The fireworks started early for the marijuana industry this past week. Just one day before the Fourth of July holiday celebrating our nation's 243rd year of independence, Canopy Growth (NYSE:CGC) issued a press release announcing that longtime co-CEO Bruce Linton would be stepping down from his role as company leader and vacate his seat on the board of directors.
The release goes on to note that co-CEO Mark Zekulin will be stepping into the role of sole CEO for the time being, but that Canopy's board would begin the search for a more permanent CEO. Or in other words, Zekulin isn't expected to retain his position as the company's sole CEO for any extended period of time.
The Bruce Linton era comes to an end at Canopy Growth
To say this announcement was surprising would be an understatement. Linton has been the face of Canopy Growth for six years. He's single-handedly responsible for overseeing the company's push toward 5.6 million square feet of cultivation space (more than 4.8 million of which is already licensed by Health Canada), which should make it the second-largest producer in Canada.
He also played a pivotal role in securing major investments from Corona and Modelo beer-maker Constellation Brands (NYSE:STZ). Constellation made an initial investment of roughly $190 million in October 2017, purchased a third of Canopy's 600 million Canadian dollar convertible offering in June 2018, and then completed a $4 billion equity investment in November 2018. All told, Constellation owns 37% of Canopy Growth today but could up its stake to as much as 56% if all warrants are executed and convertible notes turned into common stock.
Linton also oversaw a multitude of acquisitions, including the recently announced contingent-rights deal to acquire U.S. multistate dispensary operator Acreage Holdings (OTC:ACRG.F) for $3.4 billion in a cash-and-stock deal (that's predominantly stock-based). The contingency of the deal is that the U.S. federal government has to legalize marijuana before Canopy Growth can take the leap, with a 90-month window for such an occurrence to happen. Should the U.S. choose to legalize marijuana federally, Canopy will be in great shape, with infrastructure spanning 20 states on a pro forma basis, according to Acreage Holdings.
As I said, Linton was instrumental to Canopy's success as the only large-cap cannabis stock.
Linton was terminated from his role
So with things going so presumably well for Linton, why did the co-CEO bow out of his leadership role? It turns out that it wasn't exactly his choice.
In an interview on CNBC's Squawk Box, Linton let the world in on a little secret: He didn't step down but was terminated from his post as co-CEO. When asked why he was stepping down, Linton responded (transcript courtesy of CNBC):
Well, I think stepping down might not be the right phrase, right? What -- on November 1, we closed $5 billion, 4 U.S. billion for 17% of the company and a condition of that closing was the board had to be reconfigured. About eight months and two days later, I think the board has decided they wanted a different chair and a different Co-CEO. So, I'm out effective immediately and there's a search to replace the transitioning Co-CEO.
When CNBC's anchors probed a bit as to why Linton was fired, the former co-CEO gave no real specifics. Aside from mentioning that "I think the direction they [Constellation Brands] want to take it [Canopy Growth] will be determined," Linton had very little to say about what disagreements may have existed between himself and the rest of Canopy's board that led to his ouster. As a reminder, the November investment from Constellation allowed the beverage maker to place four people of its choosing (two of its own executives, and two independent directors) on Canopy's board.
Here's the real reason Linton was shown the door
However, I have a pretty good idea as to why Linton was shown the door: Canopy's ballooning losses.
Linton has made no excuses for Canopy Growth's financial performance in recent quarters. From a fundamental perspective, it's been abysmal. The company wound up losing CA$174.5 million on an operating basis during the fourth quarter and CA$670.1 million on a net basis for fiscal 2019. This is also a good time to point out that without the one-time benefit of a fair-value adjustment on biological assets, Canopy's operating loss in the fourth quarter was closer to CA$225 million.
Linton justified these losses by pointing out the importance of laying the groundwork for expansion. The Acreage Holdings acquisition that outlays $300 million in cash without any assurances that the deal will definitively occur, and substantial investments in the U.S. hemp market to deploy processing infrastructure in the U.S. in the event that the federal government legalizes weed, are all examples of what Linton viewed as necessary strategic investments that offered little-to-no near-term returns.
When Canopy Growth had no major financial backers, these decisions were accepted without question by Wall Street and investors, even if it led to quarterly losses. But with recreational marijuana now legal in Canada, it's become evident that earnings reports actually matter now. With Canopy recognizing ever-higher operating expenses as its employee base has expanded and with share-based compensation soaring, there's no masking just how bad the company's results have been.
I believe the last straw was when Canopy's growing losses began acting like a concrete block on Constellation Brands' operating results. Constellation's fiscal first-quarter results featured a $54.4 million loss on a comparable basis tied to Canopy Growth. Even though Constellation remained up by $1.6 billion on its Canopy investment on an unrealized basis when reporting its Q1 results, Canopy's poor quarterly performance was providing a tangible drag on Constellation's bottom line. The only fix was to be proactive and replace Canopy's management team with more cost-minded folks.
Although I have no clue who'll lead Canopy into the next phase of its growth, I'd be shocked if it wasn't someone who's expressed purpose is to control spending and drastically improve the company's bottom line.