Marijuana is quickly becoming a big-dollar industry, and it certainly has Wall Street and investors seeing green.
Although estimates vary wildly, the consensus projection on Wall Street is that the legal cannabis industry will deliver a compound annual growth rate in the double digits through the end of the next decade. That makes legal marijuana one of the fasting-growing industries on the planet.
These heightened expectations for growth are certainly reflected in the valuations of a number of pot stocks. Today, more than a dozen marijuana stocks boast billion-dollar market caps, with Canopy Growth (CGC -0.57%) leading the pack with a valuation of $14.5 billion.
In an industry where consolidation is expected to take precedence over the next few years, the logical expectation would be for these presumably well-funded billion-dollar cannabis stocks to do the buying. But that's not always the case. Right now, there are three billion-dollar marijuana stocks that look more like acquisition targets than acquirers.
Even though it's the third-largest marijuana stock by market cap, Cronos Group (CRON 2.65%) looks to be more of a buyout candidate than the one doing the buying.
Like Canopy Growth, Cronos landed one of the two major equity investments in the industry. Tobacco giant Altria (MO 0.27%) wound up investing $1.8 billion in the company to nab a 45% nondiluted equity stake. Altria also received warrants that, if exercised, could boost its stake in Cronos Group to as high as 55%.
As for Canopy Growth, Modelo and Corona brewer Constellation Brands (STZ 0.44%) made a $4 billion equity investment in the company in November. This lifted Constellation's equity in Canopy Growth to 37%, with the warrants it also received capable of boosting its stake to 56% on a diluted basis, if exercised.
What makes Canopy's and Cronos Group's situations so different is twofold. First, Constellation Brands is doing just fine with its assortment of alcoholic beverages throughout the world. That's not the case with Altria, which has seen its cigarette shipment volumes decline precipitously in the U.S. as adult smoking rates are the lowest in over 50 years. Altria absolutely needs an infusion of top-line growth, and cannabis can provide that spark. Constellation Brands doesn't need this spark. It merely saw an opportunity to expand into another fast-growing vice industry.
Second, Canopy Growth projects as one of the largest growers in Canada, with its 5.6 million square feet yielding north of 500,000 kilos, when licensed and fully operational. Comparatively, Cronos Group's 117,500 kilos of peak output barely keeps it among Canada's top 10 producers. Inclusive of joint ventures and royalty companies, it's not even a top-10 player.
With Cronos angling for a large share of the vape market, and Altria desperately needing a growth spark with tobacco sales declining, it would be no surprise if Altria simply purchased what it doesn't already own of Cronos Group.
Ontario-based Aphria (APHA) likely projects as Canada's third-largest grower by peak annual production, behind only Aurora Cannabis and the aforementioned Canopy Growth. Spanning Aphria's three production farms, the company expects 255,000 kilos of annual output, when operating at full capacity.
How is a company with 255,000 kilos in expected yearly output, and profitability forecast in fiscal 2020, valued at a mere $1.7 billion in market cap? The answer lies with Wall Street's faith in management...or perhaps lack thereof.
Back in December, Aphria was the target of a short-seller report from the duo of Quintessential Capital Management and Hindenburg Research. These short-sellers alleged that Aphria grossly overpaid for its Latin American assets -- a claim that was later found to be inaccurate, according to an independent committee. However, it was uncovered that a couple of executives were related parties in this Latin American deal, which ultimately led longtime CEO Vic Neufeld to step aside after roughly five years at the helm.
This also wasn't the first time Aphria's management team received a finger-wag from the public. In March 2018, when it acquired Nuuvera to bolster its international sales network, it was announced that a number of Aphria insiders held positions in Nuuvera just a day before the deal closed. While it's not unheard of for insiders of an acquiring company to hold an equity stake in the company being acquired, Wall Street and investors would want to know about it well in advance.
Thus, Aphria is facing a crisis of confidence with its management team, and its stock has suffered as a result. Green Growth Brands attempted to acquire Aphria via a hostile bid earlier this year, but Aphria's board rejected that offer because it significantly undervalued the company.
At this point, Aphria looks primed for a takeover by a production-hungry grower -- one that would, hopefully, remove the uncertainties clouding Aphria's management and future.
A third billion-dollar pot stock that could find itself the apple of a larger marijuana stock's eye is Quebec-based HEXO (HEXO -0.74%). Whereas weakness might facilitate the buyouts of Aphria and Cronos Group, this wouldn't be the case for HEXO, which is sitting pretty in a number of aspects.
For starters, the recently completed acquisition of Newstrike Brands for just shy of $200 million gives HEXO much-needed capacity. By sometime in 2020, it should be operating at its full capacity of 150,000 kilos of run-rate output per year. Buying HEXO would allow any grower to rocket up the production rankings.
Not to mention, it has what might be the most de-risked production portfolio of any grower. In April 2018, the company signed a mammoth five-year supply deal with its home province of Quebec that'll see it supply an aggregate of 200,000 kilos for the adult-use market. The amount being supplied is expected to grow annually, with Quebec holding an option to extend the deal for a sixth year. Including HEXO's ongoing ramp-up and its recent acquisition of Newstrike, the Quebec deal may account for 30% of its output through 2023.
HEXO also has a penchant for deal-making. It's formed a joint venture known as Truss with Molson Coors Brewing to develop a line of nonalcoholic cannabis-infused beverages that'll be legal by no later than this coming October. It also forged a two-year agreement with Valens GroWorks that'll see Valens extracting at least 80,000 kilos (in aggregate) of hemp and cannabis biomass for the production of high-margin derivative products.
But the very best aspect is that CEO Sebastien St-Louis has flat-out proclaimed that HEXO is for sale if it receives the appropriate premium. "In five years, there may be four global cannabis companies, and whether HEXO is a buyer or a seller on that journey, what matters to us is for our shareholders to participate in that to become one of the four. ... It's certain that if someone comes and offers a 150 percent premium tomorrow, we are for sale," St-Louis said in 2018 to the Montreal Gazette. Because the share price has appreciated notably since these comments, it's possible St-Louis and his team would accept a premium of less than 150% today.