In this segment from the MarketFoolery podcast, host Chris Hill and senior analyst Matt Argersinger consider the massive investment that beverage distribution giant Constellation Brands (NYSE:STZ) has made in leading Canadian legal pot grower Canopy Growth (NYSE:CGC).
In one fell swoop, that boosts its stake from 9.9% to 38%. Product synergy aside, the market was not seeing it. The guys talk about the future of the legal marijuana industry and why it might be a tough space to make a profit.
A full transcript follows the video.
This video was recorded on Aug. 15, 2018.
Chris Hill: Constellation Brands is in the business of alcohol. Constellation has a bunch of brands under their umbrella. They have beer, probably best-known for Corona and Ballast Point. They have wine, Robert Mondavi and Woodbridge are probably the better-known brands there. For liquor, Svedka vodka is probably their biggest brand. They have High West Whiskey, although that's more of a niche in the whiskey world.
They didn't report earnings, but they did just make a $4 billion investment in Canopy Growth, which is the publicly traded marijuana company. Trades on the Toronto Exchange under the fabulous ticker symbol WEED.
Matt Argersinger: Love it.
Hill: This takes Constellation Brands' stake in Canopy Growth from just under 10% to 38%. The stock is down about 9% on this news, and you're not surprised.
Argersinger: Not at all. [laughs] I mean, I get the idea. You want to take the edge off, you have your glass of Mondavi wine or your Corona beer, and maybe you're throwing a blunt or two. There's definitely some, I hate to use the word, synergy between cannabis and alcohol. People who love one probably love the other. But this deal doesn't make sense to me.
You have this Canopy Growth business -- which, by the way, trades for about 100X revenue right now, roughly. They're taking a $4 billion stake in it. This is all because -- this is a Canadian company. Canada is going to be fully legalizing marijuana use beginning in October. There's anticipation that sales for this company are going to surge. We're going from just this medical marijuana industry to full-fledged marijuana for everyone, so the sales are going to surge. I think that's a terrible way to look at it.
Canopy Growth is one of dozens of companies, if not hundreds of companies, that are going to be flooding into this market. The supply that's out there is going to shoot higher. I think what's going to happen is, you're going to see -- as we've seen in U.S. states that have legalized it in this country, in Colorado, Washington State, you've seen a marginal increase in cannabis usage, but the supply has gone through the roof. What happens generally, when that happens, is that prices come down. So, I think this is a pretty poor investment, and I think the market's recognizing it.
Hill: CEO Rob Sands from Constellation Brands said, "As people want to consume cannabis in a more sophisticated manner, beverages will become a more common delivery mechanism. We're not restricting ourselves to beverages just because we're a beverage company."
Even if, directionally, he's right, the number still seems out of whack. It's the $4 billion number. And, to jump from a 10% stake to a 38% stake... We talked about this recently with Zillow, and how part of the sell-off last week with Zillow had to do with their acquisition of Mortgage Lenders of America, and Zillow not having the greatest track record, in terms of acquisitions. I'd argue the same thing with Constellation Brands. They paid $1 billion for Ballast Point.
Argersinger: [groans] A huge premium. And, then, by the way, that happened two years ago, roughly, what we're seeing now as what could have been the peak of craft beer. That was a big price to pay.
Hill: And you look at their portfolio of brands, sure, they have some recognizable brands, but it's not like a Murderers' Row of beer, wine, and spirits.
Argersinger: That's the thing, too. You're adding Canopy Growth. There are no established brands in the cannabis industry! What are you really adding here? I think what they're doing is, they're picking what they think is going to be the leader in this young market. Maybe they're being a little forward-thinking, but it's going to be so hard. You're investing in a commodity product, there's no doubt about it. I don't think consumers are going to distinguish between a Canopy Growth-branded version of pot vs. another company's. They're spending a huge amount of money to do this. I don't think the returns are going to be very good with this one.
Chris Hill has no position in any of the stocks mentioned. Matthew Argersinger owns shares of Zillow Group (A shares). The Motley Fool owns shares of and recommends Zillow Group (A shares) and Zillow Group (C shares). The Motley Fool has a disclosure policy.