The investment by Altria -- maker of top cigarette brands including Marlboro -- gives it exposure to a global market that could be worth $200 billion in 15 years. And it provides Cronos Group with the cash and regulatory experience to capitalize on marijuana legalization worldwide.
A big deal
Altria's investment isn't as large as the investment made by wine and spirits company Constellation Brands (NYSE:STZ) in Canopy Growth (NYSE:CGC) last year, but it's the second-largest investment by a U.S. company in a Canadian marijuana company.
At a price of $16.25 Canadian per share ($12.12), Altria's $1.8 billion investment nets it a 45% equity stake in Cronos. Altria will nominate four directors to Cronos Group's board, one of whom will be independent, and it's receiving a warrant allowing it to boost its ownership by an additional 10% within four years at a price of CA$19 per Cronos share.
This deal is particularly significant because it injects confidence into the fledgling marijuana industry at a time when it's needed.
Marijuana stocks, including Cronos, rallied sharply higher ahead of the opening of Canada's recreational marijuana market in October, but they've been declining ever since on reports of supply shortages; uncertainty over when Health Canada will expand the products allowed in its recreational market to include high-margin vapes, edibles, and beverages, and concern over valuations.
Why Altria is investing in marijuana
Marijuana remains a schedule 1 drug in the United States, so it's prohibited federally. But 33 states have legalized marijuana use in one form or another, including 10 that have created recreational marijuana marketplaces.
The momentum toward legalization is likely to continue given that 66% of Americans (including over 50% of conservative Republican voters) favor it, according to Gallup. Washington could still crack down on marijuana companies operating in states where it's legal, but evidence suggests the likelihood of that is declining.
For example, Congress recently included laws in its latest farm bill allowing farmers more freedom to grow hemp, a low-THC variation of cannabis sativa, and the Food and Drug Administration granted approval over the summer to an epilepsy medicine derived from marijuana.
The $50 billion U.S. market will remain fragmented until marijuana prohibition ends federally, but it's a different story in Canada. That country's medical marijuana market has been flourishing since changes created a regulated licensing and retailing pathway in 2014, and medical marijuana sales there total in the hundreds of millions of dollars annually. On Oct. 17, the country's recreational marketplace opened for business nationwide, and although estimates vary, Deloitte thinks recreational marijuana sales there could eclipse CA$4 billion next year.
Marijuana headwinds are also easing in other markets, including Australia and Europe, and that has industry watchers thinking the legal marijuana market could be as big as alcohol or tobacco someday. For instance, Constellation Brands estimates legal marijuana sales worldwide could exceed $200 billion in 15 years.
What Altria is getting
Cronos Group trails competitors in sales and production, but it's growing rapidly. In the third quarter, its sales increased 186% to $3.8 million as it sold 514 kilograms of marijuana, up 213% from the year before.
The company's annualized production capacity is only about 6,650 kilograms now, but an equity offering earlier this year provided it with $146 million that it's using to increase its capacity to 40,150 kilograms early next year and eventually to 117,000 kilograms per year.
Cronos brands include Peace Naturals, sold as medical marijuana, and Cove and Spinach, two recreational brands that are available to consumers in Ontario, British Columbia, Nova Scotia, and Prince Edward Island. A hand-trimmed premium product, Cove is being positioned as a luxury brand, while Spinach is being marketed as a mainstream product to consumers who "don't take life too seriously."
Should you buy Cronos Group, too?
Altria Group is a Goliath with vast experience selling into highly regulated markets. It's an expert at supply chain and marketing, and it has important distribution connections that Cronos Group can leverage to improve its operations and connect with customers.
The $1.8 billion in cash that Altria's handing over provides Cronos with some of the deepest pockets in the industry, which should allow it to accelerate its production growth and compete against well-heeled peers, including Canopy Growth, for top-notch acquisitions.
But it's unclear when Cronos Group will turn a profit. In the third quarter, the company's total operating expenses were $6.97 million, representing 185% of sales, and Cronos lost $7.3 million, or $0.04 per share.
Cronos isn't a cheap stock on traditional valuation metrics because of its losses, but given Constellation Brands' long-term market outlook and the fact that Altria's investment essentially values Cronos at about $4 billion, investors might want to consider including this stock in their long-term growth portfolios.
Todd Campbell has no position in any of the stocks mentioned. His clients may have positions in the companies mentioned. The Motley Fool recommends Constellation Brands. The Motley Fool has a disclosure policy.