In case you haven't noticed, big things are happening in the cannabis landscape. Last year, the first in which a developed country (Canada) had legalized recreational marijuana for adults, the global cannabis industry generated $12.2 billion in sales. By this time next decade, we could see anywhere from $50 billion to $75 billion in worldwide annual pot sales, depending on your preferred estimate from Wall Street.
This growth promotes two trends: expansion and consolidation. Last year was predominantly spent on marijuana growers expanding their capacity at a breakneck pace. But we're liable to see acquisitions and mergers really begin to pick up.
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Cronos Group is in the driver's seat
One such company that sits at an advantageous position on the acquisition front is Ontario-based Cronos Group (CRON -0.41%). Whereas pretty much all marijuana stock acquisitions have been financed by issuing common stock, which isn't always the best incentive if you're a shareholder of the company being acquired, Cronos Group has the second-largest cash pile of any pure-play pot stock, behind only Canopy Growth's approximately $3.7 billion in cash, cash equivalents, and marketable securities.
The reason Cronos is rolling in the green has to do with the $1.8 billion strategic investment from tobacco company Altria that closed in March, giving the Marlboro maker a 45% non-diluted equity stake. Facing years of declining tobacco cigarette shipments, Altria views this investment as a means to boost its long-term growth, as well as create intriguing new products in the pre-roll and vape realm.
But the real story here isn't Altria dipping its toes into the cannabis pond. It's what Cronos is going to do with its boatload of cash. As a reminder, the company ended 2018 with less than $25 million in cash and cash equivalents. But as of the end of the first quarter, it was rocking $1.8 billion in cash.
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Acquiring production looks like a no-brainer...
Roughly four weeks ago, I opined that Cronos Group might consider addressing its subpar peak production with an acquisition. With management forecasting 117,500 kilos of peak global output, it slots in behind eight other individual growers in terms of output, as well as Auxly Cannabis Group and the Pure Sunfarms joint venture in terms of what it'll eventually sell per year. In short, Cronos isn't even a top-10 pot stock when it comes to producing and selling marijuana. This led me to believe that an acquisition to bolster peak production could be on the horizon.
The pot stocks I highlighted as possible targets included CannTrust Holdings (CNTTQ), OrganiGram Holdings, and Aphria, which would bring an extra 200,000 kilos to 300,000 kilos, 113,000 kilos, and 255,000 kilos of respective peak annual production to the table. Any of these acquisitions would immediately vault Cronos into a top-five position in terms of annual yield.
Among the three, I viewed CannTrust as the most logical choice, namely because I believe it could be purchased for the smallest cash component and the most reasonable premium. CannTrust has contended with delays surrounding its phase 3 Niagara expansion, which is now underway, and is undertaking an up to 200-acre outdoor grow-farm project, which is an added expense that investors hadn't been counting on until recently. In terms of production potential to current market cap, CannTrust looks to be a reasonable target for Cronos Group.
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...but what if this is Cronos Group's most logical acquisition target?
But -- and feel free to call me crazy -- what if CannTrust isn't the most logical acquisition target for Cronos? What if, instead of focusing on the company's blatant deficiencies (i.e., its production and subpar international presence), it chose to bolster the one facet of its business that could blow its peers out of the water? Perhaps the most logical acquisition target for Cronos Group is Valens GroWorks (VLNS).
If the name doesn't ring a bell, don't beat yourself up over it. Until recently, Valens GroWorks was just another one of dozens upon dozens of marijuana stocks trying to stand out from a very crowded field. But the company has really stood out in recent months by becoming the largest third-party extraction services provider.
Although it's worked out extraction agreements with many of the biggest brand-name pot stocks, its recently signed two-year deal with HEXO (HEXO) is its most noteworthy agreement. Valens will be extracting, at minimum, 30,000 kilos of cannabis and hemp biomass provided by HEXO in the first year, and 50,000 kilos in the second year, with HEXO receiving high-quality resins and distillates in return that it can use in high-margin cannabis derivatives. It should be noted that, according to Curaleaf Holdings executive chairman Boris Jordan, over half of all worldwide cannabis product sales are currently oils and other derivatives, not dried flower.
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So, why Valens GroWorks? If you recall, Cronos has signed an up to $100 million deal with Ginkgo Bioworks to gain access to its microorganism development platform. This platform can create yeast strains that are able to produce specific cannabinoids (some of which are rare) at commercial scale. If Cronos were to combine this revolutionary new extraction technique with the largest third-party extraction provider using traditional techniques, it could quickly situate itself as the go-to company for high-margin extraction services. In other words, why play catch-up on the production front when it's already close to the leading edge with regard to extraction?
Ultimately, no one, other than Cronos Group's executives, knows what acquisition targets are on its radar. But as crazy an idea as it might seem, buying Valens GroWorks would make an awful lot of sense for Cronos without breaking the bank.
