Here’s Why Canopy Growth Stock Is Ready to Stabilize

After Constellation paid $37 a share for its stake, should $33 be a floor?

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It’s been a ugly couple of weeks for Canopy Growth (NYSE:CGC) investors. Pot stock euphoria had sent CGC stock steadily higher; at one point earlier this month, CGC stock was up 170% in barely two months. Since then, however, sentiment has turned: shares have lost more than 40% in just 11 sessions.

The decline shouldn’t be surprising. As InvestorPlace contributor Luke Lango accurately predicted, investors in pot stocks sold the news of official legalization in Canada earlier this month. With no further catalyst on the horizon, and broad markets pulling back, shareholders clearly have taken profits in names like Canopy, Tilray (NASDAQ:TLRY) and Aurora Cannabis (NYSE:ACB). And as I wrote both in September and earlier this month, CGC stock was trading at a bubbly price.

Now in the mid-$30s, however, Canopy Growth stock looks rather intriguing. I’m still skeptical about the marijuana space, given valuations and the many years it will take for the industry to generate consistent profits (if they come at all). But even as I’ve questioned valuation, I’ve long argued that CGC stock is the best choice in the space. For investors still bullish on cannabis, that’s reason enough to consider Canopy shares. But there’s one more reason that could suggest the recent weakness in CGC is about to come to an end.

Constellation Shook Things Up at $37

Two and a half months ago, Constellation Brands (NYSE:STZ,STZ.B) changed the marijuana sector forever. The diversified liquor company invested almost $4 billion in Canopy Growth. CGC stock soared on the news — as did most other pot stocks, as Constellation’s stamp of approval seemed to legitimize the entire industry.

Constellation bought 104.5 million shares directly from Canopy at a price of CAD $48.60. At current exchange rates, that represents a purchase price of just over USD $37 per share. And yet CGC stock closed Tuesday below $34.

So the argument for buying Canopy Growth here is relatively simple. CGC stock is now priced at a discount to what Constellation was willing to pay. That purchase — again totaling nearly $4 billion — came after substantial due diligence by a company with a proven track record of successfully marketing liquor and beer to international consumers. If Constellation — after all that work — was willing to pay $37, shouldn’t an investor be happy to pay less?

But There’s a Catch

To be sure, the story isn’t quite that simple. Constellation did buy 104.5 million shares at ~$37. But it also received 139 million warrants as well. Some 88.5 million of those warrants can be exercised the equivalent of $38.40, and another 51.3 million can be exercised at any five-day weighted average price over the next three years. Even though the first group of warrants is out of the money at the moment, the warrants on the whole have real value. And so the effective price paid by Constellation probably is closer to $30 per share. (The exact calculation depends on how an investor calculates discount rates and volatility in the stock.)

Constellation’s deal also could give it majority control of Canopy Growth. Any investor in CGC stock at the moment has to at least be aware that at some point in the next three years, he or she could be owning a controlled company, with minimal say in board composition or other decisions.

There’s a third issue, too. Constellation stock fell — and rather sharply, in fact — on the news of the investment in Canopy. STZ stock dropped more than 6%, wiping out over $2 billion in market value. At least initially, some investors thought the $4 billion investment destroyed value. So far, trading suggests Constellation probably has broken even or so (again, depending on how an investor prices those warrants). But the initial reaction suggests that many market participants believe Constellation badly overpaid.

A Bottom for Canopy Growth Stock?

So there’s an interesting argument to be had relative to the current valuation of CGC stock against Constellation’s price. Particularly given the chart — and the valuation — I’m hardly ready to call a floor in Canopy stock. Still, at least some investors may look at the $25-$28 range — where CGC traded before the Constellation deal — as a huge opportunity.

Canopy Growth stock unquestionably is better off than it was in July, given the huge amount of capital it has to deploy in an effort to dominate its industry. And, unless the broad market continues recent weakness and simply collapses, that suggests that a Canopy Growth stock price back toward those levels will be seen as simply too cheap to pass up.

If investors are willing to pay what Constellation paid, CGC should bottom in the low 30s. If they’re willing to pay what they paid in August, CGC probably doesn’t fall further than $25. That’s not guaranteed, of course, and longer-term Canopy Growth stock could give back even more of its gains. But right now, there’s an easy story to lure investors into CGC stock. And that story should be strong enough to at least bring an end to the sell-off of the past few weeks.

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


Article printed from InvestorPlace Media, https://investorplace.com/2018/10/heres-why-canopy-growth-stock-is-ready-to-stabilize/.

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