Canopy Growth (CGC) gets 5 Billion Dollar Commitment from Constellation Brands

September 29, 2018

by Wilton Risenhoover

If you missed the news the first time, Canopy Growth Corporation announced last week that Constellation Brands had committed to a $5B Dollar Canadian investment. That’s 3.8B US dollars. For this money, Constellation Brands will get 104.5 million shares and a little over 139 million warrants. This puts the acquisition price at 48.60 Canadian per share.

This is significant not just for the money involved, but for the fact that it’s Constellation Brands, the Fortune 500 marketer of Corona and Modelo beers and Robert Mondavi Wines. This brings a significant increase in legitimacy to the company as well as the larger cannabis industry.

And it’s not just Constellation brands According to Fintel, between March and June of this year, the number of institutions reporting positions in Canopy Growth jumped from just 14 to 158, and some of the new holders include Vanguard, Morgan Stanley, Bank of Montreal, and the Royal Bank of Canada. Total reported institutional investment leapt from 57 million dollars US to 477 million, an increase of 420 million dollars. That’s no typo!

With all of this institutional interest, one might come to the conclusion that this is one of the safer cannabis plays. It is certainly safer in the sense that the company is probably the least likely to go bankrupt at this time. However, that doesn’t necessarily mean that the company is a safe investment.

First of all, the company is not yet cash flow positive, and although demand for the product is extremely high, maintaining the current rate of revenue growth will require a lot of cash. This is not like Netflix where an investment in software engineers and marketing can generate stratospheric growth and profitability.

Cannabis Growth Company is a farm, and farms require a lot of capital. With current valuations based on expectations of future growth, there will be intense pressure to meet revenue projections, and the only way to do that will be to pour every penny into capital improvements that expand capacity. Even a whiff of slowing growth could cause a significant price correction.

Additionally, this ongoing need for capital expenditures could bring the company back to the capital markets again and again, with each transaction diluting the positions of the existing shareholders.

I’m not saying that this is a bad investment. Clearly, there are many people who think otherwise. What I am saying is that this is not a slam dunk. The cannabis sector is quickly becoming the biggest investment opportunity since the dot-com era, and I Canopy Growth could continue to do well, but I expect a lot of volatility ahead.

The best comparable I can think of for this company is Tesla. Stay with me here. Both companies have favorable macroeconomic trends. Tesla has global warming, which is driving demand for clean air vehicles. Canopy Growth is benefiting from a changing regulatory environment that is - frankly - allowing people to enjoy it’s product without threat of jail time. Both companies benefit from seemingly unquenchable demand and high margin products. However, both companies require very capital intensive production processes in order to maintain revenue growth. Tesla’s recent production problems created a lot of volatility for shareholders, and it’s unlikely that Canopy Growth will escape that fate, considering the revenue growth that’s priced into the current valuations.

If you’ve got the stomach for extreme price swings, then this is probably a good medium to long term investment. If you don’t, you should probably pass on Canopy Growth.