An­a­lysts urge some cau­tion over Cronos deal.

$2.4-bil­lion in­vest­ment over ex­u­ber­ant?

National Post (National Edition) - - FINANCIAL POST - Van­maLa subra­ma­niam

Big Tobacco’s en­try into the Cana­dian cannabis space is yield­ing mixed re­sponses from an­a­lysts, some of whom are urg­ing in­vestors to view the $2.4-bil­lion in­vest­ment by Marl­boro-maker Al­tria in li­censed cannabis pro­ducer Cronos Group with a de­gree of cau­tion.

“This is a com­pany that out­side of cannabis has some se­vere sen­ti­ment against it in terms of ex­e­cu­tion of its core busi­ness,” warned Stu­art Rolfe, a spe­cial sit­u­a­tions an­a­lyst with Ver­i­tas In­vest­ment Re­search in ref­er­ence to Al­tria. “I’m not say­ing this deal is nec­es­sar­ily neg­a­tive. I’m just say­ing ex­u­ber­ance can flip around.”

Al­tria’s 45 per cent in­vest­ment in Cronos — with an op­tion of in­creas­ing its stake to 55 per cent through war­rants — sent Cronos’ shares soar­ing by more than 20 per cent in the first few hours of trad­ing Fri­day. Al­tria’s stock had a much more muted re­sponse, climb­ing just over one per cent as news of the deal broke.

As part of the deal, the Vir­ginia-based tobacco com­pany ac­quired 146.2 mil­lion newly is­sued shares for $16.25 each, a roughly 15 per cent pre­mium over Cronos’ closing price Thurs­day evening.

“Al­tria is very strong in the reg­u­la­tory side, and un­der­stands how to brand in a tightly reg­u­lated mar­ket, whether in bev­er­ages or tobacco. That’s what makes a dif­fer­ence to us, and that’s what’s go­ing to set a prece­dent,” said Mike Goren­stein, CEO of Cronos Group.

“We do think one of the largest cat­e­gories for the cannabis adult-use mar­ket will be va­por­iz­ers and that re­quires tech­ni­cal ex­per­tise. We can’t imag­ine a bet­ter partner than Al­tria on that front,” Goren­stein told the Fi­nan­cial Post.

Al­tria’s big­gest tobacco hold­ings are Philip Morris USA Inc., U.S. Smoke­less Tobacco Com­pany LLC, and John Mid­dle­ton Co. — all of which sell pri­mar­ily to the U.S. mar­ket. That makes the com­pany more likely to strug­gle with erod­ing mar­ket share, as it doesn’t have as much mar­ket ac­cess to the de­vel­op­ing world where smok­ing rates are much higher. This year alone, Al­tria’s stock lost a quar­ter of its value. The tobacco com­pany also an­nounced it would be dis­con­tin­u­ing two of its e-va­p­ing prod­ucts, MarkTen and Green Smoke, which were geared to­wards con­sumers in­tent on cut­ting down cig­a­rette use. “That was in­ter­est­ing to me. They are throw­ing in some por­tion of the towel in what should have been a growth area,” said Rolfe.

Other in­dus­try an­a­lysts say they are sur­prised that Big Tobacco is mov­ing into the cannabis space, which is not nec­es­sar­ily con­sid­ered a dis­rupt­ing force, com­pared to the way cannabis use could po­ten­tially eat into al­co­hol con­sump­tion. “If you’ve pur­chased cig­a­rettes, you’ll know that you have very dif­fer­ent pur­chase trig­gers than what a typ­i­cal cannabis con­sumer would have,” said Khur­ram Ma­lik, Partner at Ja­cob Cap­i­tal Man­age­ment Inc. “The pur­chase trig­gers for beer or al­co­hol are much more sim­i­lar to cannabis.”

But Goren­stein ar­gues that that’s ex­actly one of the rea­sons why Al­tria was an at­trac­tive op­por­tu­nity to him. “I think the fact that it’s an ad­ja­cent cat­e­gory is ac­tu­ally pos­i­tive. Al­tria wasn’t mov­ing in be­cause they were wor­ried about can­ni­bal­iza­tion, they were mov­ing in be­cause it was just a good in­vest­ment to make,” he said.

An­a­lyst Martin Landry of GMP Se­cu­ri­ties, who has had a buy rat­ing on Cronos since it be­gan trad­ing called the deal a “big en­dorse­ment” for Cronos, say­ing that Al­tria’s in­vest­ment will ac­cel­er­ate Cronos’ pen­e­tra­tion of the Cana­dian cannabis mar­ket. “Ac­cess to cap­i­tal is not go­ing to be an is­sue any longer for Cronos which gives us great vis­i­bil­ity on the com­pany for the next five years.”

Cronos is the fourth largest cannabis com­pany by mar­ket value, only this week sur­pass­ing Aphria Inc. af­ter the shares in the lat­ter plunged fol­low­ing neg­a­tive re­ports from a short-seller. Cronos has two recre­ational brands on the mar­ket right now — Cove and Spinach — sold in On­tario, B.C., Nova Sco­tia and Prince Ed­ward Is­land. The com­pany brought in revenue of $3.8 mil­lion in the third quar­ter of 2018, vastly smaller than that of Canopy Growth Corp. and Aurora Cannabis Inc., the two largest cannabis pro­duc­ers.

“They have a smaller bal­ance sheet in terms of cash, so this deal kind of solves that prob­lem. They do have a lot of pro­duc­tion com­ing on­line so they re­ally need the cap­i­tal to make sure that an­nounced ca­pac­ity comes into fruition,” Ma­lik said.

“I can’t re­ally speak to why Al­tria chose Cronos but I can say that Cronos is small and it sort of needs money. Al­tria needs a way out of cig­a­rettes. They need you, you need them, that’s what this is,” Rolfe said.



Al­tria ac­quired 146.2 mil­lion newly is­sued Cronos shares for $16.25 each, a roughly 15-per-cent pre­mium.

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