There's little doubt that marijuana has the possibility of becoming a juggernaut industry roughly 10 years from now. But between now and then, it could be quite the bumpy ride, as shareholders of Canopy Growth (CGC 10.74%), the largest marijuana stock in the world by market cap, have found out in recent months.
Since hitting its year-to-date closing high of $52 in April, Canopy Growth at one point proceeded to give back more than 70% of its market value. The most prominent pot stock has been hit with supply issues throughout Canada, the inability to sell its cannabis products in foreign markets, and has been losing money at an extraordinary pace.
It's also a company that's been looking for a permanent CEO since early July -- that is, until this past Monday, Dec. 9.
The largest pot stock in the world (finally) names its new CEO
Earlier this week, it was announced that David Klein will be leaving his post as Chief Financial Officer at Constellation Brands (STZ -0.60%) and taking over the CEO role at Canopy. The move certainly makes sense, given that Corona and Modelo beer-maker Constellation has made three direct and indirect investments into Canopy over the past two years, and the $4 billion equity investment that closed in Nov. 2018 was the largest. At the time, this investment gave Constellation a 38% equity stake in Canopy, with the option to eventually increase its holdings even further.
As noted in the press release describing Klein's imminent ascent to the CEO role (he'll begin on Jan. 14, 2020):
David brings a wealth of expertise to this role, having served in a number of senior leadership capacities over the past 14 years at Constellation Brands. His capabilities include extensive CPG [consumer-packaged goods] and beverage alcohol industry experience, strong financial orientation, and experience operating in highly regulated markets in the U.S., Canada, Mexico and Europe. David is an experienced strategist with a deep understanding of how to build enduring consumer brands while leveraging operational scale across a dispersed production footprint.
But is this the right move for Canopy Growth? Here are four off-the-cuff thoughts about this announcement.
1. Here comes the much needed belt-tightening
First of all, I was virtually convinced that the person the Canopy board would choose to succeed co-CEOs Bruce Linton and Mark Zekulin would have to first and foremost focus on cost-cutting. By hiring Constellation's CFO, this all but assures that tightening the belt at Canopy will be the first order of business.
Although Canopy Growth has been spending aggressively to expand its domestic and international reach, some of its income statement and balance sheet figures are real head-scratchers that Klein will now have to tackle. As an example, former co-CEO Bruce Linton firmly believed that giving his employees long-term vesting stock would keep them loyal and improve the long-run growth outlook for Canopy. Unfortunately, share-based compensation has been Canopy's Achilles' heel of late, with share-based compensation actually outpacing net sales for the company in the fiscal second quarter.
Likewise, the company has seemingly done a poor job of valuing its acquisitions. As of the end of the fiscal second quarter, Canopy Growth was lugging around 1.91 billion Canadian dollars in goodwill (i.e., premium paid above and beyond tangible assets). I find it improbable that the company recoups a good portion of this goodwill, making a writedown likely in the foreseeable future.
2. Why the gap?
Something I found odd about the announcement were the dates of the transition period. Klein isn't expected to take the helm until Jan. 14, 2020. Meanwhile, current CEO Mark Zekulin, who very well knew that a permanent CEO solution would replace him, is stepping down from his role as CEO and from the company's board of directors on Dec. 20, 2019. Thus, for a period of about 3.5 weeks, Canopy Growth will literally have no CEO.
I don't really understand why Zekulin's tenure wouldn't just be extended 3.5 weeks until Klein can take over or why Klein hasn't been given the go-ahead to step into his role as CEO in mid-to-late December. I mean, this isn't exactly a situation of the mice will play when the cat's away. But it's an odd situation not to have a CEO for more than three weeks with the industry in as much flux as it is right now.
3. Constellation isn't likely to up its stake in Canopy
Thirdly, I don't believe that the hiring of David Klein increases the likelihood that Constellation Brands will take a larger stake in Canopy Growth or buy the company in its entirety.
As noted, hiring Klein was a logical choice, given Constellation's existing equity stake in the company, its displeasure with the free-spending ways of Linton, and the desire to reduce expenses at the company. After all, Canopy's huge losses are, in part, being recognized by Constellation Brands on its own income statements. Klein will help flesh out unnecessary expenditures and at least put a floor underneath Canopy's poor operating performance of late.
But the two issues here are that:
- Canopy has yet to prove that it can generate a recurring operating profit and become a top-tier market-share leader in Canada or throughout the world.
- Constellation's balance sheet is already quite levered.
To speak to the latter point, Constellation is currently carrying around $13.5 billion in total debt. Its board has been quite strict about utilizing leverage, so I don't see how its directors would authorize digging deeper into Canopy without at least seeing evidence of recurring operating profits.
4. This move has plenty of potential to backfire
Fourth and finally, this announcement could come back to haunt Canopy Growth and its shareholders big time!
Wall Street seemed very pleased with the deal, sending shares of Canopy higher by 14% this past Monday, and Klein will bring a much tighter expense structure to the company. But having knowledge of consumer packaged goods and beverages doesn't necessarily make the incoming CEO a good choice to run a cannabis company. This was always my big worry for Canopy -- that it would choose a cost-cutting CEO but overlook the importance of finding someone with experience in the marijuana field.
Klein has zero experience in the cannabis industry, so I think that Canopy's acquisition strategy will come to a complete halt in the interim. It's also unclear in which direction growth, production, and derivatives will trend with Klein at the helm. Obviously, infused beverages will be emphasized, but this is expected to be an especially competitive segment of the derivatives market.
In short, Canopy's board did what it had to do, but I'm not convinced that David Klein is the long-term answer for the company.