Constellation Brands is simplifying its approach to the cannabis industry as the company announced plans today to convert its common shares of Ontario-based Canopy Growth Corporation into new non-voting exchangeable shares.
As part of the move, the alcohol conglomerate will consolidate all its U.S. cannabis assets into a single holding company, Canopy USA, allowing Canopy to make immediate moves into the U.S. market.
Constellation will retain its 35.7% ownership stake in the Canadian cannabis company, but the shift distances it from day-to-day operations, terminating its existing investors rights agreement and giving up its board voting position and ability to review Canopy’s financial results.
What does this decision involve?
Constellation and Canopy have entered a consent agreement that, if finalized, will place all of Constellation’s cannabis subsidiary companies – including Greenstar Canada Investment Limited Partnership and CBG Holdings LLC – into a newly formed entity called Canopy USA, which Canopy will use as a brand portfolio company managing its U.S. operations.
Pending shareholder approval, Canopy will create a new class of non-voting and non-participating exchangeable shares, which Constellation and its subsidiaries intend to convert all existing common shares into. Once finalized, all Canopy directors originally nominated by Constellation will resign from the board.
Canopy will own non-voting shares in Canopy USA, which are exchangeable into common shares. The two companies have entered a protection agreement “to preserve the value of non-voting shares,” the company said.
“We believe that the conversion of our ownership interest will maintain Constellation’s ability to realize the potential upside of our investment in Canopy,” Constellation president and CEO Bill Newlands said in a statement. “At the same time, this transaction and the surrender of our warrants are expected to eliminate the impact to our equity in earnings, mitigate risk to our organization, and further reinforce our intent to not deploy additional investment in Canopy aligned with Constellation’s previously stated capital allocation priorities.”
Why is this happening?
Constellation originally took a 35.7% stake in Canopy in a $4 billion deal in 2018, providing the Canadian company with funding to scale global operations in over 30 countries. However, it has been slow to expand in the U.S. due to federal prohibition of THC. Earlier this month, Constellation announced a $1.1 billion writedown for its Canopy investment.
Through Canopy USA, Canopy intends to move rapidly to expand its U.S. business with brands like gummy maker Wana Brands and vape line Jetty Extracts, which Canopy USA will acquire outright. Canopy USA is also expected to acquire fixed shares of cultivation-to-retail cannabis company Acreage Holdings. In a presentation today, Canopy said it expects nearly half of its revenue mix to eventually come from the U.S. cannabis business.
Between Acreage, Wana and Jetty, Canopy currently has a presence in 21 U.S. states, which combined reflect 85% of the total U.S. market opportunity, the company said. Projecting the U.S. THC market to pass $50 billion by 2026, the company is aiming to get ahead of federal legalization for THC while the creation of a holding company puts a “protective layer in place” to safeguard its core business operations.
Canopy and Constellation shareholders will both vote to approve the proposal by the end of the year.
“As the growth of the U.S. cannabis market continues rapidly at the state level, this strategy enables us to take control of our own destiny and capitalize on the once-in-a-generation opportunity in the largest cannabis market in the world,” said Canopy CEO David Klein in a press release. “We expect to unleash the full power of Canopy’s scalable and ideally-positioned U.S. cannabis ecosystem to unlock potential expansion opportunities. This strategy and positioning are true differentiators, which we expect to enable our investors and brands to realize value in the near term while positioning Canopy for profitable growth and a fast start upon U.S. federal permissibility.”
Klein told Bloomberg today that the move is expected to make Canopy profitable. Combined Canopy and Canopy USA will “rank among the top cannabis companies in North America by revenue,” the company said in a release.
What does this mean for Constellation Brands?
On its Q3 earnings call, Constellation noted the writedown was driven by “the period of time for which the fair value has been less than the carrying value and the uncertainty surrounding Canopy stock price recovery in the near-term,” as well as “Canopy’s goodwill impairment for their cannabis operations and the uncertainty of U.S. federal cannabis legalization.”
The company recorded a $651 million equity loss from its share ownership in Canopy, including $461 million of Canopy’s goodwill impairment.
“While disappointing, we continue to believe that Canopy’s focus on premiumizing its cannabis branded portfolio to improve their performance in Canada is appropriate and we also remain supportive of Canopy’s efforts in the U.S. to strengthen their emerging CPG brand distribution and build of a competitive THC ecosystem,” Newlands said on the earnings call.
On October 6, the same day as Constellation’s earnings call, U.S. President Joe Biden announced executive action to pardon federal offenses for simple possession of marijuana and initiating an administrative review of how marijuana is scheduled, a move that signaled federal legalization may be getting closer.
Although it’s moving away from active participation in cannabis, Constellation still retains a sizable stake in Canopy and on the earnings call Newlands said the company is still interested in the space in the future.
“We still believe that in the longer run brands are going to matter and I think they [Canopy] are positioning themselves to have the right brands that will matter over the long run here in the U.S.” Newlands said. “But look, we are optimistic, I think, everybody’s optimistic that we are going to start to see the legislation loosen up.”