Although all eyes are on Canada right now as the only recreationally legal industrialized country in the world, the thing to realize about cannabis is that it's a global opportunity. And no market around the world offers more potential than its southern neighbor, the United States.
To be fair, estimates on the sales potential of the marijuana industry vary wildly. But one consistency is the expectation that the U.S. market will make up a significant chunk of worldwide cannabis and cannabinoid-based sales. Investment bank Stifel, which has the most aggressive forecast on Wall Street, believes that U.S. cannabis/cannabinoid sales could hit $100 billion in a decade, comprising half of all global sales. Meanwhile, Christopher Carey at Bank of America foresees peak annual sales of around $166 billion for legal weed, with the U.S. contributing to 34% of this yearly total.
Suffice it to say, despite the U.S. federal government currently holding firm on its classification of marijuana as a Schedule I (i.e., illicit) substance, cannabis stocks have been placing their bets on eventual legalization.
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The easiest way for cannabis stocks to push into the U.S. market
One of the easiest ways for pot stocks to gain entry to the U.S. without specifically going after cannabis -- which despite being legal in a number of states would be a no-no for companies currently listed on either the New York Stock Exchange or Nasdaq -- is through hemp and hemp-derived cannabinoids, such as cannabidiol (CBD). That's because the farm bill, signed into law in December 2018, legalized the industrial production of hemp and the extraction of hemp-derived cannabinoids containing no tetrahydrocannabinol (THC).
CBD and THC are the two best-known cannabinoids in this space, with each serving a different purpose. THC is found in abundance in the cannabis plant (and usually in small quantities via hemp plants), and it's the cannabinoid responsible for getting users high. Meanwhile, CBD doesn't get users high, is known best for its perceived medical benefits, and can be found in the cannabis or hemp plant. The thing is, hemp is much easier to grow and less costly than cannabis, making it ideal to grow for CBD extraction purposes. Since CBD doesn't get users high, it should be an attractive product to a greater percentage of the U.S. adult population.
You should also realize that hemp-derived CBD is often being infused into high-margin derivative products. Whereas dried marijuana flower may be the most commonly associated product to the cannabis movement, it's derivative products, such as edibles, infused beverages, topicals, and vapes, that deliver much higher margins for pot stocks.
According to a newly updated report from the Brightfield Group, CBD sales in the U.S. could soar to $23.7 billion by 2023, representing a compound annual growth rate between 2018 and 2023 of over 100%.
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Cronos Group gets its foot in the door in the U.S. CBD market
To date, around half of all major Canadian pot growers have pushed into the U.S. hemp market, with Canopy Growth (CGC 12.51%) leading the way. Canopy Growth acquired cannabis-and-hemp-focused intellectual property company ebbu, based in Colorado, this past November, and is spending up to $150 million in New York state to construct a hemp-processing facility following its receipt of a hemp processing license in the Empire State in January.
This past week, Cronos Group (CRON 5.08%) became the latest major cannabis stock to join the party. Cronos announced that it would acquire four of Redwood Holding Group's subsidiaries, which are responsible for a line of hemp-derived CBD-infused skin care and consumer products that are sold under the Lord Jones brand. Although vapes are forecast to be the most popular derivative in Canada, topicals and beauty products might be the easiest means for cannabis companies to get their foot in the door in the United States.
This move by Cronos is a logical extension of the company's long-term strategy, which is to focus on high-margin cannabinoids, rather than dried flower, as well as to push into the U.S. market. The last we'd heard from management (in May) is that Cronos Group would outline its U.S. strategy over the next year. Clearly, it didn't take the company's brass long to figure out its next step.
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Here's why Cronos Group's acquisition is so unique
But there's more than meets the eye about this deal. It's an extremely unique acquisition in the cannabis industry for one reason: It's highly cash-centric.
Under the terms of the deal, Cronos is paying $300 million (U.S. dollars) for Redwood, net of the company's cash and debt. However $225 million of this (again, subject to the aforementioned adjustments) will be doled out in cash, with "just" $75 million being financed by issuing new shares of Cronos Group stock. This is the first time a major purchase in the pot industry has been financed predominantly with cash.
Mind you, Cronos Group was sitting on $1.8 billion in cash and cash equivalents at the end of the first quarter, nearly all of which was derived from a $1.8 billion equity investment from tobacco giant Altria that closed in March. Cronos certainly had the cash to make this deal happen. Nevertheless, it's been common practice for cannabis stocks to hang onto their cash with a death grip, given the uncertainties of traditional financing options and early stage hiccups throughout the industry in Canada and select U.S. states. Rather, pretty much every deal being undertaken right now involves share issuances galore and ongoing share-based dilution.
For instance, Canopy Growth aims to acquire U.S. multistate operator Acreage Holdings for $3.4 billion. The contingency of the deal is that the U.S. government needs to legalize marijuana. If the deal should go through, more than 90% of the value will be paid for with Canopy's common stock, with only $300 million being paid to Acreage's shareholders up front. Keep in mind that Canopy Growth ended its latest quarter with over $3.4 billion in cash and cash equivalents.
It's extremely rare for cannabis stocks to be willing to use their cash to make acquisitions. While I've clearly not been a fan of Cronos Group in the past, this is one instance where I have to admit that the company did a really good job of adding a valuable brand to its portfolio while only minimally diluting the value of existing shareholders.
