It’s official. Cigarette giant Altria Group (NYSE:MO) now owns 45% of cannabis company Cronos Group (NYSE:CRON), after MO paid $1.8 billion for the stake in a bid to offset waning interest in its tobacco-based products. Owners of Cronos Group stock can look forward to the launch of new products, even if neither company knows yet exactly what those new products might be.
Announced in December, the deal is materializing at a pivotal time for the so-called pot industry. Marijuana has recently been legalized in Canada, and the effort to legalize cannabis for medical and recreational purposes has been making slow and steady progress in the U.S. As of the latest tally, cannabis is legal for one or both purposes in 33 states, although it remains highly regulated.
Simultaneously, though smokeless e-cigarettes, also known as “vaping,” were widely expected to be a headwind for the global anti-smoking movement, e-cigarettes have proven to be problematic. It remains unclear to what extent this alternative will replace traditional tobacco products.
Still, legal cannabis is expected to become a $140 billion global market by 2027, and the deal speaks volumes about the potential that Altria sees in Cronos. The owners of Cronos Group stock have reasons to cheer.
Wheeling and Dealing
It’s not the first major deal within the marijuana industry, nor is it the first big post-IPO fundraiser for CRON.
Booze maker Constellation Brands (NYSE:STZ) woke up the world in 2018, investing another $4 billion in Canopy Growth (NYSE:CGC) in August after making a smaller investment in the Canadian company through a purchase of CGC stock in 2017. It appears as though the two companies initially made the deal to facilitate the creation of a hemp-based drink.
CRON raised $131 million earlier this month via the sale of its 19% stake in privately-held Whistler Medical Marijuana to rival Aurora Cannabis (NYSE:ACB).
The fresh round of funding from Altria, not unlike the proceeds from the sale of its stake in Whistler, will allow CRON to “quickly expand our global infrastructure and distribution footprint, while also increasing investments in R&D and brands that resonate with our consumer,” explains Cronos CEO Mike Gorenstein.
The two companies may already be thinking in more detailed terms than that, however.
During Altria’s fourth-quarter conference call, CEO Howard Willard commented on the then-impending partnership with CRON: “I think that both we and Cronos think there are opportunities really across the world in a variety of product categories, both recreational and medicinal, that would involve them entering new product forms and developing new products and new product brands,” adding “I think it’s early days there, and we have not restricted our thinking with regards to that.”
As the cannabis industry matures, smaller producers and dispensers realize they need funding and backing from much larger partners, while big names like Altria and Constellation recognize that cannabis can become a much-needed growth engine for them.
The Downside of the Deals for CGC Stock and Cronos Group Stock
Though such partnerships have become the new norm in the nascent cannabis industry, all players in the business, as well as the owners of names like CGC stock and Cronos Group stock, continue to navigate uncharted waters.
For example, Constellation has already suffered a paper, financial setback from its purchase of CGC stock. For fiscal Q3 of 2018 the beverage maker booked a one-time charge of $164 million related to the investment in CGC stock.
Sheer uncertainty poses a risk to the M&A underway within the cannabis arena.
In Canada, despite legalization, most consumers are still purchasing marijuana on the black market, circumventing highly-regulated dispensaries that add to the total cost of pot. Scotiabank believes that 71% of this year’s spending on marijuana in Canada will occur outside of the government-regulated market. While that figure could be pared back to 37% by 2020, it’s still relatively slow progress that may not be priced into pot stocks such as Cronos Group stock and CGC stock right now.
In the United States, marijuana is still technically illegal at the federal level. While the DEA and other federal law enforcement agencies have chosen to avoid pursuing and prosecuting most modest, small cannabis operations, the government could decide to enforce cannabis laws more strictly in the future, posing a meaningful risk to Cronos Group stock and CGC stock.
The Outlook of Cronos Group Stock
The same deal that granted Altria a 45% stake in Cronos Group also allows MO to increase its stake to 55% for another $1.0 billion.
In the meantime, the recently unveiled purchase of CRON stock has already allowed Altria to add four of its own picks to Cronos’ board of directors, setting the stage for MO to ensure that CRON’s new products will serve the cigarette company’s best interests.
The owners of Cronos Group stock are even bigger winners, however.
Although the future of the pot business is bright, it’s a highly-fragmented industry with lots of small players, most of which are debt-laden and unprofitable, and all of which lack scale and mainstream-distribution channels.
While not even Altria or Cronos ultimately know where the partnership is headed, the deal is a big step in a more profitable direction, and points to Altria’s incredible confidence in a particular company within an industry that has many participants.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can learn more about James at his site, jamesbrumley.com, or follow him on Twitter, at @jbrumley.