Though it's debatable, the biggest surprise this year in the cannabis industry wasn't the recent deflating of pot stock valuations. Rather, it was the firing of longtime marijuana visionary Bruce Linton as co-CEO of Canopy Growth (NASDAQ:CGC) in early July.
It'd be pretty fair to say that Canopy Growth, the largest marijuana stock in the world by market cap, wouldn't be where it is today without Linton. He was the leader who helped arrange Constellation Brands' (NYSE:STZ) $4 billion equity investment into the company, which closed last November. Linton also oversaw the licensing of more than 5 million square feet of cultivation, as well as positioned Canopy for domestic and international growth with multiple acquisitions, including hemp and cannabis intellectual-property company ebbu and well-known vaping-device maker Storz & Bickel.
However, it turned out that Linton's own success was the source of his demise. In nabbing Constellation Brands as an investment partner, Constellation was able to put two of its own executives, as well as two independent directors, on Canopy's board. This gave Constellation some leverage that it could exert if its 37% equity stake began to go off-kilter. In recent quarters, Canopy Growth has been losing money at an exorbitant rate, which is what led the board to make the move to ouster Linton as co-CEO on July 3.
And it's not just Linton who's being shown the door. Mark Zekulin, the current CEO and co-CEO while tenured with Linton, will step down once Canopy's board finds a permanent CEO. According to the company, a permanent CEO is expected to be named before the end of the calendar year.
But the new CEO, whoever he or she may be, isn't going to have an easy task ahead of them. With Canopy losing roughly $10 billion in market value in recent months, the new CEO is going to need to firmly address three issues to remove a number of gray clouds overhanging the company.
1. Share-based compensation: Will it be minimized?
First and foremost, you should understand that the newest CEO, whoever that may be, is being brought in to seriously tighten the corporate belt. In the company's fiscal first quarter, gross profit totaled a mere 13.2 million Canadian dollars, not including fair-value adjustments, which compares poorly with the CA$229.2 million in reported operating expenses, a 215% year-on-year increase. Though all costs rose from the prior-year period, none had a larger impact on the company's operating costs than share-based compensation, which came in at CA$87.3 million in Q1 2020, up from CA$30.1 million in Q1 2019.
When Linton was co-CEO, he firmly believed that the best way to instill loyalty in his rapidly growing employee base was to give them long-term-vesting stock. As the company's employee count grew, so did the damage done on a quarterly basis by share-based compensation. On an extrapolated basis, share-based compensation is practically a CA$350 million full-year expense.
The concern that the incoming CEO is going to need to address is how all of Canopy's expenses, especially share-based compensation, will be reduced to improve the company's margins and put it on a path to profitability. Right now, it looks as if Canopy Growth could be among the last growers to generate a recurring profit -- and that won't sit well for too long with Wall Street.
2. Goodwill: Will there be writedowns?
Another pretty sizable concern for Canopy Growth -- and the entire cannabis industry, for that matter -- is the growing powder keg known as goodwill, i.e., the premium one company pays when buying another, above and beyond tangible assets.
With the exception of Aurora Cannabis, there isn't a marijuana stock that's lugging around more goodwill than Canopy. The CA$1.93 billion in goodwill at the end of June was almost CA$388 million higher than where it stood at the end of the sequential fourth quarter. In a perfect scenario, Canopy will be able to develop the assets and patents of the companies it's acquired and completely work this goodwill off its books. But in reality, Canopy ridding itself of more than CA$1.9 billion in goodwill is far less likely than admitting it overpaid for some of its assets.
When the permanent CEO takes their post, they're going to have no choice but to address Canopy's ballooning goodwill and acquisition spree. Though a significant writedown would likely be unwelcome by shareholders in the near term, it would probably remove a lot of the balance-sheet uncertainty overhanging this stock.
3. What's the game plan?
Finally, Canopy Growth's new leader is going to have to demonstrate to Wall Street and investors that they can fill Bruce Linton's enormous shoes.
Though Linton's fault was that he didn't think too hard about the short-term repercussions of making acquisitions and expanding into international markets, he still propelled Canopy to a position of leadership. With the exception of Tilray's moonshot to a $26 billion valuation following its initial public offering last year, Canopy hasn't given up its seat at the head of the table, and Linton's presence is largely to thank for that.
The new CEO is going to have to lay out to Wall Street how Canopy Growth is going to remain aggressive in securing additional domestic and international market share, all while tightening its belt to reduce its own losses, and that of its equity partner, Constellation Brands. That's no easy task -- even for an industry with exceptional long-term growth prospects.
Suffice it to say, I don't envy the position in which Canopy's soon-to-be-announced CEO will be placed.