Last year, Corona beer maker Constellation Brands (NYSE:STZ) surprised everyone by spending nine figures to acquire a less than 10% stake in cannabis company Canopy Growth (NASDAQ:CGC). Today, the beermaker did it again, reporting an unexpected -- and massive -- $4 billion -- deal to cozy up closer to Canopy Growth. Is this a match made in heaven, or will their partnership be a bust?
What's the buzz
Canopy Growth is one of Canada's leading cannabis companies. It's spent the past three years establishing its brands as go-to products for medical marijuana patients, and big investments in production capacity have it positioned to capture a big chunk of the fast-approaching recreational marijuana market.
Canada's had medical marijuana laws on the books for a while, but it wasn't until 2014 that a national program was established creating a regulated marijuana market and opened the door to companies including Canopy Growth to participate in what's become a fast-growing industry.
In October, Canada will attempt to duplicate its success with medical marijuana when it opens what could be a much larger national marketplace for recreational marijuana.
In anticipation of growing demand for cannabis products because of recreational use, and ostensibly, to insulate itself against the risk marijuana sales come at the expense of beer, wine, and spirits sales, Constellation Brands made a $245 million Canadian ($191 million) investment in Canopy Growth last October. When it announced that investment, Constellation said it was attracted to Canopy Growth because it "has a seasoned leadership team that understands the legal, regulatory and economic landscape for an emerging market that is predicted to become a significant consumer category in the future."
Apparently, Constellation believes in cannabis potential even more now, because it's just agreed to take on debt to finance a $4 billion acquisition of roughly 38% of Canopy Growth.
Digging into the details
In exchange for a pile of cash, Canopy Growth is giving Constellation Brands 104.5 million shares that, when combined with existing stock and warrants, represents more than one-third ownership. Constellation is paying $48.60 Canadian per share, a 37.9% premium to Canopy Growth's volume weighted average price over the preceding five trading days. Constellation is also being given warrants that could one day increase Constellation's ownership above 50% in exchange for an additional $4.5 billion Canadian.
The influx of capital arguably gives Canopy Growth the industry's best financial flexibility. Canopy Growth plans to use the funds to "build and/or acquire key assets needed to establish global scale in the nearly 30 countries pursuing a federally permissible medical cannabis program, while also rapidly laying the global foundation needed for new recreational cannabis markets."
Translation: Canopy Growth will use the cash to try to dominate the marijuana market worldwide.
The pay-off for these companies could be huge. Constellation provides Canopy Growth with global marketing and distribution experience that may allow it to win a sizable share of what ArcView estimates will be a $57 billion market by 2027.
What to watch next
Constellation and Canopy Growth believe there's an opportunity to market cannabis-based beverages, but the size and scope of this deal suggests Constellation believes the marijuana market will rival the tobacco and alcohol markets in terms of sales and profitability.
While the market opportunity for marijuana companies is big, Canopy Growth has a lot of work to do for this deal to pay off for Constellation Brands. Canopy Growth's sales grew 63% year over year in the second quarter; however, sales were still only $26 million Canadian in the quarter, and that means shares are trading about 70 times the company's annualized revenue. Canopy Growth's also been losing money because of spending in preparation for the opening of Canada's recreational market later this year and in support of its growing business in Germany. In the quarter, sales in Germany accounted for 14% of total revenue, up from 2% of revenue in the same quarter last year.
Those losses are likely to continue as Canopy Growth seeks to capture opportunities elsewhere. Its already laying the groundwork to participate in marijuana markets throughout Europe and Latin America, and its plans include clinical trials to prove marijuana's effectiveness in various diseases and disorders, including insomnia.
The one market Canopy Growth isn't targeting is the United States. Canopy Growth and Constellation Brands have said they won't establish operations in the U.S. until federal laws allow it, and there's no telling when that will happen, especially given the negative comments so far from the current administration in Washington.
For now, the Constellation Brands deal gives Canopy Growth a big advantage over its Canadian competitors, but I wouldn't count those peers out yet. There's a chance that other companies, fearful of being left out of the market, come calling on Canada's other big marijuana companies. If so, Aurora Cannabis (NASDAQ:ACB) and Aphria (NASDAQOTH: APHQF) could be worth watching.