Canopy Growth Stock Is a Good Buy Even If the Acreage Deal Collapses

Canopy Growth (NYSE:CGC) has big plans, if they come too much under fire, though, it could hurt Canopy Growth stock.

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When it comes to the cannabis opportunity, a key strategy for the large operators is M&A (Mergers & Acquisitions). This makes a lot of sense as scale will likely be the critical factor for long-term success. There will be a need for multiple brands, strong distribution channels and high levels of production.

Such things can be developed by organic means, but there are major downsides. The need for huge amounts of capital, for example. Although, perhaps the most important factor is that organic growth is often just too slow.

Yet M&A can be fraught with risks too. In fact, we are getting a good sense of this with CGC recently.

Canopy Growth Stock and Acreage

It all started in mid-April when the company announced it wanted to purchase Acreage Holdings (NASDAQOTH:ACRGF) for a hefty $3.4 billion (involving a $300 million upfront payment). The company is the largest vertically integrated, multi-state owner of cannabis licenses across 20 states in the U.S. It also owns The Botanist retail store brand. On the news of the deal, the CGC stock price got a nice lift.

Now there is a novel feature to the transaction – that is, the deal will actually not close until the U.S. legalizes cannabis for recreational purposes. There is also a 90-month termination provision if this does not happen. For the most part, it’s an option on the future.

All great, right? Well, I think this is certainly the case for Canopy stock. But one important shareholder, Marcato Capital Management, of ACRGF is far from satisfied. It has a 2.7% equity stake and has indicated it will fight the deal.

The letter to the board did not mince words, saying the deal is “value destroying.” Interestingly enough, it points out the divergence in the reaction from Wall Street. ACRGF stock fell by 6% whereas Canopy Growth stock has gone up 15.2% (as of May 6th).

According to the letter: “In total, Canopy’s market capitalization has increased by roughly US $3.5 billion since the deal announcement, indicating pro forma economic value to Canopy of US $6.9 billion — over 100% greater than the price offered to Acreage shareholders.”

The letter also notes other issues: the uncertainty of the closing, the valuation’s discount to industry multiples, such as for CGC, Cronos (NASDAQ:CRON), Tilray (NASDAQ:TLRY) and Aurora Cannabis (NYSE:ACB); and the lack of third-party participation in the bidding (the acquisition agreement does not even include a “Go-shop” provision).

OK so what now? What could be the impact on CGC?  It’s true that Marcato Capital Management has a relatively small position in the company. But then again, agitation from an activist shareholder can attract other like-minded investors. The result is there will likely be more pressure to change the deal.

Yet this type of deal is unusual because it is conditional on the potential overturning of a federal law. Despite all the optimism, it is far from clear when there could be a change. Let’s face it, when it comes to the government, things are usually fairly slow. This definitely bolsters CGC’s position when it comes to the valuation.

In other words, both sides have valid arguments.

Bottom Line on Canopy Growth Stock

For CGC stock, I think the deal for ACRGF is spot-on and is structured right. But I also believe there will need to be a bump-up on the valuation to get the transaction to a clean close. And given the huge opportunity in the U.S. market, I think this will be well worth in.

In the meantime, Canopy Growth stock is still positioned nicely to grow even without the deal. The company has built an integrated global platform that has the backing of $4 billion from Constellation Brands (NYSE:STZ). CGC also should continue to benefit from the Canadian market as well as the cannabidiol (CBD) opportunity. But again, I think the story gets even better with ACRGF.

Tom Taulli is the author of High-Profit IPO StrategiesAll About Commodities and All About Short SellingFollow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

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