Canopy Growth Stock Is Getting Too High for Its Own Good

A $370 million acquisition apparently creates over $1 billion in value for Canopy

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I’ll agree that if an investor is going to invest in pot stocks, Canopy Growth (NYSE:CGC) is the way to go. While the valuation of CGC stock still looks high, that’s true across the sector, and there is a big opportunity here. Meanwhile, the $4 billion investment into Canopy Growth stock by Constellation Brands (NYSE:STZ) gives the company more than enough capital as well as valuable experience and expertise in the consumer space.

The issue is that investors probably shouldn’t be buying pot stocks, at least at these prices. And that includes CGC stock. I wrote last month that Canopy Growth stock — and those across the sector — had echoes of the dot-com bubble. Big gains Monday in CGC — and, again, the sector as a whole — only add to that sense.

In the near term, it may not matter. I thought Tilray (NASDAQ:TLRY) was overpriced at $30 — and argued then that valuation wasn’t going to be a short-term driver. TLRY went to $300, of course. It now trades at $161, and still looks badly overpriced.

Pot stock investors can dismiss any such naysaying at the moment – they’ve been right so far. But Monday’s movement, and news this week, look a lot like past crazes. History suggests that at some point, even a stock like CGC will come back to Earth.

Tack On Another $1 Billion for Canopy Growth Stock

The big news for CGC stock on Monday was that Canopy Growth is acquiring ebbu, a hemp researcher based in Colorado. Intellectually, the deal makes some sense. Ebbu can add to Canopy’s R&D capabilities as it works on genetic breeding and looks to lower costs in cannabinoid production.

The price, though, looks steep. Canopy is paying $25 million CAD in cash (a little over $19 million U.S.). But the company also is issuing over 6.2 million shares of Canopy Growth stock — worth, at the current price, roughly $350 million (U.S.).

That’s 370 million U.S. dollars for what essentially looks like an ‘acqui-hire’. And that $370 million deal has led CGC stock to increase nearly 14% — and increase in value by roughly $1.4 billion. Was the deal that good? Is ebbu management that dumb to take such a below-market deal?

Other Factors for CGC Stock

To be fair, it’s not necessarily clear that the acquisition drove all of Monday’s gains, despite some observers seeing a correlation. The entire marijuana sector had a strong day, with TLRY and Aurora Cannabis (OTCMKTS:ACBFF) both climbing 11% and Cronos (NASDAQ:CRON) gaining 19%. It may be that the sector was due for a good day, after market weakness last week. In other words, CGC stock may have gained anyway, acquisition or not — or the acquisition could be boosting the entire sector.

Investors are also excited about the legalization of marijuana in Canada, which now is scheduled for Wednesday. Personally, I think that’s a terrible reason to buy the sector; the exact date has an immaterial impact on share prices, which are based on profits in 2021 (assuming these companies are profitable by then) and 2028, not November 2018.

And as InvestorPlace’s Luke Lango pointed out, Wednesday could set up a “sell the news” event for the sector — particularly after Monday’s gains.

It’s worth pointing out that these are enormous gains in the context of the equity markets. 14% is a good year for a stock. In a hot sector in a bull market, it’s easy to forget how big the volatility, and the share price increases, have been for CGC and its peers. Monday’s gains just in these four stocks added over $4 billion in market value by my calculations. Is the marijuana opportunity that much more valuable today than it was on Friday?

Be Careful Out There

Marijuana is going to be a huge opportunity worldwide, admittedly. But that doesn’t mean marijuana stocks like CGC are going to rise forever. Valuation matters — if not now, then at some point.

And I’d still caution investors to understand that a mature market isn’t necessarily a profitable market. If legalized marijuana use rises to the extent proponents believe, the product will be commoditized in some sense. There’s no reason why Canopy Growth or Tilray necessarily becomes the Procter & Gamble (NYSE:PG) or Coca-Cola (NYSE:KO) of weed. Competition will be intense. And at the end of the day, most opportunities are based on manufacturing (though Canopy has acquired a retail brand, Hiku) where profit margins just aren’t that high. Those profits aren’t coming for years, either, which matters to the current fair value of the stock.

After all, the Internet proved to be as transformative as most thought it would in 1999. Yet most dot-com era stocks wound up plunging. The same fate may not be in store for pot stocks, but the trading Monday sure looks familiar to someone who saw 1998 and 1999 up close.

As of this writing, Vince Martin has no positions in any securities mentioned.


Article printed from InvestorPlace Media, https://investorplace.com/2018/10/canopy-growth-stock-gets-little-bubblier/.

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