How Shareholder Dilution Post Constellation Brands Investment Impacts Our Price For Canopy Growth Corp.

Back in August, a massive $4 billion (~CAD 5 billion) investment by alcoholic beverage giant Constellation Brands (NYSE: STZ) was announced into Canopy Growth Corporation (TSX: WEED, NYSE: CGC). This heavy investment takes the share of the latter to 38%, while also providing further warrants that could take the stake to over 50%, from 9.9% previously, and makes it the biggest deal in the marijuana space until now. Shares in Canopy, as well as other pot stocks, jumped on this news, amid speculation of other beverage makers investing in cannabis companies. Constellation’s $4 billion investment will help the pot company to bolster its leadership position as it gives them the funds needed to strategically build or acquire key assets in the almost 30 countries pursuing a medical cannabis program. The money is also likely to be invested in the cannabis edibles space. However, what many investors have failed to pay heed to is the shareholder dilution this tremendous investment has resulted in. In this note, we show what impact this event may have on our fair price estimate for Canopy Growth Corp.

We arrived at a CAD 42 price estimate for Canopy Growth Corporation based on revenue projections of CAD 371 million for FY 2019, a P/S multiple of 25, and a share count of 220 million. The market price stood at CAD 65 as of September 27, 2018, implying our price estimate is lower by 35%. However, a possible share count of 325 million would result in a significant downgrade to our price estimate.

Canopy’s International Expansion Key To Its Lofty Valuation

Canopy was an early mover in the Canadian and international marijuana market, which has helped it to become the biggest player in this field. In 2014, there were only a limited number of countries which had allowed cannabis usage in some form, including Canada, Israel, Czech Republic, Netherlands, and Uruguay. Since then, a number of other countries have relaxed their attitude to cannabis, and till date at least 20 additional countries including Argentina, Austria, Australia, Brazil, Denmark, Chile, Columbia, Germany, Greece, Israel, Italy, Jamaica, Lesotho, Mexico, Netherlands, Norway, Poland, Puerto Rico, South Africa, Switzerland, and Turkey have formally legalized medicinal cannabis access. Moreover, countries such as Belgium, Ireland, England, France, Portugal, Spain, and India are exploring the legalization for medical purposes. Such a prospect provides a tremendous avenue for growth, and enables Canopy to fulfill its lofty global aspirations. Furthermore, the appeal of the edibles market is expected to increase at a fast pace once legalized in Canada (expected to happen next year), given its growth in the U.S. For example, in Colorado, the share of edibles and concentrates went up from 11% and 13% at the beginning of 2014 to 15% and 29% by the end of 2017. Furthermore, in California and Oregon, their combined share exceeds 35%. Constellation’s massive presence in the consumer goods industry will also help Canopy in better understanding customer trends and ensure better brand positioning.

Significant Shareholder Dilution Post Investment

We used a share count of 220 million to arrive at our CAD 42 price estimate for Canopy Growth Corp. But if we look at the presentation given by Constellation Brands upon announcing its investment into the company, we can see that the company already held 18.9 million shares in the pot company (acquired in November 2017). Post the new investment in August, the alcoholic beverage company acquired an additional 104.5 million shares, taking its shareholding to 35%, and with the exercise of additional warrants, its stake would go up to 38%. Consequently, its total share count of 123.4 million (18.9 million+ 104.5 million) for a 38% ownership, would imply a total shareholding of ~325 million. This would suggest a significant dilution for the existing shareholders.

In our model, if we increase our share count from 220 million to ~325 million, the sales per share falls from $1.69 to $1.14. Using the same P/S multiple, our fair price for Canopy Growth Corp. nosedives to $29, an over 30% decline. If you don’t agree with our forecast, you can make adjustments to the price drivers and arrive at your own price estimate for the company by clicking here for our interactive dashboard on Our Outlook For Canopy Growth Corp. In FY 2019.

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