Earlier this month, Canopy Growth (NYSE:CGC), a leading Canadian cannabis company, reported its third-quarter results for fiscal 2019.
Net revenue soared 282% year over year to 83 million Canadian dollars, driven by the Oct. 17 opening of Canada’s recreational marijuana market. Canopy posted an operating loss of CA$157.2 million and a loss per share of CA$0.38, driven by its heavy investing in growth initiatives. (Net income was positive, but that’s only due to changes in the fair value of financial assets and liabilities.)
Management’s comments during earnings calls can often reveal key insights about a company’s prospects and strategy. While there were several other very interesting things covered on Canopy’s Q3 call (transcript via Seeking Alpha), one topic stuck out: how the company is positioning itself to hit the ground running as soon as it can legally enter the U.S. marijuana market, which could occur sooner than many investors probably realize.
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Why Canopy can’t currently enter the U.S. marijuana market in states where the substance is legal
Canopy can’t enter the U.S. marijuana market right now because the stock exchanges on which the company is listed — the New York Stock Exchange (NYSE) and the Toronto Stock Exchange (TSX) — prohibit their listed companies from engaging in any enterprise that is illegal on a federal level. Marijuana in the U.S. falls into this category, despite it being legal in many U.S. states for medical and/or recreational use. After November’s midterm elections, there are 32 states where medical marijuana is legal, and 11 states plus Washington, D.C., where recreational use is permissible.
The STATES Act: How Canopy could potentially enter the U.S. marijuana market before federal legalization
Canopy Growth could potentially enter the marijuana market in the U.S. states where the substance is legal before federal legalization, thanks to a bipartisan bill introduced to Congress last June, the Strengthening the Tenth Amendment Through Entrusting States (STATES) Act, which we’ll get to in a moment.
This would be a massive opportunity for the company. In 2017, this country’s legal marijuana market brought in revenue of about $8.5 billion, or 89% of total global revenue, according to ArcView Market Research and BDS Analytics. The same source projects that this market will grow at a compound annual growth rate (CAGR) of 22% over the next five years, to $23.4 billion.
Here’s what Canopy Growth founder and co-CEO Bruce Linton had to say in response to a question about the STATES Act:
Anything that would allow at a state level the activities that currently occur in the state not to be offside federally, and as a result enable parties like NYSE to see it such that our [stock] listing would be maintained immediately means that we’re in.
And so there are a bunch of formulations [of legislation] that could result in us being able to immediately enact our plan in any of those states. And it’s feeling… that it [will be] sooner [rather] than later.
The STATES Act would recognize the legalization of marijuana in those states where it’s legal on a state level, with the primary aim of the legislation being to prevent federal interference with states that have legalized cannabis. Naturally, there are political maneuverings going on with respect to this bill, but it appears that it has a good shot at passing in a form that would enable Canopy Growth to enter the U.S. marijuana market in states where the substance is legal without losing its NYSE listing. The bill’s timeline is uncertain, but it could potentially pass as soon as this year or next.
How Canopy is positioning itself to hit the ground running as soon as it can legally enter the U.S. marijuana market
Linton said in an interview earlier this month that Canopy was open to investing as much of $500 million in the U.S. hemp market. (The passing of the U.S. Farm Bill, which became effective on Jan. 1, cleared the way for Canopy to enter the U.S. hemp market.) An analyst on the earnings call questioned Linton as to why such an “awfully big investment,” to which he remarked:
[W]e think there are going to be multiple states [where we’ll] have to operate production and processing of hemp and that there’ll be industrial-park scale. That asset group and the channel we sell through will lend itself extremely well to cannabis if and when… [Emphasis mine.]
Linton’s “if and when” can be safely taken to mean “if and when Canopy can enter the U.S. marijuana market.” So, it seems like Canopy is open to investing more than it might otherwise in the U.S. hemp market in order to lay the groundwork for when it enters this country’s marijuana market. It seems like a great strategy, particularly given the company has deep pockets thanks to receiving $4 billion last fall from alcoholic beverage giant Constellation Brands, which increased its ownership stake in Canopy Growth to 38%.