Global beer, wine and spirits giant Constellation Brands Inc. (STZ) is exerting increasing control over troubled Canadian-based cannabis products company Canopy Growth Corp. (CGC), in which it has an ownership stake of roughly 37%. Canopy's share price has plummeted 60% from its 2019 high of $52.79 set in intraday trading on April 30, to a closing price of $21.13 on Dec. 12. In the process, its market capitalization has been slashed from about $18.2 billion to just $7.3 billion.

In a move typical for troubled companies, David Klein, the chief financial officer (CFO) for Constellation Brands, will become Canopy's third CEO in a year on January 14, 2020. While Canopy's stock jumped on the news, it is still down drastically from its April high.

Key Takeaways

  • Alcoholic beverage giant Constellation has made a big bet on legal pot.
  • Its stake in Canadian pot company Canopy Growth is in the red.
  • Canopy is producing losses, as black market pot is much cheaper.

Significance For Investors

In Nov. 2017, Constellation acquired 18.9 million shares of Canopy, representing a 9.9% ownership stake, plus warrants to purchase another 18.9 million shares, for $191.3 million. In Nov. 2018, Constellation bought an additional 104.5 million Canopy shares for $3.87 billion, plus warrants to purchase another 139.7 million shares. This increased Constellation's ownership stake to 36.6%. 

At the current market price, Constellation's $4.1 billion investment in Canopy is now worth only $2.6 billion. This represents a cumulative loss of $1.5 billion, or 37%. Oppenheimer analyst Rupesh Parikh estimates that Canopy will lose more than $500 million during the two-year period that ends March 2021.

For the quarter ending Sept. 30, 2019, Canopy lost, in Canadian dollars, $375 million, while the loss for the six-month period ending on that date was $1.656 billion. At the current exchange rate, these figures translate to, in U.S. dollars, $285 million and $1.259 billion, respectively. The losses increased by 13% and 292%, respectively, from the same periods in the prior fiscal year.

Analysts Owen Bennett and Ryan Tomkins at Jefferies are skeptical and maintain an underperform rating on Canopy. "We are not convinced this is a wholly positive result," they wrote in a recent research report. They worry that Constellation may push Canopy to invest in beverages containing THC and CBD, a business that they call "unproven." 

Another problem is that legalization of recreational cannabis, or marijuana, usage in jurisdictions such as California and Canada has not put the illegal black market in pot out of business there. Two years after legalization, 80% of the pot sold in California is still via the black market, and spending on legal pot has declined by 17%. In Canada, the black market is estimated to provide 71% of all pot sales in 2019.

Looking Ahead

"There are not enough stores in Canada to sell our products...and it's very hard to take on the black market," outgoing Canopy CEO Mark Zekulin stated in a TV interview, as quoted by Forbes. Legal pot in Canada costs about 83% more than illegal pot, largely due to heavy taxation, the report adds.

Meanwhile, Forbes estimates that Canopy would have to increase its annual sales in Canada by about $3 billion to break even. That would represent about 300,000 to 600,000 kilos, or more than half the nation's entire consumption, per Statistics Canada.