A Constellation Buyout Would Harm Canopy Growth Shareholders

Stocks to sell

Canopy Growth (NYSE:CGC), with a $6.5 billion market capitalization, and 2.7 billion CAD in cash, remains better positioned than most of its peers.

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Nonetheless, like most other marijuana equities, it continues in a downtrend. Worse, little on the horizon has appeared that could keep Canopy around. This decline could bring a grim scenario that would prevent most of Canopy Growth’s long-term success from accruing to shareholders.

In late October, I urged investors not to trust the rally in the high-flying pot stock. It would go on to lose about one-third of its value in a post-earnings plunge before bouncing off its lows. At the current stock price near $18.70 per share, it has lost about 10% of its value since I made that prediction. Unfortunately for Canopy Growth bulls, it continues to trade below the 50-day moving average.

The company also remains in limbo in the C-suite. Canopy Growth investor Constellation Brands (NYSE:STZ) used its influence to oust the company’s founder from the CEO position in July. Since that time, it has not found a permanent replacement. As InvestorPlace’s Will Ashworth mentions, it may even miss its self-imposed deadline to appoint a new CEO by the end of 2019.

Constellation and Canopy Growth

Still, Constellation has made Canopy Growth what it is today. Thanks to Constellation’s investments, the cannabis name still holds one of the strongest balance sheets in the industry. Canopy’s size and remaining funds leave it well-positioned despite analyst projections of continuing losses.

However, this could go poorly for shareholders. The reason why is that stock declines place Constellation in a better position to buy Canopy Growth outright.

Yes, Constellation recently stated it would not provide additional cash outside of the exercise of warrants. Nonetheless, as things stand now, Constellation already owns 38% of the company. Moreover, as people drink less, revenues for STZ have fallen, and profits have not increased significantly. Hence, Constellation needs cannabis to return it to consistent growth.

Buyout Danger

This could hurt investors as any buyout could come at a much lower stock price. Despite losing nearly two-thirds of its value since the spring, Canopy trades at levels too high for fundamentals to rescue it. The stock sells at almost 25 times sales. That far exceeds Constellation’s price-to-sales ratio of 4.3 and that of Altria (NYSE:MO), which trades close to 4.7 time sales.

I do not think Canopy will fall to a comparable P/S ratio anytime soon. However, in a buyout situation, the growth investors who bought Canopy Growth would exchange it for a slower-growth, dividend-producing investment. This means equity losses, which mounted quickly, could take years to recover.

As mentioned before, I think Constellation’s cash will help Canopy Growth weather a downturn in cannabis equities. However, the potential for a buyout at a lower price means reduced profits or steeper losses for shareholders. For this reason, I would think twice about investing in marijuana with Canopy Growth.

The Bottom Line on Canopy Growth

A buyout by Constellation could hamper the growth potential of Canopy. Marijuana equities have sold off sharply since the spring as a weed supply glut and legal barriers have forced cannabis companies to revise revenue and earnings forecasts downward. This has hammered marijuana stocks, Canopy Growth included.

However, Constellation’s firing of Canopy’s previous CEO points to its power in the company. Moreover, Constellation needs marijuana to reinvigorate sales and earnings growth. Such conditions point to a likely takeover, especially if the pot stock falls to a much lower price.

Such a move means two things for current shareholders. Not only will they have sustained massive losses in a volatile stock, but they will also have to recover those losses in a slow-growth equity. This means it could take years to recover their investment.

Since the attributes of Canopy Growth may not accrue to shareholders, investors should consider avoiding this stock.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

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