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Expect Cronos Stock to Fall as Losses Widen

Cronos (NASDAQ:CRON) stock has fallen more than 50% from its recent peak in March 2019 as the company has continued to produce losses. CRON stock is likely to continue falling as management recently indicated that its EBITDA losses will continue to widen.

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Cronos Group is fairly unique in that it has repeatedly emphasized its focus on the CBD market and its related products rather than THC-cannabis products. Like others in space, Cronos wants to reach the U.S. and the larger global market.

But just like all the other cannabis stocks, CRON stock has been hurt by continuing cash flow losses despite growing sales.

For example, its recent second-quarter earnings reported sales of $10.2 million CAD, a 58% increase over the first quarter. But its adjusted-EBITDA cash flow loss of $17.8 million CAD was 99% higher than in Q1. This was because marketing, sales and research and development costs rose faster than net sales grew.

Moreover, CFO Jerry Barbato made it clear during CRON’s earnings call that adjusted-EBITDA losses will continue to widen during the second half of this year. Even more troubling is the fact that CRON management declined to give any guidance about the extent of expected losses for the second half of 2019.

Cronos Stock’s Stake in Altria

On March 8, Altria (NYSE:MO) closed on a 45% purchase of CRON stock for $2.4 billion CAD along with a warrant to buy another 10% of CRON stock over the next four years, for up to $1.4 billion CAD.

MO also received four of the expanded board’s seven director seats and appointed a CFO who was previously chief strategy officer at Altria. Since Altria now has effective management control over CRON, the U.S. Securities and Exchange Commission has ruled that CRON will have to report its annual 2019 earnings in U.S. Generally Accepted Accounting Principles (GAAP) for 2019.

The Altria investment and potential additional cash is both a plus and minus for CRON stock. In December 2018 Cronos stock shot up on the news of the stake. But CRON stock has slid since March when the deal closed as losses have widened. Investors have also begun to realize that a lower CRON stock price is good for Altria, rather than investors, if MO wants to buy up the remaining 10% controlling stake in CRON.

When CRON announced the deal Dec. 7, MO agreed to buy its stake at $16.25 CAD per share. Since then, CRON stock has fallen to $15.10 CAD today. The warrants have an exercise price of $19.00 CAD but are good for four years, beginning March 2019.

So if CRON ever needed the extra $1.4 billion CAD from Altria, CRON stock would have to rise to above $19.00 CAD per share ($14.42). The problem is that CRON trades today at $15.10 CAD today ($11.43) which is almost 30% lower than the MO warrant exercise price.

How Does CRON Benefit from MO?

It may not even be in Altria’s interest for the stock to rise that high, since it already has an effective blocking control of the CRON stock. Altria has the right to “top up” its investment in CRON in order to keep its stake undiluted. Although that would provide additional funds to CRON, it also effectively means no company could ever make an offer for CRON without Altria’s approval.

The one real benefit from Altria’s investment is that CRON now has a strategic investor. CRON can make acquisitions, investments and run losses as long as it wants, knowing that it could always turn to Altria if the warrant funds were ever needed.

Altria would likely insist on a repricing of their CRON warrants in order to bring the exercise price lower and closer to the present price of CRON stock. This would mathematically give MO a greater than 10% increased stake in CRON stock.

The Bottom Line on CRON Stock

Investors can expect that earnings and cash flow losses will widen, just as management indicated. It is not clear that investors will benefit from this. If sales rise, but adjusted losses widen, how does that help CRON stock move up?

CRON can afford these increasing losses it has $2.3 billion CAD in cash and investments on its balance sheet. It also has a strategic partner, with effective control of the company, willing to help finance those losses. But that strategic partner also acts as a blocking entity for any takeover. It also may be willing to let losses widen at CRON in order to buy up more shares down the road at an even lower price.

For these reasons, expect CRON stock to continue to fall as its losses widen over the next several years.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.

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