Whether you realize it or not, marijuana is big business. In our neighbor to the north, recreational weed is set to be legalized in 27 days. When the curtain is finally lifted, demand is expected to overwhelm the market, and in the process put loads of cash into the pockets of businesses up and down the cannabis supply chain.
But this growth isn't lost on companies outside the cannabis industry. The past two months have featured no shortage of deals in the marijuana arena between brand-name companies and the pot industry.
Dealmaking is all the buzz in the cannabis space
For example, at the beginning of August, Molson Coors Brewing Co. announced a joint venture with Quebec-based HEXO Corp. (previously Hydropothecary) to develop cannabis-infused beverages. Although infused beverages won't be legal come Oct. 17, new forms of consumption are expected to be discussed and approved by Parliament next year. This should allow Molson and HEXO a head start on much of their competition.
An even bigger statement was made by Modelo and Corona beer maker Constellation Brands (STZ 0.60%) when it announced its intent to take a $3.8 billion equity stake in Canopy Growth Corp. on Aug. 15, 2018. This actually marks the third such investment for Constellation into Canopy Growth, with the company acquiring a 9.9% stake in October 2017 for what was only $190 million at the time, and purchasing a third of a 600 million Canadian dollar convertible note offering in June. If Constellation Brands were to exercise the 139.7 million warrants that come with its latest investment, as well as convert its notes to shares of common stock, it could build its stake in Canopy Growth to north of 50%.
The big question is: Which brand-name beverage maker is next?
While we do have some clues, the following three brand-name drink makers appear the likeliest to step up and find a cannabis partner.
One well-known beverage company that could follow in Constellation's and Molson's footsteps is U.K.-based Diageo (DEO -0.06%), which is known for brands such as Captain Morgan, Smirnoff, Johnnie Walker, and Guinness, among others. According to preliminary annual results reported by the company in July, net sales grew by a microscopic 0.9% in its latest fiscal year. In short, the company needs a spark that cannabis-infused beverage may be able to provide.
In late August, rumors began to swirl that Diageo was in discussion with three leading marijuana companies, although no specific company names were divulged, nor was there any consensus from the unnamed sources as to when a deal might get done. Those rumors have since quelled a bit.
There are, however, three relatively large cannabis producers that could be ripe for a partnership, and may be among the names Diageo was considering:
- Aphria: Aphria is expected to slide in as the third-largest producer by peak production at 255,000 kilograms. With a diverse product line, it'd make for a solid choice.
- Aurora Cannabis (NASDAQOTH: ACBFF): Aurora Cannabis is expected to be the largest producer when at full capacity (570,000 kilograms). Its sheer scale makes it a target for beverage companies.
- Tilray: The newest hot pot stock, Tilray should be capable of more than 100,000 kilograms of annual production once it further expands capacity.
With sales stagnant and cost-cutting only driving profits so far, Diageo should be compelled to find a cannabis partner.
OK, so there's little guesswork needed with this one. Earlier this week, multiple news outlets reported that beverage giant Coca-Cola (KO -0.82%) is in serious talks with Aurora Cannabis to partner and produce cannabidiol (CBD)-infused beverages. CBD is the non-psychoactive component of the cannabis plant that's perhaps best known for its medical benefits. Though there's no guarantee a deal is reached, it clearly shows Coca-Cola's interest in finding a cannabis partner.
For Coke, pushing into beverages that would target medical marijuana users is a smart move for two reasons. One, though its top-line sales are rising, the only region that delivered negative organic growth during the second quarter was North America. This could be a way of genuinely moving the needle back in the right direction within the next couple of years.
Secondly, alternative cannabis products generally have a considerably higher margin than dried cannabis, which is prone to commoditization. The branding power of Coca-Cola combined with the niche aspect of the medical marijuana industry should allow such a product to be priced with a hefty premium and healthy margins.
As for Aurora Cannabis, its leading production capacity makes it a logical target for Coca-Cola. Aurora is primarily focused on the medical market, meaning a push into infused beverages would advance its existing game plan.
Keurig Dr. Pepper
Although absolutely no rumors have swirled around Keurig Dr. Pepper (DPS), which was formed earlier this year from the merger of Dr. Pepper Snapple Group and Keurig Green Mountain, the maker of single-serve K-cups, I believe it could be the perfect beverage maker to turn to the green rush.
The merger of these two companies is expected to result in cost synergies and improve branding power (and thus pricing power) by giving it more shelf-space clout. But Keurig Dr. Pepper's second-quarter operating results weren't all that impressive. Keurig's sales were essentially flat, while Dr. Pepper Snapple Group saw operating income fall 3.5% as a result of ongoing inflationary pressures. Like Diageo and Coca-Cola, its business needs a spark.
What would make a pairing between Keurig Dr. Pepper and a cannabis company so unique is the company's lead position in the single-serving K-cup space. Even with a number of smaller single-serve, cannabis-focused pod companies popping up in recent years, Keurig would be able to use its deeper pockets and brand name to essentially wipe them off the map.
Secondarily, Keurig Dr. Pepper could also turn to pairing CBD with its well-known sparkling beverage lineup of 7UP, A&W Root Beer, and, of course, Dr. Pepper.
It's certainly not the first name that jumps off the list of big-name beverage companies looking for a cannabis partner, but it may wind up being the most logical.