A number of Canadian cannabis companies have recently sold stock at discount prices in order to raise cash so they won’t run out or default on their loans. One company that isn’t diluting its shareholders is Canopy Growth (NYSE:CGC), which is great news if you own CGC stock.
When Canopy Growth sold an initial chunk of its stock to Constellation Brands (NYSE:STZ) in October 2017 and then a much larger piece in August 2018, most experts thought the cannabis company would benefit from Constellation’s expertise in making and distributing alcoholic products on a global basis.
As for Constellation, it wanted to add a fourth revenue stream to go with its beer, wine, and spirits businesses. Canopy was and still is an ideal fourth leg for its global ambitions.
Things have gone sideways in the 21 months since it acquired an additional 28% of Canopy’s business for a cool $4 billion. However, I don’t think anyone could have predicted how far off the rails the Canadian cannabis industry would travel since phase one legalization in October 2018.
In five years’ time, all of these stumbles will be ancient history. If you own CGC stock, you’ll be very glad Canopy Growth sold a big stake to Constellation. That’s because the cash it took in return for a 38% stake and an option for Constellation to up that to more than 50% is starting to look like a real godsend.
Here’s why.
Dilutive Transactions
Since the beginning of March, both Hexo (NYSE:HEXO) and Tilray (NASDAQ:TLRY) issued stock at 20% discounts. In Hexo’s situation, its bankers basically told it to raise at least 40 million CAD from share sales by the end of April or risk defaulting on its loans.
Hexo CEO Sébastien St-Louis put on a brave face for the press and investors.
“At the end of the day, the discount relative to the opportunity is irrelevant,” St-Louis said.
“It’s a question of scale and it’s a question of survival and both those things are very challenging, and we’re in an environment where most companies can’t access capital the way Hexo can.”
Perhaps. But the reality is you don’t sell stock at historic lows unless you absolutely have no other alternative.
Canadian cannabis companies were struggling heading into 2020. The coronavirus has made things that much worse. Just because the cannabis potential in Canada is significant, does not protect companies like Hexo from bankruptcy. Bankers don’t care about anything other than protecting their loans from defaulting.
In essence, Hexo was forced to walk the plank. Which is too bad because I’ve been excited by its Truss beverages partnership with the Canadian arm of Molson Coors Beverages (NYSE:TAP).
Back in November, I wrote an article that highlighted why Canopy Growth and Cronos Group (NASDAQ:CRON) stocks were much cheaper than people realized.
The argument?
They both were trading, on a price-to-net-cash basis, for far less than some of the other Canadian cannabis companies. At the time, Canopy was trading at 3.7-times net cash while Cronos Group was just 1.6-times net cash.
“Cronos, on the other hand, chose to partner with Big Tobacco. Altria (NYSE:MO) owns 45% of Cronos and can increase that to 55% — and Canopy did the same with Big Booze — Constellation Brands owns 38% of Canopy and has the right to increase that to above 50%. To date, it appears that Cronos and Canopy’s shareholders have the last laugh,” I wrote Nov. 8.
Given all that’s taken place in the subsequent six months, Canopy and Cronos look even smarter.
The Bottom Line on CGC Stock
On March 4, Canopy Growth announced the closure of two greenhouses in British Columbia and the cancellation of plans to open a third greenhouse in Ontario. The move eliminates 500 jobs at the two facilities resulting in a fourth-quarter pre-tax charge of 700 million to 800 million CAD.
“When I joined Canopy Growth earlier this year, I committed to focusing the business and aligning its resources to meet the needs of our consumers,” stated Canopy Growth CEO David Klein. “Today’s decision moves us in this direction, and although the decision to close these facilities was not taken lightly, we know this is a necessary step to ensure that we maintain our leadership position for the long-term.”
In my most recent article about Canopy Growth, I argued that it made more sense to buy Constellation’s stock if you wanted to bet on the cannabis company. Since then, STZ is down 9.1% through April 14 compared to 13.9% for CGC.
I believe that Constellation was smart to put David Klein in charge of Canopy. So does former CEO Bruce Linton. The greenhouse closures are another sign the company is going to be run more efficiently in the future — and that’s a good thing.
At current prices, I don’t have a problem with investors buying CGC stock. However, if you’re not one for risk, I’ll continue to recommend STZ instead.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
