Altria Group (NYSE:MO) is joining the mega-cap firms eager to hedge against a potential decline in their home business. On Dec. 7, the firm said it would invest a $1.8 billion stake in Cronos Group (NASDAQ:CRON). Meanwhile, Constellation Brands (NYSE:STZ) bought Canopy Growth (NYSE:CGC) at the beginning of this year.
The bad news is that the retail money is not following these big companies. The stock price of cannabis stocks — excluding Cronos because of the deal — and the mega-cap firms are falling toward 52-week lows. In light of these pot stocks all falling, should Altria have paid less for Cronos or will the early investment pay off in the long run?
Altria is buying 45% of Cronos, signaling that it wants a partnership with the existing management team and the board of directors. With the premium of over 40% paid, the tobacco giant will have the right to nominate four directors to serve on the Board. Cronos will now have seven directors, up from five. The agreement includes a warrant that will let Altria buy Cronos stock at CAD $19.00 over the next four years.
Altria’s equity ownership gives the company plenty of the diversification it needs outside of the tobacco market. If consumer tastes shift from smoking to the consumption of cannabis, the value of Altria’s position in Cronos should increase.
How Cronos Stock Fits in Altria’s Strategy
This strategy has clear near-term risks that markets are considering. Cronos is making almost nothing but the stock market values the company with a market cap of $2.27 billion. Sales growth is hardly assured and Cronos will need Altria’s funds to invest in itself. Cronos said:
“The proceeds from Altria’s investment will enable us to more quickly expand our global infrastructure and distribution footprint, while also increasing investments in R&D and brands that resonate with our consumers.”
Even though Constellation Brands took a minority stake in Canopy Growth by investing even more money ($4 billion), its market and strategic value differ from that of the Altria-Cronos tie-up. Constellation is likely targeting the beverages and sleep aids market. Conversely, Altria is positioning itself in helping Cronos grow globally over the next decade. It believes Cronos will produce a product in an adjacent category that complements Altria’s core tobacco business.
Value investors should take notice in the sharp pull-back in Altria stock. After the stock fell 16.5% in the last month, the gap widened further from Wall Street’s target price. According to Tipranks, analysts have a price target of ~$69, suggesting the stock has upside of 29%.
Constellation Brands also has potential upside. The average price target on STZ stock is $244, which is ~31% below the recent stock price of $187.
Investors shifted their attention away from tobacco and alcohol stocks and speculated on marijuana stocks. This paid off for those who bought Cronos or Canopy Growth before the deals were announced.
It is anyone’s guess as to which weed stock will get the next big investment. If no new deals come up, the share price of stocks in this sector will drift lower. Markets will not ignore the quantitative fundamentals. With costs outpacing sales, the market may only tolerate the losses from weed stocks for so long.
For Cronos, Altria’s big investment will take away that concern and give management the resources it needs for R&D and for funding its global growth ambitions.
As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.