For years, the cannabis industry has grown by leaps and bounds. Worldwide marijuana sales more than tripled from 2014 to 2018, reaching nearly $11 billion, and some Wall Street analysts have forecast a roughly 18-fold increase in global annual sales by 2030 to approximately $200 billion. With sales forecasts like these, it's easy to see why investors have flocked to marijuana stocks.

These sales projections are also a big reason behind heightened merger and acquisition activity, and equity investments, into the pot industry in 2018 and the first half of 2019. Out of the numerous acquisitions and investments in the cannabis space that came to fruition, the largest to date is the November 2018 equity investment of $4 billion from Modelo and Corona brewer Constellation Brands (NYSE:STZ) into Canopy Growth (NYSE:CGC), the largest publicly traded pot stock in the world.

A potted cannabis plant next to a bottle of wine.

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According to a recent note released to clients by Pablo Zuanic, cannabis industry covering analyst at Cantor Fitzgerald, Constellation is "more likely than not" at this point to buy the remainder of Canopy Growth that it doesn't already own. But does Zuanic's thesis hold water? Let's take a closer look. 

Constellation has been building a position in Canopy for some time

Before completely diving into the positives of a potential acquisition of Canopy Growth, it's important for investors to understand just how deep Constellation Brands already is into Canopy from a monetary perspective. Although Constellation did make the $4 billion equity investment into Canopy, it actually was the third time that Constellation directly or indirectly took a stake in the company.

Back in October 2017, Constellation Brands became the first brand-name company to dip its toes into the pond by paying approximately $190 million for a 9.9% equity stake in Canopy Growth. Then, in June 2018, Constellation acquired a third of Canopy's CA$600 million ($460 million) offering of convertible debentures. Though Constellation could choose to accept repayment of this debt in cash, it may also be able to convert its debt into Canopy's common stock in the future. Likewise, Constellation received warrants with its massive equity investment in November 2018 that could be exercised in the future.

In short, Constellation didn't just make a single investment into Canopy Growth in November 2018. Even though investors tend to focus on this singular event as game-changing, Constellation has been digging into Canopy Growth for more than two years.

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Here's why a Constellation-Canopy combination might make sense

Now that we've got that out of the way, let's examine why acquiring Canopy Growth could work out in Constellation's favor.

First, Constellation would be able to acquire what it doesn't already own of Canopy for a reasonably inexpensive price. Zuanic suggests that acquiring what it doesn't already own of Canopy at a 15% premium would only amount to a little over $5 billion. Considering that Constellation has already (directly and indirectly) invested more than $4.3 billion into its aggregate equity stake in Canopy, this is a pretty reasonable price to pay to make the full leap into a high-growth industry.

Second, we're talking about internalizing all partnered development projects, and thereby reaping the full rewards of doing so. For instance, Constellation and Canopy are working together to create a line of nonalcoholic cannabis-infused beverages. Buying Canopy would allow Constellation to reap the full reward of this line of derivative products, as well as Canopy's other high-margin ventures, including its push into Canadian edibles.

Third, it would combine two companies that already have diverse international distribution networks. Constellation is a major alcohol player throughout North America, with Canopy Growth having an export, production, research, or partnership presence in 17 countries, including a hemp-processing license in the U.S. (in New York State). There would, presumably, be sizable synergies realized by combining these distribution networks.

Fourth, former Constellation Brands CFO David Klein is set to take the reins as CEO of Canopy Growth. Klein, one of Constellation's own, will undertake the necessary steps to turn the largest pot stock in the world into a mature and sustainable business.

Finally, it would be a logical step by Constellation's management to expand into another high-growth vice industry. It's not so much that premium alcohol sales aren't thriving for Constellation throughout North America, as it is that cannabis represents another avenue of steady long-term growth, especially with a younger generation of consumers.

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Zuanic's thesis has a pretty big flaw

I admit, there's a lot here that makes sense. Constellation already being waist-deep in its aggregate investment, and recently installing its former CFO as Canopy's new CEO, both make for solid reasons to combine these two companies. But Zuanic's thesis overlooks a pretty sizable problem. Namely, Constellation's balance sheet is already stretched more than its management team would care for.

Over the past four years, Constellation's total debt has roughly doubled to more than $12 billion, and it has in excess of $1 billion in short-term borrowing and long-term debt coming due over the next 12 months. Though the company is expected to generate $2.3 billion in operating cash flow for fiscal 2019, it has only $94 million in cash and cash equivalents on its balance sheet.

In layman's terms, the only way Constellation Brands is going to be able to acquire Canopy Growth is if it further balloons its outstanding debt. Constellation's management made it clear following that $4 billion equity investment in November 2018 that maintaining fiscal discipline is important. Thus, I don't see how Constellation makes a play for Canopy Growth given the current state of its balance sheet.

What's more, Canopy's own balance sheet is not in the best shape. The company looks to have grossly overpaid for a number of acquisitions and is now lugging around CA$1.91 billion ($1.47 billion) in goodwill. This would come atop the $7.77 billion in goodwill that Constellation already has on its balance sheet from previous acquisitions. Thus, the combined company, inclusive of a premium paid to acquire Canopy, could have more than $10 billion in goodwill, perhaps representing as much as 30% of total assets. 

Suffice it to say that while I appreciate Constellation Brands' equity investment into Canopy Growth and believe the two can grow together in the cannabis industry, I don't believe an acquisition is likely.