When Canopy Growth Corporation (NYSE:CGC) landed a partnership with -- and a large investment from -- Constellation Brands (NYSE:STZ) last year, it only made sense that major alcoholic-beverage makers would look to make deals with other Canadian marijuana-growers. The natural question was: "Who's next?" We now know the answer to that question.
On Wednesday, Molson Coors Brewing (NYSE:TAP) announced that it was partnering with The Hydropothecary Corporation (NYSE:HEXO), also known as HEXO, on a joint venture to develop cannabis-infused beverages. In addition, Molson Coors will receive warrants to purchase shares of HEXO.
The deal was a tremendous boost for HEXO, with its stock price soaring 18% after the joint venture with Molson Coors was announced. This partnership also is likely to have a broader impact on other Canadian marijuana stocks.
How HEXO won
Reports surfaced in June that Molson Coors was in discussions with at least four Canadian marijuana growers about partnering to develop cannabis-infused beverages. At the time, BNN Bloomberg mentioned that the prospective candidates included Aurora Cannabis and Aphria (OTC:APHQF).
How did HEXO beat out these larger rivals? For one thing, buying a sizable stake in the company is a lot cheaper than doing so with either Aurora or Aphria. HEXO's market cap prior to the announcement of the Molson Coors deal was $590 million compared to $3.1 billion for Aurora Cannabis and $1.8 billion for Aphria.
We can also parse through what Molson Coors and HEXO stated publicly about the deal. Frederic Landtmeters, CEO of Molson Coors Canada, mentioned four specific attributes of HEXO in his comments. He noted first that the company was "a recognized leader in the medical cannabis space in Canada." That's especially the case in Quebec, where the company holds the highest market share.
Landtmeters also said that HEXO "will bring robust production capacity." On this front, HEXO is behind both Aurora and Aphria. However, the company is on track to have an annual production capacity of 108,000 kilograms by March 2019.
In addition, the Molson Coors Canada CEO referred to HEXO's "track record of innovation." I suspect this was a key factor in Molson Coors' decision-making process. HEXO was the first Canadian marijuana grower to market cannabis peppermint oil sublingual mists and oral marijuana powder products.
But Landtmeters stated that the most important criteria of all in choosing HEXO was the company's "shared values when it comes to doing business the right way and earning the trust of consumers." HEXO CEO Sebastien St-Louis echoed this in his comments, saying that the two companies "have established a relationship built on trust."
St-Louis also mentioned that Molson Coors and HEXO "share a track record of excellent practices, as well as respect for law and regulations." That remark could be viewed as a swipe at Aphria because of a controversy involving several members of Aphria's management team failing to disclose personal stakes in Nuuvera prior to Aphria's acquisition of the smaller company. Aphria's executives maintained that they did nothing that violated Canadian laws.
A big opportunity
It's not surprising that Molson Coors, like Constellation Brands, wanted to partner with a marijuana grower. Although Canada's legalization of recreational marijuana in October 2018 won't include cannabis beverages or other edibles, these products should be legally allowed in the country sometime next year. And the market opportunity could be massive.
Cannabis market research firm BDS Analytics thinks that cannabis edibles, which include beverages, could provide "perhaps the highest financial returns of any cannabis sector." In Colorado, which legalized recreational marijuana several years ago, sales of cannabis edibles account for 15% of the total cannabis market.
Perhaps most important, cannabis edibles could appeal to consumers who otherwise might not consider trying marijuana products. BDS Analytics conducted a survey in four U.S. states that all the legal use of recreational marijuana. The firm found that respondents who don't currently use marijuana indicated that cannabis edibles would be the product they'd be most likely to try.
Just because Molson Coors and Constellation Brands are alcoholic beverage makers, don't necessarily look for cannabis-infused beer or other combinations of alcoholic beverages and cannabis. Canopy Growth CEO Bruce Linton told CNBC that his company and Constellation Brands would likely roll out cannabis-infused beverages such as zero-calorie drinks with mixtures of cannabinoids. Similarly, Molson Coors' Landtmeters said that the joint venture with HEXO would develop "non-alcoholic, cannabis-infused beverages."
More deals to come?
There could be a bigger impact on the Canadian marijuana industry. Other leaders in the industry undoubtedly desire to develop and launch cannabis-infused beverages. The question now is the same question that came up after the Constellation-Canopy partnership: "Who's next?"
Aphria already has a distribution agreement with Southern Glazer's, the largest wine and spirits distributor in North America. Southern Glazer's distributes alcoholic beverages rather than make them, but it's possible that Aphria's relationship with the company could open doors to talk with beverage makers.
My view is that many companies will take a wait-and-see approach. They'll watch as Constellation, Canopy Growth, Molson Coors, and HEXO launch cannabis-infused beverages in Canada next year.
The giant in the alcoholic beverage industry, Anheuser-Busch InBev, appears to be adopting this stance. CEO Carlos Brito recently said in an interview with Just-drinks that "cannabis is something that we as a company are trying to learn more about." Brito added, "We'll continue to follow it. But, for now, we don't feel we need to do anything."
I think that alcoholic beverage companies will especially monitor developments in the much larger U.S. market. If the U.S. relaxes federal marijuana laws, it could present an opportunity that's too lucrative to ignore. And it could mean that more Canadian marijuana growers will find themselves with big partners -- and larger market caps.