U.S. cigarette-maker invests in cannabis
Marlboro producer strikes $2.4-billion deal for stake in Toronto pot company
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.”
Altria Group Inc. says it will kill two of its next-generation products to focus on ‘more compelling reduced-risk tobacco product opportunities.’