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Let's Face It, Marijuana Equity Investments Have Flopped

By Sean Williams - Feb 15, 2020 at 10:51AM

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Brand-name companies are finding little early-stage success in the high-growth cannabis industry.

The marijuana industry is expected to be one of the fastest-growing industries in the world this decade. Although estimates vary on Wall Street, legal weed sales are forecast to hit between $50 billion and $200 billion per year by 2030. For context, this would represent an approximate 400% to 1,800% increase in annual revenue from what the industry generated in worldwide sales in 2018.

This growth projection is a big reason cannabis stocks rapidly expanded their production capacity and product offerings, and is also why a handful of brand-name companies dipped their toes into the water over the past two years. Unfortunately for two brand-name businesses, their equity investments into cannabis stocks have not gone as planned.

A clear jar packed with dried cannabis that's seated atop a fanned pile of cash.

Image source: Getty Images.

Constellation's investment in Canopy Growth fizzles out

The most prominent equity investment in the entire pot industry is Corona and Modelo beer maker Constellation Brands' (STZ -0.28%) stake in Canopy Growth (CGC -7.32%), the largest marijuana stock in the world by market cap.

Though Constellation is best known for completing a $4 billion equity investment into Canopy in November 2018, which upped its stake in the company to 37%, this actually marked the third time it had directly or indirectly invested in Canopy. Back in October 2017, Constellation made the first equity investment into the pot industry by taking a 9.9% stake in Canopy for approximately $190 million. In June 2018, Constellation also gobbled up a third of Canopy's 600 million Canadian dollar convertible debt offering, which, if executed, would allow the company to up its ownership in Canopy Growth.

When Constellation made its massive $4 billion investment, the thinking was twofold. First, and most obvious, it was expected that Constellation would work with Canopy to develop a line of nonalcoholic cannabis-infused beverages. And second, it was believed that Constellation's investment would allow Canopy Growth to rapidly expand its domestic and international operations, thereby providing Constellation Brands another means of growing its business beyond beverages.

The problem is that supply issues throughout Canada and a delay in Canopy's infused beverage launch have stymied this partnership's near-term prospects. Canopy announced last month that, despite receiving its license from Health Canada in November, its scaling process for infused beverages isn't yet complete. This is somewhat embarrassing considering that Constellation's expertise lies with beverage production and marketing.

A cannabis leaf laid atop carbonation in a glass, with cannabis leaves set to the right of the glass.

Image source: Getty Images.

On the supply front, Ontario takes a good portion of the blame. Canada's most-populous province had only 24 dispensaries open at the one-year anniversary of recreational sales commencing, which is creating supply bottlenecks for traditional cannabis products, as well as newly launched derivatives.

While it's possible that Constellation Brands' equity investment turns around, it has completely fizzled out in the early going and even cost Constellation in its quarterly operating reports.

Altria's investment in Cronos Group goes up in smoke

Investors have witnessed similar struggles with Altria Group's (MO -0.28%) equity investment into Cronos Group (CRON -3.07%).

For those who may recall, Cronos closed its $1.8 billion equity investment from Altria in March 2019, giving the tobacco giant a 45% equity stake in the company. Altria, like Constellation, also received warrants as part of the deal that may allow it to up its ownership at a later date.

Given Altria's production and marketing knowledge when it comes to smokable products, this partnership appeared to make a lot of sense. With Cronos desiring to be a leader in vape products, Altria was expected to aid the company with developing and launching vapes in Canada. As a reminder, derivatives are a considerably higher-margin product than traditional dried cannabis, and vapes are believed to be the most popular of all alternative cannabis products.

What's more, the $1.8 billion Altria provided Cronos Group in return for a 45% stake in the company was expected to allow Cronos to develop its product portfolio and expand into overseas markets. Considering that U.S. cigarette shipment volumes have been declining in the U.S. as the adult smoking rate falls, Altria's investment ultimately gives it an opportunity to diversify away from an industry that's becoming ever-more challenging.

A vape pen next to a small vial of liquid and neatly arranged dried cannabis flower.

Image source: Getty Images.

However, supply issues in Canada and vape-related health concerns have sacked investor hopes in the meantime.

As noted earlier, Ontario's lack of an adequate number of retail locations has created supply issues for close to 40% of Canada's population. Even with Ontario shelving its lottery system for retail store licenses in favor of a more traditional review-and-approve system, it'll be a while before derivative supply becomes widely available to consumers.

The other issue here is the health concerns raised from a number of mystery lung illnesses in the U.S. that were directly tied to e-cigarettes and vaping. Since last summer, 64 people have died and 2,758 people have been hospitalized with lung injuries associated with e-cigarettes or vaping, according to the Centers for Disease Control and Prevention (CDC). Even with the CDC identifying the likely culprit of these lung illnesses, there's still a lot of concern regarding the long-term health risks associated with vaping -- especially when it comes to vaping tetrahydrocannabinol (THC)-containing products. In fact, Alberta has temporarily banned the sale of vape products until it's completed a safety review. Until more is known about these health effects, vape products could see weaker-than-expected sales.

Considering what we've seen happen to Constellation Brands' and Altria's equity investments in the early going, it's possible that other brand-name companies will remain gun-shy of the pot industry for the foreseeable future.

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Stocks Mentioned

Constellation Brands, Inc. Stock Quote
Constellation Brands, Inc.
$234.17 (-0.28%) $0.66
Altria Group, Inc. Stock Quote
Altria Group, Inc.
$50.95 (-0.28%) $0.14
Canopy Growth Stock Quote
Canopy Growth
$5.44 (-7.32%) $0.43
Cronos Group Stock Quote
Cronos Group
$3.31 (-3.07%) $0.10

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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