Mergers and acquisitions (M&A) have been extremely popular among cannabis companies in the past year. According to Viridian Capital Advisors, 306 M&A deals took place during 2021, compared to only 86 in 2020, for a 286% jump year over year.
That trend is expected to continue in 2022 as larger multi-state operators scoop up smaller companies in an attempt to expand in growing markets, and to enter markets on the verge of opening.
Canopy Growth (CGC -12.02%), which is headquartered in Canada and has inroads in the U.S., has made its presence known in a big way. But until federal legalization in the U.S., investors may need to tolerate volatility in the stock. Can the company's investments outshine its obstacles in order to achieve a brighter future?
Pushing back a timeline for profitability has investors seeing red
Canopy has been struggling to grow its market share and attain results to make it profitable. Fiscal year 2022 has been no different. In November, its second-quarter results came in at a loss of $16 million, driven by supply challenges and slow launch of BioSteel, its line of nutritional drinks and beverage powders that it spent $36 million in 2019 for a 72% stake. The estimated annual revenue for BioSteel is $6.6 million, meaning that all things being equal, it would take over five years to recoup that price in revenue -- and longer to make a profit off of it if you figure in related expenses.
Ultimately, the red flag for investors and analysts is that the company has pushed back its target for profitability after it once stated it would achieve that during fiscal 2022. The anticipation of further declines in market share and a longer timeline to profitability, combined with slow progression toward U.S. federal legalization of cannabis, is what led me to replace Canopy in my portfolio back in November. The bad news has also led to numerous downgrades among analysts as the stock price continues to plummet, down nearly 50% since November.
The company is facing the reality of softening market share in Canada, as noted by Piper Sandler's (NASDAQ:PIPR) Michael Lavery, who downgraded the stock to underweight in December. During 2021, smaller licensed producers OrganiGram Holdings and Auxly Cannabis Group both made huge gains in market share, going from 4% and 5%, respectively, to 7% and 10%, as Canopy's retail market share declined from 8.2% to 7.2% from August to December. Canopy's U.S. sales were also down nearly 30% during that time span.
A flurry of downgrades have followed, from Stifel Financial, Bank of America, CIBC, and Cantor Fitzgerald's noted analyst Pablo Zuanic agreeing that reduced estimates are a determining factor for the downgrade, and that the current quarter is likely to bring continued disappointment to shareholders. I guess we'll see on Feb. 9 when the company releases its quarterly results.
The No. 1 selling gummy brand comes in green
Whether those results come in stronger than expected or not, federal legalization of cannabis can't come soon enough for Canopy. As it struggles to find profitability, it's been making purchases that have the potential to catapult it from a dismal outlook to what could be a moonshot's worth of returns for investors.
When Canopy signed an agreement with multi-state operator Acreage Holdings in April, it spent $300 million for the right to acquire 100% of the shares of Acreage. That agreement could turn into a $4 billion purchase upon legalization and would give Canopy control of cannabis licenses currently held by Acreage across 20 states, resulting in immediate revenue sources.
Purchases continued in 2021, reaching a climax in October when it announced the purchase of rights to Wana Brands, the No. 1 selling edibles brand in North America, at an up-front cost of $297 million. Ownership of Wana would give Canopy even stronger penetration into the U.S. market. Wana manufacturers its gummies in Boulder, Colorado, as part of a 12-state footprint including top markets in California, Arizona, Illinois, Michigan, and Florida, as well as in Canada. By the end of 2022, Wana expects to have licenses across 20 U.S. states, including anticipated burgeoning markets in New York and New Jersey.
But the deal with Wana is similar to the Acreage agreement in that it hinges on the U.S. making the primary psychoactive component of cannabis -- THC -- federally legal. According to Wana's chief marketing officer, Joe Hodas, that could happen within the next three years. If he's correct, it will open the door for all of the best marijuana stocks. But Canopy, in particular, will have its place among the top competitors based on a strong footprint and an edibles market that has been growing, and is expected to continue to do so at a compound annual rate of 30% through 2025.
Until then, it will be up to the company to gain the confidence of investors by providing stronger revenue and making a profit. The promises of what could be are certainly enticing, but the probability for a few more swings and misses is enough to keep me on the sidelines for now.