Anyone thinking that Constellation Brands (STZ -1.71%) was starting to regret its multibillion-dollar investment in Canopy Growth (CGC -1.80%) just found out how far off base they were. Constellation announced on May 1 that it had exercised nearly 18.9 million warrants to buy another 5.1% of Canopy Growth's outstanding shares for $245 million Canadian, which translates to close to US$174 million.
Canopy Growth has been a major drag on Constellation's financial performance every quarter since the big adult beverage company invested $4 billion in the Canadian cannabis producer in 2018. The cannabis industry continues to face significant challenges, and Canopy is still losing a lot of money. So why did Constellation up its stake in Canopy Growth? Here are the top three reasons.
1. Cannabis' long-term opportunity
Constellation Brands CEO Bill Newlands stated in the press release announcing his company's exercise of Canopy Growth warrants, "While global legalization of cannabis is still in its infancy, we continue to believe the long-term opportunity in this evolving market is substantial." This reiterated Constellation's view when it first invested in Canopy.
The adult beverage giant has maintained for quite a while that the global cannabis market could top $250 billion within the next 15 years or so. To put this number in perspective, it's more than twice the size of the total U.S. beer market today, the market where Constellation makes most of its money currently.
Constellation's latest investment shows that the company still believes in the potential of the cannabis industry. And Newlands was correct that the global legalization of cannabis is still only in its infancy. Canada legalized adult-use recreational marijuana less than three years ago, becoming the first major economic power to establish a recreational pot market that was legal at the national level.
2. Canopy Growth poised to be the biggest cannabis winner
Believing in the future of the global cannabis market is one thing; continuing to pour a lot of money into Canopy Growth is another. But Constellation is convinced that Canopy Growth is poised to be the dominant player in the cannabis industry over the long run.
Newlands said unabashedly that "Canopy is best positioned to win in the emerging cannabis space." He said basically the same thing in his comments in Constellation Brands' Q4 conference call last month. What's behind this belief that Canopy Growth will be the industry's biggest winner?
Canopy continues to command the highest market share in Canada. Thanks to Constellation's investments, it also is in a stronger financial position than its peers. Newlands thinks that Canopy's new cannabis-infused beverages are "game-changers" for the industry. Canopy is in the best position to quickly enter the U.S. market if federal marijuana laws change.
3. Confidence in David Klein
Perhaps the most important reason why Constellation is betting even bigger on Canopy Growth, though, is the high level of confidence in new Canopy Growth CEO David Klein. Newlands made clear just how much Constellation supports Klein, stating, "we are confident in the strategic direction of the company under David Klein and his team."
That's not surprising in the least. Klein formerly served as CFO of Constellation Brands. He and Newlands worked together for years. As Canopy's largest shareholder with several seats on the company's board of directors, Constellation hand-picked Klein to lead the cannabis producer.
Klein has already taken aggressive steps to put Canopy Growth on a path to profitability. In mid-April, Canopy announced a restructuring of its global operations to cut costs and conserve cash.
Constellation Brands has its reasons to up its stake in Canopy Growth, but is it a smart investment? Only time will tell. But with Constellation's confidence in the long-term future of the global cannabis industry and David Klein's leadership of the company, now was a great time to pull the trigger in exercising some of its warrants. The marijuana stock has lost two-thirds of its value over the last 12 months and is the cheapest it's been since late 2017.
It's possible that Constellation could buy even more of Canopy Growth in the future. The company still holds nearly 140 million warrants to purchase additional Canopy shares.
However, it's also possible that Constellation could still sell some of its Canopy Growth stock. Constellation stated that "depending on market conditions, general economic and industry conditions, Canopy Growth's business and financial condition and/or relevant factors, Constellation Brands may develop other plans or intentions in the future."