U.S. cig­a­rette-maker in­vests in cannabis

Marl­boro pro­ducer strikes $2.4-bil­lion deal for stake in Toronto pot com­pany

Winnipeg Free Press - - BUSINESS - TIF­FANY KARY, KRIS­TINE OWRAM AND ARMINA LIGAYA

LTRIA Group Inc., the U.S. maker of Marl­boros, made a $2.4-bil­lion in­vest­ment in a Cana­dian pot com­pany on Fri­day based on a sim­ple premise: cannabis is grow­ing fast, and cig­a­rettes are not.

Al­tria has agreed to take a 45 per cent stake in Toronto-based mar­i­juana pro­ducer Cronos Group Inc., mark­ing a ma­jor to­bacco com­pany’s first foray into cannabis. It has the op­tion to take ma­jor­ity con­trol in the fu­ture. The to­bacco gi­ant si­mul­ta­ne­ously said it will kill two of its next-gen­er­a­tion prod­ucts, fu­elling talk that a po­ten­tial deal with Juul Labs Inc. could come soon.

With U.S. smok­ing rates fall­ing fast, Rich­mond, Va.-based Al­tria is un­der pres­sure to find new av­enues to ex­pand. Mar­i­juana is now al­lowed in an in­creas­ing num­ber of states, but is still il­le­gal on the fed­eral level in the U.S. That makes Canada, which le­gal­ized recre­ational use in Oc­to­ber, a large lab­o­ra­tory for the nascent in­dus­try.

“We be­lieve cannabis is an ex­cel­lent strate­gic fit for to­bacco,” Jef­feries an­a­lyst Owen Ben­nett said in a re­search note ear­lier this week. It’s a log­i­cal fit, be­cause “big to­bacco knows how to cul­ti­vate crop, knows how to deal with reg­u­la­tors, they are at the fore­front of va­por­iza­tion tech­nol­ogy and they also ar­guably have less rep­u­ta­tional risk than other fast-mov­ing con­sumer goods,” he said.

It’s clear Al­tria has re­assessed its com­pet­i­tive po­si­tion. It also an­nounced on Fri­day that it will dis­con­tinue two of its next-gen­er­a­tion to­bacco prod­ucts and its oral nico­tine-con­tain­ing ones to fo­cus on “more com­pelling re­ducedrisk to­bacco prod­uct op­por­tu­ni­ties.” The com­pany at­trib­uted this to reg­u­la­tory re­stric­tions and lack of fi­nan­cial prospects for those prod­ucts.

This sug­gests “an an­nounce­ment to ac­quire a stake in Juul could come very soon,” Wells Fargo an­a­lyst Bon­nie Her­zog said in a Fri­day re­search note. Juul could com­ple­ment the cannabis busi­ness, she said.

Al­tria spokesman Steven Cal­la­han

Ade­clined to com­ment be­yond the com­pany’s press re­lease.

Al­tria shares rose as much as 3.2 per cent to US$56.14 on Fri­day. Its stock had fallen 24 per cent this year through Thurs­day’s close — il­lus­trat­ing how in­vestors had be­come pes­simistic about the com­pany’s fu­ture amid ris­ing reg­u­la­tions and taxes on to­bacco.

The com­pany isn’t likely to rush into ex­er­cis­ing the war­rants that could bump its stake up to 55 per cent, but it’s pos­si­ble that Cronos will even­tu­ally be­come part of the to­bacco gi­ant, Bloomberg In­tel­li­gence an­a­lyst Ken­neth Shea said.

“It looks like an un­der­stand­ing that they would be­come one and the same,” Shea said, not­ing that Al­tria will also have four of seven board seats.

Al­tria got a good deal, par­tic­u­larly as Cronos is one of a dwin­dling num­ber of li­censed cannabis producers that haven’t al­ready es­tab­lished an ex­clu­sive re­la­tion­ship with a con­sumer prod­ucts com­pany, he said.

The Marl­boro maker’s $2.4-bil­lion bet on Cronos is by far the big­gest move by Big To­bacco into pot, and bodes well for the over­all cannabis sec­tor, said Martin Landry, an an­a­lyst with GMP Se­cu­ri­ties.

“When you look at the com­mit­ment that Al­tria makes, they’re ob­vi­ously look­ing at the sec­tor for the next 10 to 20 years. And they’re see­ing a ton of growth,” he said in an in­ter­view.

The deal is a “big en­dorse­ment” for Cronos and is “re­as­sur­ing” for the in­dus­try, amid ris­ing con­cerns that pot com­pa­nies’ val­u­a­tions may be too lofty, Landry added.

Many stocks in the volatile sec­tor were up on Fri­day af­ter the deal was an­nounced. Pot producers Aurora Cannabis and Canopy Growth Corp’s shares in Toronto were up by roughly eight per cent and four per cent, re­spec­tively, at mid­day.

The value of pub­licly traded Cana­dian cannabis com­pa­nies had soared lead­ing up to Oct. 17, when sales of cannabis be­came le­gal un­der rules and reg­u­la­tions es­tab­lished by Ottawa and the prov­inces.

Ma­jor pot stocks have gen­er­ally pulled back from their highs in re­cent weeks amid re­ports of sup­ply short­ages and com­pli­ca­tions with the sales process un­der the new regime.

Al­tria’s in­vest­ment marks the lat­est move by a U.S. com­pany in an es­tab­lished in­dus­try to tap the bur­geon­ing Cana­dian cannabis in­dus­try.

In Au­gust, al­co­hol gi­ant Con­stel­la­tion Brands said it would in­vest an ad­di­tional $5 bil­lion in Cana­dian pot pro­ducer Canopy Growth Corp., in­creas­ing its stake to 38 per cent.

As well, U.S. to­bacco leaf mer­chant Al­liance One In­ter­na­tional said its sub­sidiary ac­quired a 75 per cent eq­uity stake in Char­lot­te­town-based Canada’s Is­land Gar­den in Jan­uary.

Cowen an­a­lyst Vivien Azer said it’s not sur­pris­ing that Al­tria opted for a path­way to a ma­jor­ity con­trol of Cronos. Al­tria is pay­ing 25 times for­ward sales, she said, and in her view, Al­tria is “buy­ing their way out of a bind” af­ter al­most two decades of vol­ume de­cline for U.S. cig­a­rettes, and a chal­leng­ing 2018 for e-cig­a­rettes.

Cronos CEO Mike Goren­stein said the part­ner­ship with Al­tria doesn’t limit the cannabis firm from en­gag­ing with other strate­gic part­ners.

“In fact, we think this part­ner­ship makes us col­lec­tively a more at­trac­tive part­ner” for other po­ten­tial in­vestors, Goren­stein said on a con­fer­ence call Fri­day. The most at­trac­tive piece of the part­ner­ship is Al­tria’s ex­pe­ri­ence deal­ing with reg­u­la­tory agen­cies, he said.

Al­tria has been grap­pling with a U.S. Food and Drug Ad­min­is­tra­tion that’s in­tent on strength­en­ing re­stric­tions on some of the va­p­ing prod­ucts that have caught on with younger users.

Cronos’s Goren­stein said his com­pany and Al­tria agree that de­vel­op­ing brands and in­tel­lec­tual prop­erty is more valu­able than grow­ing plants and should be the fo­cus go­ing for­ward.

“When we were strate­gi­cally plan­ning how we would en­ter cannabis years ago, one of the com­pa­nies that we looked at and had a lot of re­spect and ad­mi­ra­tion for was Al­tria,” he said.

“It’s worth not­ing that Al­tria does not grow their own to­bacco. We think that model of grow­ing your own plants is very dif­fi­cult to scale and to ex­e­cute well. That was some­thing we’re very aligned with.”

STEVE HEL­BER / THE AS­SO­CI­ATED PRESS FILES

Al­tria Group Inc. says it will kill two of its next-gen­er­a­tion prod­ucts to fo­cus on ‘more com­pelling re­duced-risk to­bacco prod­uct op­por­tu­ni­ties.’

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