Canopy Growth (CGC 15.03%) is a company that's in the midst of a transition. What once used to be a top Canadian cannabis company is now a business that looks determined to primarily be operating in the U.S. pot market -- even though it can't technically enter it due to the federal ban on marijuana.
It may be a risky move, but here's why I see becoming a multi-state operator (MSO) as Canopy Growth's end goal, regardless of what it takes to get there.
Canopy sounds like it's giving up on the Canadian market
The more moves Canopy Growth makes, the more it seems evident that it is planning an exit from Canada. This month, it announced that it would be laying off 800 workers and that it would be shutting down its flagship facility in Smiths Falls, Ontario.
Earlier this year, the company also completed the divestiture of its Canadian retail operations, which is yet another big move for the business. That's a complete reversal from the outlook then-CEO Bruce Linton had in 2018 when he projected that in Ontario alone, the company would have around 400 pot shops.
When Canopy Growth released its latest earnings report earlier this month (for the last three months of 2022), the company said it was "transitioning to an asset-light model in Canada" as sales were down 28% year over year, in what was another brutal performance for the business.
Management appears frustrated with the status quo
Not only are Canopy Growth's actions telling, but so too are CEO David Klein's words. On the company's most recent earnings call, his frustration with the Canadian market was palpable: "Today, there are two very different cannabis markets in Canada: one that's legal, highly taxed, and regulated; and one that's thriving and illicit. The unregulated illicit market is generating billions of dollars of revenue, with a 40% market share, and faces virtually no risk of enforcement."
And he isn't seeing the situation improving anytime soon, either. "We expect the sector challenges to remain for years to come. And as a result, the sustainability of this legal sector is in question."
With a gloomy outlook like that, it's hard to imagine the CEO wanting to exert much effort on the company's Canadian operations. One market that is growing and where there may be potential for growth is in the U.S.
Canopy USA may be the answer, even if it means getting delisted from the Nasdaq
In October 2022, Canopy Growth announced the launch of Canopy USA, a business that would be home to its U.S. cannabis investments (including Acreage Holdings and Wana Brands). It's a controversial move. Canopy Growth can't technically consolidate cannabis companies without getting into trouble with regulators and the exchanges, since it would involve federally illicit businesses.
Even though the Nasdaq Composite has objected to the idea of consolidating Canopy USA, that doesn't appear to be influencing Canopy Growth's position. While the company stated on its earnings call that it plans to remain dual-listed, in a filing from Oct. 27, 2022, it stated that "it disagrees with the Nasdaq's objection and thus has no assurance that it will remain listed on any stock exchange it is currently on."
Could Canopy Growth end up like other MSOs?
Canopy Growth looks like a company that clearly wants to be operating in the U.S., and I wonder if it's willing to pay the potential price of no longer being on the Nasdaq to accomplish that. Given the signs and actions of management, I suspect that is its end goal. The danger of doing so is that it would end up trading like other MSOs, which investors often value at cheaper multiples than their Canadian counterparts. In return, however, the company may be able to enjoy much better growth prospects and enter into new U.S. markets as more states legalize cannabis use.
Shareholders will be able to vote on the Canopy USA strategy in April.
Should you buy Canopy Growth stock?
Generally, I'd stay away from a transitioning business unless you have a good reason to believe that the transition will be successful. And I'm not convinced becoming an MSO will solve the company's growth problems or get it anywhere near breakeven, as it would face hefty competition from Curaleaf Holdings, Green Thumb Industries, and many other established MSOs. Plus, Canopy Growth's stock could end up trading at a lower sales multiple (if it loses its Nasdaq listing).
The safest move for investors is to avoid the stock for now, and see how the situation develops, as there's a lot more uncertainty than normal facing this pot stock.
