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Why Investors Should Like How Cronos Group Is Spending Altria's Money (So Far)

By Keith Speights – Aug 6, 2019 at 7:00AM

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The tobacco giant's $1.8 billion investment isn't going up in smoke. Cronos appears to be using its big cash stockpile wisely.

It's been nearly five months since tobacco giant Altria (MO 0.94%) forked over close to $1.8 billion in cash to Canadian cannabis producer Cronos Group (CRON -1.66%). Since then, Cronos shares have plunged more than 35%. Analysts and investors became concerned that the stock was overvalued after a big run-up following the announcement in December of the partnership with Altria.

But investors should like how Cronos Group has been putting Altria's money to work. Here are three specific ways that Cronos is spending its big cash stockpile that should pay off for shareholders over the long run.

Hand holding stacks of cash with another hand ready to receive the cash.

Image source: Getty Images.

1. Premiere U.S. CBD skin care products

Many investors cheered last week with Cronos Group's significant move into the U.S. hemp CBD market. On Aug. 2, the company announced that it was acquiring four of Redwood Holding Group's operating subsidiaries. Redwood is best known for its hemp-derived cannabidiol (CBD)-infused skin care and other consumer products sold under the Lord Jones brand.

Cronos will pay $225 million in cash plus $75 million in newly issued stock as part of the deal. In return, the company will immediately become a major player in the U.S. hemp CBD products market. Lord Jones ranks as one of the top CBD skin care brands and is sold by leading cosmetics retailer Sephora.

Investors have a good reason to be happy about Cronos Group's latest transaction. Market researcher Future Market Insights estimates that the CBD skin care market will total $645 million this year and expand by a compound annual growth rate (CAGR) of over 33% through 2027. That growth rate translates to a market of over $6.3 billion within the next eight years -- a market in which Cronos should be very competitive thanks to its Redwood acquisition.

2. Next-gen vaporizer research

Cronos announced in May the opening of a research and development facility in Israel. This R&D facility, named Cronos Device Labs, is focusing on developing next-generation vaporizer products designed for cannabinoids. The company didn't provide details on how much money it's spending on the R&D facility.

Why is Cronos Group's efforts to develop next-gen vaporizers good for investors? Cronos CEO Mike Gorenstein hit the nail on the head, stating, "Vapor is already one of the most popular forms of cannabis consumption, and we see a clear opportunity for Cronos Group to introduce the next generation of vaporizer products designed specifically for cannabinoid formulations."

The Canadian cannabis derivatives market scheduled to open in October 2019 should boost vape-related product sales dramatically. Altria also brings plenty of expertise to the table to help Cronos navigate this potentially lucrative market, especially with the tobacco company's big investment in Juul.

3. Cultured cannabinoids

Cronos stock jumped last September when the company announced what it called a "landmark partnership" with Ginkgo Bioworks. The two companies agreed to collaborate on developing cultured high-purity cannabinoids from engineered strains of yeast.

That partnership shifted into a higher gear in July with Cronos announcing that it's acquiring a state-of-the-art fermentation and manufacturing facility from Apotex Fermentation. Cronos didn't say how much the facility cost, but stated that it "intends to use existing cash on hand to fund the acquisition," adding that the amount "is not expected to be material" to its cash position.

Interest in rare cannabinoids for use in medical products is increasing. However, the costs for extracting these cannabinoids from cannabis plants is high, especially on a commercial scale. Cronos Group's new facility should enable it and Ginkgo to produce high-quality and high-purity cultured cannabinoids at commercial scale at a much lower cost than traditional methods. This could give Cronos a big advantage in the medical cannabinoids market.

One less exciting way the Altria cash is being put to use

There is one way that Cronos is using its big Altria-funded cash stockpile that isn't so exciting: keeping the lights on. Cronos again posted an operating loss in its first-quarter results announced in May. (It did report a profit in the quarter, but only a paper one resulting from a large gain on the revaluation of derivative liabilities.)

As long as the company loses money, it will have to tap into its cash to fund ongoing operations. But as Cronos Group's capacity increases and more adult-use recreational marijuana retail locations open in Canada, the company's financial position should improve. Cronos at least doesn't have to worry about raising cash like some of its peers do.

I suspect that Altria has been very supportive of how Cronos has used its cash over the last few months. Entering into the U.S. hemp CBD market, preparing for the vape market, and getting ready for a potential payoff from the Ginkgo partnership appear to be smart moves that lay the foundation for long-term success.

Keith Speights has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Cronos Group Inc. Stock Quote
Cronos Group Inc.
$2.96 (-1.66%) $0.05
Altria Group Stock Quote
Altria Group
$42.90 (0.94%) $0.40

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