-scale dilution have been tossed aside.
Cronos also lands a partner that has deep pockets, understands how to reach new consumer pools, and has a vested interest in its success. As its exclusive distribution partner, Altria has every incentive to push Cronos’ brands.
Opinion: Altria grossly overpaid for its stake in Cronos
But while Wall Street and investors are hailing this as a great deal for both parties, I’m going to have to disagree.
It’s a fantastic deal for Cronos, which snagged a greater-than-30% premium to its share price from the prior-day close and will soon have more than enough cash on hand to make its corporate strategy come to life. As for Altria, the price it paid for this equity investment is a head-scratcher.
Paying $1.8 billion and not even acquiring more than half of Cronos Group is confusing for two reasons. First, Cronos Group’s long-term fundamentals aren’t really that impressive. The costs of capacity expansion and brand building are liable to push Cronos into a loss, or at best a marginal profit, in fiscal 2019. Cronos Group still has a long way to go before its Peace Natural and Original BC brands have the same consumer lure as the Tweed brand from Canopy Growth. Essentially, Altria bought into one of the least fundamentally attractive pot stocks, which, after a more-than-30% premium to its prior-day closing price, make sit that much less appealing.
The second factor is that there were far, far more attractive growers available for Altria to partner with based on market cap and peak production potential. Setting aside Aphria, which is mired in allegations at the moment, growers like OrganiGram Holdings (NASDAQOTH:OGRMF) and CannTrust Holdings (NASDAQOTH:CNTTF) come to mind as having much more to offer a company like Altria than Cronos Group.
OrganiGram is on track to hit 113,000 kilograms of peak annual production when fully operational. That almost perfectly coincides with the peak potential from Cronos, which is getting 70,000 kilograms of peak production from its joint venture known as Cronos GrowCo, 40,000 kilos from Peace Naturals, and about 1,500 kilos from Original BC.
OrganiGram is also scaling its operations more quickly than Cronos at the moment — and it’s doing so with considerably better cost efficiency, since OrganiGram’s Moncton, New Brunswick, location features a proprietary three-tiered growing system. All told, OrganiGram is valued at less than $470 million, yet it has Cronos topped in a number of key categories.
As for CannTrust, it’s expected to generate in excess of 100,000 kilograms of annual production when its Niagara Greenhouse facility is complete and fully operational. The 1.3 million square feet of growing space for CannTrust is focused on hydroponics, with moving containerized benches creating a perpetual harvesting system. In plainer English, this means more consistent, low-cost production. CannTrust can almost certainly scale its operations much faster than Cronos can, yet the company is valued at only $613 million.
What Altria saw in Cronos is really a head-scratcher to this investor, and I’m not entirely convinced that Altria will see any near- or intermediate-term returns on its aggressive investment.
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