The marijuana industry is changing before our eyes and maturing at a rapid pace. What had been a completely taboo industry but a few years ago is now a legal industry in Canada, and legal in some capacity throughout two-thirds of all U.S. states.
But as is common with even the fastest-growing industries, growing pains are beginning to be felt. In Canada, persistent supply issues have kept cannabis off the shelves in licensed stores, whereas in the U.S. we've witnessed bouts of oversupply and high tax rates negatively impact sales. The adverse impact these issues are having on the top- and bottom-line figures for cannabis companies has begun weighing on marijuana stock valuations.
And, more directly, they may have even cost a top figure in the industry his job.
For six years, Bruce Linton shaped Canopy Growth
Last Wednesday, July 3, Canopy Growth (NYSE:CGC) surprised investors by announcing the departure of co-CEO Bruce Linton, who has played a pivotal role in the company's growth for the past six years. With Linton at the helm, Canopy Growth expanded to 5.6 million square feet of cultivation capacity across roughly 10 grow sites, and has managed to get more than 4.8 million square feet already licensed by Health Canada. For context, the backlog of licensing applications (mostly for cultivation) was over 800 as recently as January, meaning Canopy has done an excellent job of getting its facilities ready for peak production.
Linton is also the brainchild behind the $3.4 billion contingent-rights acquisition of Acreage Holdings (OTC:ACRGF) in the United States. The cash-and-stock deal has already been approved by investors but now waits on the contingency: The U.S. federal government must legalize marijuana for the deal to be completed. If and when the U.S. government does change its tune on weed, Canopy Growth could be set up with retail, grow, and/or processing capabilities in 20 states, which will be on top of its hemp-processing presence in up to eight U.S. states, as of 2020.
However, Linton might be best known for his role in orchestrating Corona and Modelo beer maker Constellation Brands' (NYSE:STZ) $4 billion equity investment in the company that closed last November. This marked the third investment in Canopy from Constellation, and it wound up increasing its equity stake to 37%. Should Constellation choose to exercise the warrants it also received, and convert 200 million Canadian dollars of notes into common stock, it could increase its equity stake to as much as 56%.
Losses were likely Linton's undoing
Despite the cash Canopy received from this investment proving vital to its international expansion strategy, it's the Constellation partnership that looks to have been Linton's undoing.
Although the press release from Canopy clearly states that Linton was stepping down from his role as co-CEO and his position on the board, the former co-leader of Canopy set the record straight on CNBC's Squawk Box by announcing that he had been essentially fired from his post. Despite offering no specifics in his interview as to why he was let go, the most likely reason has to do with Constellation Brands being unhappy with the material weakness it was seeing on its own income statement as a result of Canopy's widening losses.
Linton made no apologies for Canopy's poor performances on the earnings front. He has frequently reminded Wall Street and investors of the importance of laying the infrastructure needed to be successful over the long run, and how this infrastructure could prove costly in the interim. For example, outlaying $300 million in cash to Acreage Holdings with no guarantee that the U.S. federal government will legalize cannabis is one of a handful of examples where Linton threw caution to the wind in favor of his long-term vision for Canopy.
When Linton had no brand-name investors backing Canopy Growth, he had full control over the company's future. But when Constellation made its game-changing equity investment, it was also able to place four people of its choosing (two Constellation execs and two independent directors) on Canopy's board. This made Constellation a major voice in the direction that Canopy Growth would head.
When Canopy reported its fiscal fourth-quarter operating loss of CA$174.5 million a few weeks ago, as well as a CA$670.1 million net loss for the full year, Constellation's brass voiced its displeasure. The simple fact that Canopy also caused Constellation to lose $54.4 million on a comparable basis in its most recent quarter looks to be the final straw, which may be why Linton was shown the door.
The hits just keep on coming
But if you thought that Linton's departure would be a one-day event, you're sorely mistaken. With what's arguably the center of Canopy's universe now removed from the picture, it's unclear who will lead the company, dictate strategy, and reduce losses in the quarters that lie ahead. These uncertainties reared their head in the form of a downgrade this past Friday, July 5.
Analyst Nikolaas Faes at Bryan, Garnier & Co. wound up downgrading his firm's rating on Canopy to neutral from buy, while also chopping his price target to CA$60 ($45.83) from CA$85 ($64.93). For added context, this price target reduction implies $6.6 billion in reduced market cap from where Faes and his firm stood on Canopy prior to the ouster of Bruce Linton.
And Faes wasn't the only analyst to chime in on the news. Stifel analyst Andrew Carter, who chose to maintain his firm's buy rating on the company, commented in a note to clients on the day of Linton's departure that Linton's vision and founder status would be "sorely missed." Carter conceded that the writing was somewhat on the wall given Canopy's poor operating performance and the control Constellation can wield on Canopy's board, but was nevertheless surprised to see such an important figure in the cannabis industry cast aside.
On the bright side, Linton put the wheels in motion in such a way that it would be very difficult to change course now. Even without his leadership, Canopy will continue to push into the U.S. hemp market, and is awaiting the hopeful legalization of marijuana in the United States.
But what remains to be seen is what happens to Canopy's other expenditures. Linton relied heavily on long-term options and share-based compensation to incent employees to stick around. However, this share-based compensation has been accounting for an increasingly high percentage of total expenses. It'll be curious to see what Constellation does with share-based expensing at Canopy.
It's these growing number of uncertainties that suggest the fallout from Linton's departure is nowhere near over.