From bad to worse. There’s no end to Canopy Growth’s (NYSE:CGC) miserable 2019. On Monday, CGC stock slumped another 4% to hit its lowest point since April 2018. With CGC breaching the $23 mark, it’s a stunning turn of events for a stock that traded above $50 not that long ago.
It’s one thing that CGC keeps sliding; that might be acceptable. After all, the marijuana sector (NYSEARCA:MJ) in general has plummeted in recent months. But what’s worse is that there’s no credible plan to turn Canopy around.
What’s Constellation’s Plan For Canopy?
At the heart of the Canopy Growth stock story is the relationship with Constellation Brands (NYSE:STZ). Constellation became frustrated with Canopy’s corporate direction. On Constellation’s Q1 earnings conference call in June, Constellation’s CEO stated that they were talking to Canopy on an “almost daily” basis to ensure they were “focused on the right things.”
It appears the former Canopy CEO Bruce Linton was not focused on what Constellation wanted. Constellation would go on to oust him shortly thereafter, and it seems that Constellation may be losing some passion for the Canopy business now.
On that June conference call, they mentioned the name Canopy nearly three dozen times. Fast forward to the Barclays Consumer Staples Conference in September, and Constellation CFO David Klein said the name Canopy just four times.
In doing so, Klein emphasized that under Constellation’s care, the company will now focus on a few opportunities, while foregoing its previous freewheeling culture that wanted to dominate the across-the-broad spectrum of the marijuana business. Klein stated that:
“We, the Board, felt that it was time to make a change from that startup culture to a culture that was going to be more focused. I think the biggest mistake that can be made in the cannabis space today is spreading yourself too thin […] that won’t entail major changes in terms of the strategy at Canopy but just some tweaks to kind of what we’re doing today and more focused application of capital and resources.”
A Strategic Clash
Constellation’s CFO claims this is merely some “tweaks” to the business rather than a wholesale retrenchment of operations. But a recent interview with Canopy’s ex-CEO Bruce Linton cast things in a different light.
Linton suggested that Constellation is a boring company focused on quarterly earnings rather than a dynamic growth operation:
“So when you have a slow growth, high cash flow, very profitable, big old company, what they don’t have is growth. What they have is earnings per share. So every 90 days their shareholders want to say, “How well did you do in the last 90 days? Did you make a little more profit?”
Tech companies or good cannabis companies, they’re all about growth [… I]n my world I give everybody equity and I see it as free, even though it might show up on the books as 200 million in a quarter, it’s not cash affecting, it’s motivation creating. And so it doesn’t hurt me. But your earnings per share looks terrible.”
As you can see, Linton appears to now be suggesting that Canopy is not a good cannabis company anymore. Under Constellation’s leadership, Canopy will have to focus on quarterly metrics rather than having that entrepreneurial spirit.
Was Linton out of Control?
Now, if you’re Constellation, you can say that Linton needed to be reined in because he was making bad deals. Take the acquisition of Hiku which brought the Tokyo Joe brand of coffee shops and cannabis retail operations.
Canopy purchased Hiku in an all-stock deal worth nearly C$600 million at the time. It appears to be worth just a small fraction of that; Hiku’s old CEO quit Canopy almost immediately, and Hiku’s retail operations bring in minuscule revenue.
That deal made particularly little sense as Canopy already had its Tweed retail brand as well. Why spend around half a billion dollars on another marijuana brand with minimal operations or revenues at the time of purchase? You can make similar arguments for many of Canopy’s deals.
Why get stuck in the Acerage deal in the U.S. so early, for example, when little will happen on that front until federal legalization? And the list goes on.
Constellation May Rein Canopy In Further
At this point, a big issue for Constellation is that it is risking substantial damage to its share price due to betting too much on Canopy. Constellation’s market cap is less than $40 billion, making its $4 billion investment in Canopy a major chunk of Constellation’s overall value.
By contrast, Altria (NYSE:MO) is twice as big as Constellation, and it invested significantly less in Cronos (NASDAQ:CRON) than Constellation did in Canopy.
This means that Altria can have some patience with Cronos; it’s not the end of the world if the investment takes a few years to play out. For Constellation, however, Canopy’s poor results have been a fiasco. In fact, Constellation lost nearly a billion dollars in its 2020 Q1 results due to a huge writedown on the value of its Canopy stock warrants.
Constellation is now focused on returning cash to shareholders via dividends and a stock buyback. At the Barclays conference, it reiterated its commitment to this capital policy. Given its nearly $10 billion debt load, however, Constellation can’t keep spending freely.
As a result, look for it to limit any further cash burn at Canopy as it tries to rebuild shareholder value. Even that may not be enough, short interest in Constellation stock is surging as bears bet that the Canopy deal will end up clobbering both firms.
CGC Stock Verdict
It may be tempting to buy CGC stock after its massive decline, but what’s the catalyst to lead a rebound anytime soon? Constellation appears to be realizing that it has a massive problem on its hands.
It wants to turn its efforts back to its successful beer business and focus on dividends and share buybacks. That’s all fine and well if you own Constellation stock.
But Canopy is looking more and more like an orphan. Its former leader is gone, and there’s little evidence that Constellation’s less aggressive business plan will work in its place. It seems Canopy will suffer more losses and writedowns of bad purchases such as Hiku in the coming months. If you want to buy CGC stock, at least wait for tax-loss selling to finish closer to the end of 2019.
At the time of this writing, Ian Bezek owned MO stock. You can reach him on Twitter at @irbezek.
