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3 Reasons Aphria Won't Chase Canopy Growth Into the U.S. Market

By Cory Renauer – May 6, 2019 at 8:17AM

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Canopy Growth investors won't like what Aphria's interim CEO has to say about the Acreage deal.

Canopy Growth (CGC -8.31%), the world's largest cannabis company, has made waves with a bold acquisition that could give it a large U.S. presence. Every time one of the big growers agrees to buy something big, it's customary to pester CEOs of its largest peers with questions about making a similar purchase. 

It's also typical for CEOs to say whatever they think investors want to hear. Since marijuana stock investors tend to get excited when companies like Aphria (APHA) buy something big, you'd expect its interim CEO to pretend he has a plan to do the same. 

A U.S. flag partly hidden under pot leaves.

Image source: Getty Images.

However, Aphria's recently appointed executive chairman and CEO, Irwin Simon, isn't following the standard playbook. Instead, he wants to focus on the bottom line, and probably knows what he's doing. After all, the company he founded 25 years ago, Hain Celestial, became a highly profitable owner of dozens of consumer packaged goods brands.

Here are three reasons not chasing Canopy Growth south of the border is the right decision. 

1. No control

This is the main reason Irwin isn't willing to enter a deal similar to Canopy Growth's option to acquire Acreage Holdings (ACRGF). The deal's bizarre terms give Canopy Growth the right to acquire Acreage Holdings, but only if the Drug Enforcement Agency relaxes marijuana's controlled substance rating from Schedule 1 to something that allows legal sales at the federal level. 

Simon criticized Canopy Growth for spending $300 million up front for the right to buy Acreage for what could be $3.4 billion and perhaps a lot more. Canopy has no control over Acreage's operations, and a lot can change before the 7.5-year option to buy expires.

Acreage is still losing money, and there's a chance it won't be worth a nickel in a few years. There's also the chance that Canopy shares will rise significantly before the option to buy presents itself. According to the terms, Acreage shareholders will receive 0.5818 common shares of Canopy Growth for each of their Acreage shares.

A pot leaf on a hundred-dollar bill on a wooden surface.

Image source: Getty Images.

2. Just say no to federal legalization

Simon didn't mention the pickle the U.S. cannabis market is in right now, but it's another big reason Canopy shareholders will probably never see a return from the Acreage investment. More members of Congress are willing to back the end of prohibition than ever, but rescheduling cannabis would require the U.S. Food and Drug Administration (FDA) to regulate it as a real drug. 

Under the FDA's purview, healthy state markets for legal cannabis will very likely be regulated to death as they are in Canada and California. For example, in U.S. states with loose regulations, 100 mg of THC per edible is standard. Health Canada wants to limit the amount of THC in one edible package or beverage container to 10 mg, plus they must be free of sugars, colors, and sweeteners.

Just 10 mg is weak enough that accidental consumption isn't going to endanger anyone unless they eat like Homer Simpson. It's a sensible rule, but it will also drive most edible sales underground because 10 mg is completely useless to daily cannabis users, who account for a majority of total sales. 

Dry cannabis flower on top of cash on a wooden surface.

Image source: Getty Images.

3. This is a low-margin game now

In states where cannabis has been decriminalized, police aren't too interested in shutting down businesses that don't follow all the rules. In California, recently shuttered illegal storefronts disappear from the Weedmaps app more slowly than new ones are popping up. Thanks to regulations and high taxes, state legal cannabis sales in California fell to $2.5 billion in 2018, from $3.0 billion in 2017 when only medical marijuana was legal.

Canada's unlicensed storefronts and mail order marijuana services charge 30% to 50% less for dry flower. To compete, Irwin understands that Aphria needs to control costs wherever he can. Aphria has a gigantic growing facility in Canada, and the company thinks it can produce process, and ship quality cannabis at a lower cost than peers in its domestic market. 

An estimated 34% of total cannabis spending in Canada during the last three months of 2018 was legal. Licensed marijuana sales peaked in December, which means over 100 licensed producers must share a market with around $913 million in annualized sales. Only the most disciplined Canadian producers will survive, and Irwin's determined to give Aphria a chance.

A good stock to buy now?

Aphria's careful new approach is a big step in the right direction, but now probably isn't the time to buy the stock. Aphria shares aren't worth half as much as they were when Canada's adult-use program began last October, but Aphria's still a $1.7 billion company in a low-margin industry.

If Aphria were close to breaking even, the stock might be worth a closer look. Unfortunately, the company lost $108 million during the three months ended Feb. 28.

Simon wants to make Aphria a successful consumer packaged goods company, but those packages must be plain and dull. With plenty of better investment options to choose from, it's best to wait until Simon figures out a way to build a new packaged goods brand with both hands tied behind his back.

Cory Renauer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Stocks Mentioned

Aphria Inc. Stock Quote
Aphria Inc.
Canopy Growth Stock Quote
Canopy Growth
$3.31 (-8.31%) $0.30
Acreage Holdings, Inc. Stock Quote
Acreage Holdings, Inc.

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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