Cannabis Stock on Focus: Canopy Growth (CGC) – A Word of Caution

Canopy Growth (CGC) continues its acquisition spree by taking a minority stake of circa 25% in Seth Rogens “Houseplant” business according to High Times as of March 27th. Data points on the ball park of what Canopy paid remain unclear, but this acquisition is on the back of a $1.5bn spending spree in the 9 months to December 2018.

Expansion Continues

It is becoming increasingly evident that Canopy is continuing to expand rapidly, and perhaps at all costs to establish a firm position in an industry that is both young and growing at rates of 21% per annum. The upside is that establishing a competitive position early on is that it retains the potential lead to scale first as the industry moves forward, and with a projected market size of $199bn by 2030 the scope for material future profitability remains undimmed in the eyes of many investors.

The Acquisition of Houseplant Likely Serves Key Ambitions

As seen in deals with other major celebrities including Martha Stewart and Snoop Dog, Canopy believes (and probably correctly) that this is a commoditized product that requires significant branding and marketing investment to become materially appealing to consumers compared to the various generic brands available off the shelf. The ability to stand out on a crowded shelf of (almost) identical and homogenous products provides a material long term competitive advantage should it be executed successfully.

Leveraging the substantial status and appeal of these major brand moving forward will undoubtedly add value to the product lines involved resulting in increased margins compared to competitors.

Expansion Risks

While margins may well be improved, the overall added value to shareholders is far from certain. Canopy is acquiring businesses and operating assets at similar multiples to its own stock. Which is to say it is paying substantially more than book value for assets that are largely unproven and unprofitable. This is a considerable and material risk to the long-term value for shareholders. As acquisitions dilute current shares due to stock issuances so to does it run down the cash pile Canopy currently retains on its balance sheet.  This is coupled with losses that continue to increase on a month by month basis while beginning to materially impact the overall financial health of the company. In short, investors expect to see material margin and profitability improvements over the short to mid term horizons if Canopy expects to maintain the wider confidence of investors and the market.

Furthermore, management are rewarded stock and performance-based compensation on the aggregated number of deals in terms of mergers and acquisitions made. This has potential to lead to a significant conflict of interest between the CEO and management running Canopy and the shareholders who own it. While not uncommon, it is usually worth pointing out areas where managements interests do not necessarily align with that of shareholders, and this remains one of them.

Conclusion

Canopy remains a fascinating company to watch, and is still the dominant force in the industry at present. Yet investors must remain vigilant to both the frequency and the scope of M&A activity for Canopy stock moving ahead, history tells us acquisitions tend to destroy value more often than not, and so skepticism remains deserved until proven otherwise, at least in the authors opinion.

To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.

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