Earlier this year, there wasn't a hotter cannabis stock around than Cronos Group (NASDAQ:CRON). The exceptionally popular Canadian grower more than doubled at one point during the first quarter, with the biggest catalyst being an announced equity investment from tobacco giant Altria Group (NYSE:MO). This deal, which closed in mid-March, featured a $1.8 billion cash investment that gave Altria a 45% non-diluted stake in Cronos.

Altria's equity investment in Cronos Group was viewed as a game changer

This budding partnership between Cronos and Altria, as well as the serious cash infusion that came with this investment, was expected to be a game changer for Cronos. After all, the company ended 2018 with less than $25 million in cash and cash equivalents on its balance sheet, but had a long to-do list that it wanted to tackle. The $1.8 billion Altria supplied instantly eased Cronos Group's cash concerns and gave it the ability to tackle a number of long-term growth strategies.

A handful of cannabis buds lying atop a messy pile of cash.

Image source: Getty Images.

For example, Cronos announced that it was going to buy Redwood Holdings, the company behind the cannabidiol (CBD)-based beauty line Lord Jones, in early August. With a price tag of $300 million, Cronos utilized $225 million in cash from its equity haul with Altria, while only minimally diluting its existing shareholders by issuing its own stock to cover the remainder of the deal's value. This purchase was designed as a means of pushing into the U.S. CBD market and is one of many objectives the company aims to tackle with its cash.

For its part, Altria has used its equity investment/partnership as a means to diversify beyond the U.S. tobacco scene. Adult cigarette smoking rates in the U.S. are now at an all-time low, dating back to the mid-1960s, with Altria leaning on price hikes and the addictive nature of nicotine to grow its top and bottom lines. By investing in Cronos, Altria opened itself up to a potentially new and fast-growing North American revenue stream. With Altria's keen knowledge of what U.S. smokers want, the expectation has always been that the company would provide the marketing and development expertise that would allow Cronos Group's line of vape products to succeed. As a reminder, derivative pot products, such as vapes, will begin hitting Canadian dispensaries by the midpoint of December.

Cronos Group's mammoth cash pile can't mask its shortcomings

This would appear to be the perfect scenario for Cronos Group to succeed. But looks can sometimes be deceiving, especially in an industry that's contending with a number of growing pains.

Rather than maintaining its first-quarter gains, Cronos Group has been among the worst-performing cannabis stocks since the end of March, with its shares down an unsightly 66% over that time frame. In fact, despite ending its most recent quarter with $1.51 billion in cash, cash equivalents, and marketable securities, the company's market cap has shrunk all the way to $2.16 billion -- effectively valuing the company's operations at $650 million over cash. 

This raises the question: Could Cronos Group's market cap actually dip below its end-of-quarter cash balance? Feel free to call me crazy, but I do believe it's a real possibility.

To understand how Cronos could lose another $650 million in market cap, you first have to understand what's shaved more than $4 billion in value off the company over the past eight months.

A cannabis leaf laid within the outline of the Canadian flag's red maple leaf, with rolled joints and a cannabis bud to the left of the flag.

Image source: Getty Images.

First, there are clear issues with the supply of legal-channel pot products in Canada. Regulatory agency Health Canada has been overwhelmed with cultivation, processing, and sales license applications for years, and it's been unable to approve growing and/or sales licenses in a timely manner as a result. This is one reason we haven't seen consumer demand met throughout Canada.

To add to this point, we've also witnessed certain provinces slow-stepping the rollout of physical dispensaries. Right now, Ontario, a province of around 14.5 million people, has just two dozen locations open that legally sell cannabis. Even with the second stage of a lottery system that'll triple the number of dispensaries in the province, it's still not nearly enough to meet consumer demand. Both of these regulatory and procedural issues have driven consumers to the black market.

Secondly, it's important to understand that Cronos Group isn't the major player that Wall Street initially made it out to be. Despite partnering with Altria, Cronos' flagship grow site is Peace Naturals, a campus with no more than 40,000 kilos of annual capacity. Cronos GrowCo, the company's joint venture with a group of investors, won't complete construction until later this year, and won't begin production until sometime in the second half of 2020, assuming it's fully licensed. Even then, as a joint venture, Cronos will be effectively splitting the proceeds with its partners. Between GrowCo, Peace Naturals, and its overseas grow sites in Australia and Israel, Cronos Group might be responsible for only around 80,000 kilos of production a year. There are more than a dozen growers that could surpass this output.

Thirdly, Health Canada delayed the launch of high-margin derivatives, including vapes, until mid-December. The expectation, up until around midyear, had been that derivative products would be on dispensary shelves by no later than October. That changed with an announcement from Health Canada, and has been made worse by persistent supply issues. While all of these supply problems are fixable, they're going to take some time to correct.

An accountant chewing on a pencil while closely analyzing figures from his printing calculator.

Image source: Getty Images.

Fourth, and maybe most damning, Cronos Group's operating results haven't been good. If we were to strip out its revaluation of derivative liabilities (the warrants given to Altria as part of the equity investment), as well as fair-value adjustments, Cronos continues to lose quite a bit of money on an operating basis.

What's more, the company's sales are considerably lower than many of its peers. The company's third quarter featured just 12.7 million Canadian dollars ($9.6 million) in sales, which is peanuts for a company that sported a market cap of more than $6 billion earlier this year. Cronos also announced plans to divert some of its cultivation space at Peace Naturals to derivative production and processing in its third-quarter press release. This appears to be a roundabout way of cutting output expectations in the near term even more.

Fifth and finally, a vape-related health scare could continue to curb vape sales growth throughout North America for the foreseeable future. This would be a pretty significant red mark for the Altria-Cronos partnership.

In sum, Canada has clear supply issues that won't quickly resolve, Cronos isn't the major player it was made out to be, and its operating results have been pedestrian, at best. With Cronos' cash pile likely to continue shrinking, a decline in market cap below $1.51 billion is a distinct possibility.