After alcoholic beverage giant Constellation Brands invested $4 billion in Canopy Growth (CGC -8.58%) a few years ago, the cannabis producer was in a great position to grow its business. But just getting an influx of cash doesn't by itself fix the problems a company may have under the hood.
Canopy Growth has continued to burn through funds, and recently filed a shelf prospectus to raise as much as $2 billion. Should investors be worried about the company's financial situation, or is this just a smart strategic move?
What is a shelf prospectus?
A shelf prospectus allows a company to offer securities multiple times over a designated period. This spares the business from having to issue a new prospectus each time it wants to raise money and provides it with the flexibility to tap into the markets as it sees fit. In the case of Canopy Growth, it could help the company quickly take advantage of rising stock prices. In just the past six months, its share price has doubled -- and that slightly underperformed the Horizons Marijuana Life Sciences ETF, which was up around 100% during that period. Investors have been particularly bullish on pot stocks again after voters in four more states chose to legalize marijuana for recreational use in November.
Under its shelf prospectus, Canopy Growth will have up to 25 months to sell securities worth up to $2 billion (roughly 2.5 billion Canadian dollars). The company notes that the reasons for the offerings may vary. It also said it may "invest funds which it does not immediately use." But one obvious reason could be to help offset its cash burn.
Is the company burning through too much cash?
As of Dec. 31, Canopy Growth reported that it had cash and cash equivalents of CA$825 million on its books, down from CA$1.3 billion just nine months earlier. During that time, the company used CA$367.9 million on its day-to-day operations. When combined with its investing activities, which include the purchase of short-term investments and equipment, it spent a total of CA$696.8 million. That's 17% less than the CA$843.4 million it used up during the same period in the previous year. However, that still represents 84% of its cash and cash equivalents.
At that level of cash burn, it appears Canopy Growth is spending about CA$77.4 million every month on its investing and operating activities. At that rate, its cash balance would last for approximately 11 months. But investments and capital purchases are discretionary. If operating activities were its only outlays, it would have enough cash to run for more than 20 months. And this doesn't even factor in the value of the company's short-term investments, which totaled CA$768.6 million as of the end of 2020. If the company were in a tough situation, it could liquidate some or all of those holdings.
Based on this, the answer is no -- Canopy Growth won't run out of money anytime soon. While the decision to sell more shares may raise eyebrows, it is not a reason for investors to panic.
What should investors make of this move?
The shelf prospectus didn't offer any hints as to what Canopy Growth could be planning to do with a large influx of cash. It is also entirely possible that the company isn't planning anything yet, and simply wants an easy way to raise funds. Even if it was looking to make a big acquisition, it could fund the purchase by issuing more shares, as all-cash deals are not common in the cannabis industry.
However, given that CEO David Klein says he expects his company to be operating in the U.S. within the next year, it's possible that he and his team want to ensure they can raise money quickly and easily in case they need funds to tap into new opportunities. Whether or not you agree that Klein's timeline is feasible, the shelf prospectus makes a lot of sense under those circumstances. The money could also help fund Acreage Holdings, which the cannabis producer has a pending deal with, or it could simply give Canopy Growth a way to easily expand its existing operations in the U.S. (Currently, it only sells hemp products in the states.)
Overall, the move looks to be solely a strategic one at this point. Having financial flexibility in a fast-growing industry is usually not a bad idea. The company may be planning to spend some big money in the near future. And if you agree with its CEO that U.S. legalization is around the corner, then a more robust balance sheet could make the pot stock a better buy.