When the curtain finally closes on 2018, it'll probably go down as the most game-changing year in history for the marijuana industry.
Even though pot stocks didn't deliver the same monumental returns as in 2016 or 2017, the industry received a far greater reward in October: validation. On Oct. 17, recreational marijuana was legalized in Canada, ending years of debate on the issue and lifting roughly nine decades of active prohibition of adult-use cannabis. As a legalized product, recreational weed could wind up adding $5 billion or more in annual sales, once the industry is fully up to speed.
Yet, the interesting thing about the pot industry is that it's about more than just dried flower. Although dried cannabis is the product most folks associate with legalization, it's also going to be the likeliest to be oversupplied and commoditized over time. This has been the case in Colorado, Washington, and Oregon, and it'll probably be the same in Canada within a few years. It means that marijuana companies need to do everything in their power to diversify their portfolios by including alternative products.
Beverage companies bubble over at marijuana's growth potential
In recent months, cannabidiol (CBD)-infused beverages have been one of the "alternative" consumption options that's been all the rage. Cannabidiol is the nonpsychoactive cannabinoid best known for its perceived medical benefits.
What's interesting about the CBD-infused beverage movement is that infused beverages aren't legal in Canada -- at least not yet. When the Cannabis Act was signed into law in June 2018, it was done so with only dried cannabis and cannabis oils being legal. Other consumption options are expected to be discussed and approved this upcoming summer, but aren't legal as of now in Canada.
However, that's not stopping brand-name beverage companies from making deals. On Aug. 1, Molson Coors Brewing Co. (NYSE:TAP) announced a joint venture with Quebec-based HEXO Corp. to develop cannabis-infused beverages. HEXO stands to be a top-10 producer once it's running on all cylinders, while Molson Coors Brewing is angling to halt a decade-long downtrend in its Canadian market share. Presumably, CBD beverages would appeal to medical and recreational consumers and be a nice way of introducing people who've never tried a cannabinoid-based product to its potential.
Two weeks later, Constellation Brands (NYSE:STZ) announced what would become the largest deal in marijuana history when it made a $4 billion equity investment in Canopy Growth Corporation. Aside from just working on new products, which would presumably include CBD beverages, Constellation is making a bet on the long-term success of legal weed with its 37% equity stake in Canopy.
This small-cap "pot stock" wants in on the action
But it's not just large, brand-name beverage companies that are after their piece of the CBD beverage market. Smaller players are entering this space and laying a lot on the line in order to be competitive.
In mid-September, New Age Beverages Corp. (NASDAQ:NBEV), a previously nondescript maker of ready-to-drive coffees and teas, kombucha, energy drinks, and relaxation drinks, put itself on the map by announcing its intent to develop a line of CBD-infused beverages. It wound up unveiling its concept during an October convenience store show in Las Vegas, Nevada. Its product line includes a CBD-infused sparkling water (CBD WTRM), a CBD-infused shot (CBD SHOTTM), and a CBD-infused tea (CBD TEATM). In October, the company announced plans to launch with distributors and independent U.S. retailers in the fourth quarter, with a national/regional launch by March or April 2019.
However, the U.S. market simply isn't enough for New Age Beverages. After all, the global CBD market is expected to grow from $591 million to $22 billion between 2018 and 2022, according to the Brightfield Group. With this in mind, New Age, on the heels of a $45 million stock offering less than a month ago, announced the $85 million acquisition of privately held Morinda Holdings on Monday, Dec. 3. The deal will include $75 million in cash (paid for with New Age Beverages' cash on hand) and $10 million in New Age Beverages restricted stock.
Why buy Morinda Holdings? While it's probably nice that New Age can add $240 million in sales and $20 million in adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) over the trailing 12 months, the real dangling carrot here is that Morinda is selling its products in 60 countries, including China. By paying $85 million for Morinda, New Age essentially purchased the infrastructure needed to reach nearly a third of the world with its CBD-infused beverages, assuming CBD is legal in the countries in question.
Don't get too excited just yet
Now, before we go and reward New Age Beverages with an even more inflated market cap following its acquisition, my suggestion would be to not get too excited.
To begin with, New Age Beverages wasn't doing a whole lot with its existing product line before announcing its venture into CBD beverages or its Morinda acquisition. Current-year organic sales are expected to increase by less than 1%, with Morinda bringing in year-over-year sales growth of a modest 5%. That's not exactly groundbreaking growth from what'll represent its core line of beverage products.
Secondly, New Age Beverage isn't profitable with its existing line of products, and may not head into the black in 2019 even with the addition of Morinda. It's possible that the $10 million in cost synergies between these two companies, when combined with higher sales as a result of their merger, could lead to a full-year profit next year, but chances are it would be negligible on a per-share basis if this were to happen.
And third, there's the real possibility that the CBD-infused beverage space will be crowded within the next year or two. Even though New Age has distribution partnerships in place, it doesn't have the deep pockets of a Molson Coors or Constellation Brands, meaning it'll be hard for such a small-fry to compete.
While I don't fault New Age Beverages' push into CBD beverages, I don't exactly understand its valuation at this point. The chance of investors being disappointed is, in my opinion, quite high.
Sean Williams has no position in any of the stocks mentioned. The Motley Fool owns shares of Molson Coors Brewing. The Motley Fool recommends Constellation Brands and Hexo. The Motley Fool has a disclosure policy.