Sundial Growers (SNDL -1.93%) became one of the most-hyped meme stocks on the market earlier this year, but much of the initial fervor over the Canadian cannabis operator has died down now. However, Sundial's share price remains up close to 90% year to date.
The company has leveraged its success to expand into a new area of focus. In March, Sundial announced a joint venture with investment management firm SAF Group. Over the subsequent months, the company upped its funding of this joint venture, and now has 538 million in Canadian dollars committed to it -- roughly $430 million. Will Sundial's big bet pay off?
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Behind Sundial's $430 million bet
Why did Sundial and SAF Group team up? They saw an opportunity to generate solid returns by building a portfolio of debt, equity, and hybrid investments in the cannabis industry. The companies formed their joint venture, named SunStream, to capitalize on this opportunity.
In particular, SunStream is focusing on investing in cannabis-related vertically integrated businesses. Since both Sundial and SAF Group are based in Canada, where medical and recreational adult-use cannabis has been legal for several years, it makes sense that the joint venture will prioritize deals in the Canadian market.
One of the top priorities for SunStream is to create a Canadian special purpose acquisitions company (SPAC). The pricing pressures for Canadian cannabis operators right now could enable a SPAC to easily find one or more candidates to acquire and take public.
However, SunStream isn't limiting its sights to Canada. It's also considering international opportunities.
Sundial initially committed CA$100 million to the joint venture in March. In April, the company increased its funding to CA$188 million. Earlier this month, Sundial upped its financial commitment by CA$350 million.
Expanding on what's working
There's a good reason why Sundial is staking so much money on the SunStream joint venture. So far, the company's investments on its own in other cannabis businesses have worked out quite well.
Sundial Growers CEO Zach George noted his company's initial success with its investments when he first announced the partnership with SAF in March. He stated at that time, "SunStream will enable Sundial to remain focused on our core operations, while leveraging the strength of SAF's private equity and credit investment expertise on a global scale."
That early investment success showed up in Sundial's first-quarter results. The company posted positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) for the first time ever, thanks mainly to its investments.
Sundial's stake in SunStream hasn't kept the company from continuing to make more investments on its own, though. In May, Sundial revealed that it had bought more than 10% of Valens, a leading Canadian cannabis-extraction company.
Two glaring drawbacks
The most glaring drawback to Sundial's investment strategy is that the company has had to raise the cash used in investing by issuing new shares and warrants. This has caused dilution in the value of Sundial's existing shares.
How problematic is this dilution? While Sundial's market cap has nearly quadrupled so far this year, its share price has risen by less than one-third of that percentage increase.
Sundial also faces another key challenge with its investments: It can't invest directly in the U.S. cannabis market. That's a serious limitation, considering that the U.S. claims the biggest legal cannabis market in the world.
Zach George acknowledged this issue in his comments during Sundial's Q1 conference call. However, he noted that the company could invest in the U.S. market in non-THC-related businesses. George also said that Sundial expects the U.S. opportunity "will evolve over time."
Even with these two drawbacks, though, it's quite possible that Sundial's big bet will pay off. As is the case with any investing opportunity, however, it depends on what the specific investments are.
