Cronos (NASDAQ:CRON) is down over 64% from its peak but it is still quite overvalued. Moreover, compared to all the other major Canadian cannabis stocks, Cronos stock is the most expensive.
You can see from this table below that CRON stock is trading at high multiples of revenue compared to its peers.
The table shows that it has an Enterprise-to-Revenue ratio of 58 to 1. This is higher than any other Canadian cannabis stock.
Moreover, CRON stock has the second-lowest level of revenue among the group. So why is it so overvalued?
For one reason, Cronos is still losing money on a cash flow basis. During the six months ending June 30, Cronos posted an operating cash flow loss of $76 million CAD. This included an operating cash flow loss in the most recent quarter of $57 million CAD.
Moreover, Cronos is still reporting non-GAAP measure losses. It lost $17.7 million CAD in adjusted EBITDA in Q2 and another loss of $9 million in Q1. Analysts expect further losses in the quarter ending September, which will be reported on November 12, 2019.
Posting losses are a factor in why the Cronos has been falling. But why is it still so overvalued?
Altria and Cronos Stock
I believe the market is putting too much credence in the late 2018 Altria investment in CRON stock.
In December 2018, Altria (NYSE:MO) announced a US $1.8 billion in Cronos at a price of CAD$ 16.25. Altria is the parent company for Philip Morris USA.
The investment closed in March 2019. Today Cronos trades at CAD$11.03, or over 30% below the price Altria paid for it, but Altria has effectively taken control of Cronos (soft of).
For one, it controls four of the seven board member seats. Its investment for 45% of Cronos also comes with a warrant to purchase another 10% of the company, raising the Altria control to 55%. So if Altria controls the board does it actually control Cronos?
Altria Warrants to Buy Cronos Stock
The price for the 10% warrants is CAD $19.00 per share. So as of today, with Cronos priced at $11.00 CAD or so, these warrants are “out-of-the-money.”
In other words, in order for Altria to pay CAD $1.4 billion to gain majority voting control of all of CRON stock outstanding it would have to overpay for the shares by 73%.
That is, Altria would have to pay a 73% premium to buy the last 10% of the stock to gain majority control. Altria has a $86 billion market value and has $1.8 billion in cash on hand, plus $30 billion in debt. But more importantly, it produces over $2.3 billion in quarterly free cash flow. So Altria can easily afford to pay that premium.
So the market seems to think that Altria will pay up for this majority control. But the money Altria pays to acquire that control will just go into Cronos – a company that it now would control. Altria could dividend out a majority of that cash back to itself once it had gained control.
So this is not a real reason to overvalue CRON. That leaves only one reason. Altria will not allow Cronos to run its losses forever and deteriorate Cronos’s value.
Games that Altria Could Play
The truth is that Altria could wait until Cronos had effectively used up all its cash in operating losses and then renegotiate the warrants. This kind of game occurs all the time.
Altria does not care that the stock price is down. The more losses Cronos racks up, the more that the company will need the additional CAD$1.4 billion from Altria in the future. Then Altria could renegotiate the price of the warrants at a lower price per share, and for a larger stake in Cronos.
In fact, taking this thought to the extreme, it would behoove Altria to wait until the stock had fallen quite far before it steps in to help the company with more cash. It could possibly even take complete control of Cronos if losses continue to deteriorate its financials further.
What Should Investors Do?
Cronos stock is still expensive despite its recent drop. Its majority control partner may or may not be a blessing in disguise. Be wary of large US companies coming bearing gifts that have strings attached. I would make sure that Cronos starts to report profits before making an investment or increasing your stake in Cronos stock.
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. The Guide focuses on high total yield value stocks, which includes both high dividend and buyback yields. In addition, subscribers a two-week free trial.
