Cronos Group (CRON 3.93%) has been chomping at the bit to get into the U.S. market. And that's evident even from its financials. Although the company makes the bulk of its money in Canada, it includes that in its "rest of world" segment. The company has been launching hemp-based products in the U.S. for the sake of penetrating the market. And it is also working on developing low-cost cannabis products that could make it a big player in the industry.
Its latest move involves the option to acquire a 10.5% stake in U.S.-based cannabis operator PharmaCann. Although it can't integrate the business into its operations today, it can position Cronos for some great opportunities once the market opens up for Canadian cannabis companies.
Why this deal may sound familiar
This isn't the first time that a cannabis company in Canada has put a deal in place to expand in the U.S. before it can actually do so. Canopy Growth (CGC 4.76%) famously did so back in 2019 when it said it would acquire multistate operator Acreage Holdings -- once it is federally permissible in the U.S. (it's still anyone's guess when that might be). Cronos' deal with PharmaCann is similar in the sense that it comes with caveats relating to legalization. What Cronos has right now is an option to acquire a 10.5% stake in the business, paying $110.4 million for it. The deal gives Cronos flexibility should it want to pursue other opportunities. And that's important, as a lot can change in the cannabis industry by the time it might be possible to complete the transaction.
PharmaCann isn't nearly as large as Acreage but it does have a presence in six particularly attractive markets: Illinois, Ohio, Maryland, Pennsylvania, Massachusetts, and New York -- which recently legalized marijuana for recreational use. Although the business is private and so no financials are publicly available on it, Cronos President and CEO Kurt Schmidt did say that the company's "disciplined capital allocation" was a key reason they liked PharmaCann, which suggests to me that it isn't burning through piles of money.
Is Cronos the Canadian cannabis producer best positioned for success in the U.S. market?
Cronos was arguably already in a good spot to penetrate the U.S. market once it finally opens up, even before this latest deal. With tobacco giant Altria owning a 45% stake in Cronos, the cannabis company would already be a step ahead of many of its rivals that don't have a major U.S.-based partner to work with. Not only can Altria help with distribution (when legalization takes place) but it adds financial stability that can help facilitate growth. That's key as Cronos already has multiple cannabidiol (CBD) brands in the U.S. with Lord Jones, Peace+, and Happy Dance -- which it launched and co-founded with actress Kristen Bell.
And the biggest advantage Cronos might have is soon to come: low-cost cannabis. The company has been working with Ginkgo Bioworks on cultured cannabinoids that will help bring down the cost of its cannabis products. It projects that before September, it will be able to begin producing cannabigerol (CBG), a compound that is less common than CBD and that, as a result, could drive higher prices and margins. Cronos believes these new products will be the first to reach the market in Canada.Its lab-grown products could also cost just pennies per gram to make, a fraction of what conventional methods are costing cannabis producers right now.
Strengthening its bottom line is going to be in Cronos being a better investment as for the first three months of 2021, it reported an adjusted EBITDA loss of $37.1 million -- three times its net revenue of $12.6 million.
Should you invest in Cronos on this latest news?
The move to acquire PharmaCann is a promising one but at a 10.5% stake, I would have liked to see a higher percentage. While Cronos could still yield significant influence in the U.S. company's operations, it's nowhere near the high stake that Altria has in Cronos or the 38% ownership that beer maker Constellation Brands (NYSE: STZ) has in Canopy Growth.
However, the deal certainly puts Cronos in a stronger position to succeed in the U.S. market now that it can potentially tap into a multistate operator to help grow its brand. And combined with low-cost cannabis production on the way, Cronos now looks to be in the best shape among Canadian cannabis companies poised to enter the U.S. market.
The question is whether the price is right as Cronos' stock isn't cheap, trading at a price-to-sales multiple of nearly 60 (Canopy Growth is at just 21). But if you are willing to hang on to the stock for the long term, it could pay off as its share price could quickly soar once production of CBG ramps up and its prospects for profitability improve. However, with marijuana legalization still not on the horizon in the U.S., I would wait on the sidelines for now and wait for Cronos to drop in price before considering a move, as pot stocks can be very volatile.