Cronos shares soar on Altria investment, but deal has some analysts preaching caution - EcoFinBiz Blog

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Cronos shares soar on Altria investment, but deal has some analysts preaching caution

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 and 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 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 American 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.

Cronos is the fourth largest cannabis company by market value.

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-sheller. 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.

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