By now, we’ve all heard the news: Bruce Linton, co-CEO of Canopy Growth (TSE:WEED), the world’s largest supplier to the cannabis markets, left the company last week. Asked about his departure from the company he had led to industry dominance, Linton said, “I think stepping down might not be the right phrase. I was terminated.”
Specifically, Linton was terminated by Constellation Brands (STZ), which controls 4 of the 6 seats on Canopy’s board of directors. Constellation, which own the Mexican beer brands Corona and Modelo, put $4 billion into Canopy in the second half last year and has been disappointed in the results. Canopy’s stock has slipped 20% since April this year, and under Linton’s guidance the company was spending money freely to acquire additional growing facilities and acreage. These are long-term investments, however, and Canopy found itself struggling to meet product demand in recent months. The result was a disappointing fiscal Q4 for Canopy, and the end of Constellation’s patience.
The Quarterly Numbers
In June, Canopy reported net revenue for Q4 of $94.1 million in Canadian currency, for a gain of 13% over the previous quarter, an impressive 313% year-over-year, and C$400K over the forecast. The lion’s share of the revenue, C$68.9 million, came from the recreational cannabis sector. That number is more than double the recreational revenue reported by Canopy’s largest competitor, Aurora (TSE:ACB).
On the red side of the ledger, those rosy recreational revenues represented a 4% decline from Q3. Canopy also reported a 41% quarterly drop in sales to the medical cannabis sector. These declines, despite the overall revenue growth, reflect the company’s difficulties meeting demand – a problem facing the entire Canadian cannabis sector as rapidly growing suppliers work to expand production, develop distribution networks, and implement marketing.
This brings us to Canopy’s worst number, and the one that most likely pushed Constellation to act: the company lost C$323.4 million in Q4, significantly worse than the C$54.5 million net loss in the year-ago quarter. On a per-share basis, the Q4 2019 loss came to 98 cents.
An Expensive Vision
The reported losses could not have come at a worse time for Canopy. Just days before the quarterly report, Canopy’s shareholders had approved the company’s Acreage Holdings deal, by which Canopy purchased, for a $300 million down-payment, acquisition rights to the US company. The agreement stipulates that Canopy will buy Acreage for $3.4 billion – but after cannabis is legalized at the US Federal level. Acreage is a major producer in the US, with operations in most states with legal cannabis, so the deal gives Canopy a potential entrance to the US market. But it does tie down $3.4 billion, the bulk of the company’s cash reserves, on a move that may or may not happen.
Now-former CEO Linton justified the heavy investment in production in terms of a future vision – he sees Canopy expanding its position as the largest player in the cannabis market. Of the company’s aggressive capital expenditures, and resulting operating losses, Linton said, “We’ve taken five quarters to create an eight-times bigger platform. That decreases margins in the short term, but means we have a massive number later.”
Constellation’s Different View
Canopy wasn’t making its moves in a vacuum, however. Constellation now owned 35% of the company, and controlled the board. And Constellation wanted a return on its $4 billion investment, which it hasn’t been getting. Canopy shares are down 24% since the end of April, while STZ has been somewhat range-bound in the same time frame, trading essentially flat in the short term and down 7% year-over-year.
So, it’s no shock that, after a surprise board meeting that did not include Bruce Linton, Canopy announced on July 3 that Linton’s partner, co-CEO Mark Zekulin, would be taking over operation of the company. In its statement, Canopy said, “Mark has played an integral role in the company’s success since its inception, including managing all aspects of the company’s day-to-day operations.” Zekulin, in accepting, acknowledged that new blood will be brought in: “I personally remain committed to a successful transition over the coming year as we begin a process to identify new leadership that will drive our collective vision forward.”
According to reports, the firing comes from Constellation’s CEO, who was described as “not pleased” after Canopy’s Q4 report, most especially by the company’s increasing operating losses. Linton seems to have taken his departure with some grace, saying, a bit cheekily, “Sometimes entrepreneurs are entrepreneurs because they’re not super employable. You don’t always mesh well with everybody in the play pen.”
Wall Street’s analysts have been keeping a close watch on Canopy, as it is the dominant player in North America’s expanding cannabis market. BMO Capital’s Tamy Chen, writing of the quarterly report, says that Canopy may continue to disappoint if additional cannabis-related products, such as e-cigarettes and beverages, do not take off after approval. She sees Canopy as a ‘Hold’ for now, taking a wait and see attitude.
Writing from Stifel, W. Andrew Carter gives Canopy a ‘buy’ rating. He acknowledges that Constellation is likely behind Linton’s termination, and will be instrumental in selecting his successor, but also says that Canopy will “sorely miss” Linton’s vision. He does see Constellation’s influence as a positive, however, putting Canopy on “a more focused long-term strategy to win markets and form factors that matter.”
Five-star analyst, and cannabis market expert, Vivien Azer, from Cowen & Co., has been following Canopy for several years now. Regarding the recent quarterly report, she said, “The magnitude of losses for WEED has expanded far more than we had expected,” and added that, given Constellation CEO William Newlands’ stated displeasure, she was not surprised that Linton was terminated. While commending Linton for his vision and success in building Canopy to a leading position, Azer also said, considering the current situation, “We believe new leadership will be a welcome change.” She remains optimistic about Canopy's prospects, rating the company a ‘buy’ on her belief that it will outperform the markets in the coming year.
Overall, Canopy has a ‘Moderate Buy’ from the analyst consensus, based on 8 buy and 5 hold ratings given in the past three months. Even with the company’s difficulties – operating losses and slowing revenue growth – there are no ‘sell’ ratings on this stock. Shares trade on the Toronto Stock Exchange for C$52.63; the average price target of C$73.13 gives WEED an impressive 38% upside potential. Canopy is also listed on the New York Stock Exchange, as CGC, where it sells for $40.
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