The tobacco industry is getting squeezed. Older smokers continue to step off the boat and younger generations are less and less interested in picking up the smoldering torch.

Last year, this trend resulted in the lowest rate of Americans heading to flavour country in recorded history. Beverage producers like Anheuser-Busch InBev (BUDFF.Q) are also watching their market shares slowly erode as craft beer continues to capture the interest of younger drinkers.

As such, both sectors have turned their eyes to the legal cannabis sector to fill their financial bellies. Today’s announcement of Altria (MO.Z), purveyor of such popular brands as Marlboro and Rothmans, entering into a subscription agreement with Cronos Group (CRON.T), is another clear indicator of this trend.

Cronos Group, which operates two wholly-owned Canadian LPs and has a market presence spanning five continents, is set to receive approximately CAD$2.4 billion in equity investment through a private placement in exchange for common shares that would give Altria 45 percent ownership interest in Cronos. The deal also includes warrants, that if exercised, would pump up Cronos’ coffers by an additional CAD$1.4 billion and increase Altria’s hold to 55 percent.

Besides giving Cronos a massive war chest to carry out its mandate, Altria’s partnership would add another integral skillset to Cronos’ expansion arsenal as Cronos Chairman, President and CEO, Mike Gorenstein, explained, “As one of the largest holding companies in the adult consumer products sector, Altria has decades of experience in regulatory, government affairs, compliance, product development and brand management that we expect to leverage, particularly as new markets for cannabis open around the world.”

The news of today’s subscription sent Cronos shares up 22.76 percent to $17.06 per share, giving the cannabis giant a CAD$2.49 billion market cap. Cronos’ stocks have been on an upswing since the December 3rd announcement they were in early talks with Altria.

According to the Financial Times, Altria also sat down with Tilray (TLRY.Q) and Aphria (APHA.T), although with the recent allegations against Aphria and its hammered share price, one would assume it has become far less attractive for such a scenario.

All of this follows the mega deal announced in the middle of August which saw Constellation Brands (STZ), whose beer portfolio includes Corona, Negro Modelo and Pacifico, inject CAD$5 billion in Canopy Growth Corporation (WEED.T). As a result, Canopy’s stock soared 56 percent and set the cannabis company’s market cap at $11 billion, putting it in line with corporate heavyweights like Canadian Tire (CTC.T) and placing it solidly in front of the cannabis pack.

The markets are so in love with this trend that even the hint of a deal sends investors into a frenzy. As illustrated by a BNN Bloomberg report on September 17 which stated soft drink giant Coca-Cola (KO.WI.Z), whose signature drink initially sported medicinal amounts of cocaine and opium, was seriously entertaining the idea of returning to its recreational therapeutic roots. In the report, BNN Bloomberg contended that the company who gave us the modern-day image of Santa was in talks with Alberta-based grower, Aurora Cannabis (ACB.T).

BNN Bloomberg‘s piece sent Aurora shares flying and the stock shot up 17 percent. Shortly afterward, trading in Aurora was halted so the company could respond to a request by the IIOC. In that response, the cannabis producer was decidedly vague on who it might be exploring possibilities with, but was adamant that it had no agreement, understanding or arrangement with any beverage company. Coca-Cola was also quick to publicly state that it wasn’t interested in  cannabis but may be interested in following the growth of non-psychoactive CBDs as an ingredient in wellness beverages.

This intense focus on the behalf of tobacco and beverage producers shows no signs of letting up and as cannabis legalization spreads throughout the US and international markets like the UK, which allowed its first medical cannabis prescription this week, begin to mature, cross-sector partnerships like the Altria-Cronos deal will become commonplace.

How much is too much?

However, it may look like the present fervor has led to some hasty decisions based on FOMO as evidenced by the massive Constellation (STZ.P) / Canopy Growth agreement. Canopy Growth is hopelessly overvalued for its business, reporting a net loss for Q1 2019 of CAD$90.8 million. Much of this red ink was attributed to fair value loss in warrants and options, which the company hopes won’t have a discernible impact on Q2 numbers, but still let’s just say for argument’s sake that Canopy had made a profit in Q1 and instead of losing $0.40 per share, they made $0.40. That still leaves the company with an incredibly high P/E ratio of 26.06.

Canopy isn’t the only one, the whole sector suffers from overzealous optimism. Tilray has a lot under the hood and is actively working to become a leader in medical cannabis research. The once little-known entity made a huge public market debut this year, reaching a $17 billion market cap before settling into its current $9 billion-dollar valuation. It too has yet to make a profit.

Other companies, like Sproutly (SPR.C), Tinley Beverage Co. (TNY.C) and The Green Organic Dutchman (TGOD.T), sit a little closer to home, sporting market caps of $61.49 million, $40.4 million and $731.99 million respectively.

Ironically, both Sproutly and Tinley are focused on the beverage market: Sproutly with its patent-pending proprietary APP technology, leading the way in water-soluble cannabinoid extraction; and Tinley with its signature Tinley(TM) 27 line of cocktails, sporting less sugar and calories than their alcohol counterparts. While TGOD has dedicated itself to the provision of top quality organic cannabis through a national distribution network it established when the company inked a supply partnership agreement with Velvet Management, Canada’s largest wine distributor. Dollar for dollar, these companies make more economic sense when it comes to valuation.

Are these mega-deals headed for disaster?

Grand View Research analysts predict the global legal cannabis market to reach US$146.4 billion by 2025, while back in May, the Financial Post pegged the valuation of the then-90 publicly listed Canadian cannabis companies at $31 billion. Certainly this a rather healthy figure for a market which has yet to appear and as tobacco and beverage biggies jostle for their piece of the pie there will be some losers.

It wouldn’t be the first time that billion-dollar deals have gone south as evidenced by the Quaker Oats / Snapple acquisition which generated a $1.4 billion loss for investors in just 27 months when Quaker unloaded the drink maker for $300 million. Or the AOL Time Warner merger which generated a $90.0 billion dollar loss for investors in 2002.

In the end, investors should be careful before jumping on the bandwagon when these monster cannabis deals hit the wire. I’m not saying these agreements are bad, but the prices involved certainly don’t reflect any sort of reality and won’t until the market matures. And despite the aforementioned predictions, no one is 100 percent sure how that will be. So, before you buy into the hype, take a good look ahead and always remember that financial realities will inevitably come home to roost. It will be interesting to see how all this plays out over the next 12 months. Good luck to all!

–Gaalen Engen

FULL DISCLOSURE: Tinley, The Green Organic Dutchman and Sproutly are Equity Guru marketing clients.

Written By:

Gaalen Engen

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