For some time, some large players in the alcohol industry have been lobbying against the legalization of cannabis in the United States. This isn’t really all that surprising. Given the potential for recreational-use cannabis to steal market share from alcohol – especially beer – producers, it only makes sense for them to try to protect their turf.
That potential became reality when beer sales in Colorado, Oregon and Washington (three states with laws permitting recreational-use cannabis) fell by 4.4% from January 2015 through December 2016. Correlation does not necessarily equal causation, however. And overall trends for beer were pretty dreadful during most of that time – with sales in the category down 1.5% (or 2.8% if you exclude the craft beer segment) during 2016. So maybe there’s nothing to it. Right?
Some pretty smart folks are thinking about this quite a bit. And one such smart player is industry powerhouse Constellation Brands. Yep, you read that right. The company that brings you a beer routinely rated among the worst-tasting and yet best-selling in the United States, is thinking about weed.
In fact, Constellation is thinking so much about it that this morning it announced that it had acquired a minority stake in Canopy Growth Corporation. Haven’t heard of them? Perhaps you’ve not been paying enough attention. By most measures, Canopy is the world’s biggest cannabis company, with assets that include the world’s largest cannabis production greenhouse, a 350,000 square foot monster in Ontario. Canopy is publicly traded in Canada, with its shares listed on the Toronto Stock Exchange under the symbol … wait for it … “WEED”. Seriously. I can’t make that up. The company has a market capitalization of just over $1.5 billion (USD). For comparison, that makes Canopy’s market capitalization just a bit higher than the market cap for the Dillard’s department store. This is not a small operation.
So what is Constellation doing here, and what can we learn from it?
First off, we should acknowledge that the investment – while meaningful in terms of real dollars – isn’t enormous from the standpoint of Constellation’s balance sheet. Their last quarterly report with the SEC showed just over $3.3 billion in current assets on the books as of August 31, 2017. So their investment in Canopy – at $191 million – isn’t going to break the bank.
Second, we should remember that Constellation has been pretty acquisitive as of late. Regular readers will recall that Constellation purchased High West Distillery last year and made a play for Brown-Forman earlier in 2017. So Constellation is prepared to take some risk and make some big (and interesting) bets.
Perhaps most importantly, however, we should take away from this that Constellation apparently thinks that the push for cannabis legalization is likely to continue and to be ultimately successful. The market for cannabis in Canada (where Canopy is located) is reasonably big – up to about $8.7 billion (CAD) or $6.8 billion (USD). But the market for cannabis in the United States, where it is confusingly legal for purposes of state law – either for recreational or medicinal purposes (or both) – but nevertheless illegal for essentially all purposes under federal law, is projected to be much larger. In fact, the annual market for cannabis in California alone – where untold millions of limes meet an unfortunate end as they are submerged in Constellation’s aforementioned beer – is projected to be roughly $7 billion.
It seems improbable that Constellation would make this bet if it did not believe that cannabis legalization in the US was reasonably likely. And more to the point, Constellation seems to be making a bet which is intended to hedge against the potential for cannabis to eat into its alcohol sales. If you’re wagering on a two-horse race, and you can get good odds on both of the horses, why not make that extra bet?
Constellation got good odds on this second horse. It got its 9.9% stake for a decent price – plus received the right to acquire the same number of additional shares through exercise of warrants in the future. So it can have own under 20% of Canopy at some point in the future if it thinks the price is right. Plus it gets the chance to collaborate with Canopy on the development of cannabis-related beverages in the future which – at the risk of beating a dead-horse of a metaphor – is a bit like getting the two horses in the race to merge into a single eight-legged animal with less than a furlong to go.
I’m looking forward to watching this race.