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Canopy Growth looks to the U.S. as Canada’s cannabis edge dulls

Canopy Growth Corp.’s (WEED.TO) plan to buy Acreage Holdings Inc. (ACRG-U.CN) in a $3.4 billion deal has been likened to a shot from a starter’s pistol in a race to buy U.S. cannabis assets previously deemed untouchable by companies listed on major exchanges.

Many see the bet on U.S. federal legalization by the biggest pot player as confirmation of the American market’s massive untapped value, raising the question of how long the rest of Canada’s cannabis industry will remain a stock market darling if Washington eases legal restrictions on the drug.

According to a press release issued last Thursday, the combination of Canopy and Acreage would “immediately create the undisputed leader in U.S. cannabis, the only relevant market where Canopy Growth does not yet have a major presence.”

The all-stock deal, which hinges on federal legalization in the U.S., would see Smiths Falls, Ont.-based Canopy absorb licenses or agreements in 20 states. Acreage had 24 vertically integrated dispensaries and 63 dispensaries licensed through managed service agreements, as of March 2019, according to company reports.

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More importantly, the deal clearly telegraphs Canopy’s American expansion plan to investors without running afoul of the major exchanges its stock trades on.

Steve White, chief executive officer of Acreage-rival Harvest Health & Recreation Inc. (HARV.CN), is among those who see the complex agreement as a blueprint for more consolidation.

“It’s a fantastic deal for Canopy. It’s also a fantastic deal for Acreage,” White told an audience at the Benzinga Cannabis Capital Conference in Toronto last week. “You have to really commend Canopy for doing something that everybody in Canada needs to be doing. They did it first, again.”

Canopy has built a reputation for firsts in the cannabis business. Trading on a public exchange, hitting US$1 billion in market value, and securing a big investment from a major consumer brand, just to name a few.

White predicts Canopy’s plan to acquire the New York-based multi-state cannabis operator will be “a blueprint for big consumer packaged goods companies, alcohol companies, and big retailers” who will “take that structure and buy into the fastest-growing market in cannabis; the United States.”

Canopy’s planned acquisition of Acreage comes amid a flurry of stateside dealmaking. Harvest announced a $850 million all-stock transaction to acquire Chicago-based Verano Holdings in March. Last October, New York-based iAnthus Capital Holdings Inc. (IAN.CN) acquired MPX Bioceutical in a $640 million deal. California cannabis chain MedMen Enterprises Inc. (MMEN.CN) bought PharmaCann in a $682 million all-stock transaction that same month.

Cowen’s Vivien Azer, one of the industry’s top U.S. analysts, forecast in January that U.S. cannabis sales will reach $80 billion by 2030, if pot is federally legalized.

Greg Taylor, chief investment officer at Purpose Investments, said until now, exposure to U.S. cannabis has been a pipe dream for Canadian licensed producers wary of losing their listings on the big boards. He predicts competition to buy U.S. cannabis assets will heat up as the country leans closer to federal legalization, and other major firms attempt to mirror Canopy’s deal.

“If people can get a toe-hold in before those doors open, I think this could be an interesting way to do it,” he said of Canopy’s bid for Acreage.

“Constellation I’m sure was certainly involved in this, given that they are on Canopy’s board. They’ve found a way to get exposure to U.S. cannabis, essentially through a two-hands removed party.”

Beer and wine giant Constellation Brands Inc. (STZ) invested $5 billion in Canopy last year in a blockbuster deal that upped its ownership interest to about 38 per cent. Shares of the New York-based beverage company have climbed more than seven per cent since reports of the Canopy-Acreage deal surfaced last week.

GMP analyst Martin Landry upgraded Canopy to “buy” from “hold” on Monday, hiking his price target by $7 to $72. Toronto-listed Canopy shares climbed 7.93 per cent on Monday, closing at $64.37.

Benchmark analyst Mike Hickey separately noted that the deal “illuminates a path for the U.S. cannabis market.”

‘The Canadian advantage is shrinking’

The asterisk on the Canopy-Acreage deal, federal legalization of cannabis in the United States, would eliminate the chief competitive advantage for Canadian licensed producers — better access to capital markets.

For White, the catalyst could be the passage of the STATES Act, legislation that would exempt cannabis from most federal drug laws within states that have legalized it.

He said that would pave the way for Canadian Securities Exchange-listed, U.S.-focused cannabis companies like Harvest to step up to the to big boards, levelling a key playing field with the large Canadian licensed producers.

“What they (Canopy) did, is they took a stock . . . that trades at a higher multiple than the U.S. companies by seven-fold, and they used that currency to acquire something that is going to grow in the very near future at a rate that unlike anything else across the globe,” White said.

“If something like the STATES Act were to pass this year, then a transaction like Canopy/Acreage could be consummated . . . if that happens and we can also list on the NYSE, that seven-times multiple between us and our Canadian peers disappears.”

Taylor said questions remain about what exactly constitutes “federal legalization of cannabis in the United States” under the terms of the Canopy-Acreage deal. What’s more clear, he said, is that Canadian cannabis companies will not be able to rely on tapping the capital markets to stay ahead of U.S. rivals for much longer.

Investing in U.S. cannabis is getting easier. The Evolve U.S. Marijuana ETF (USMJ.NE) became the world’s first U.S.-focused cannabis ETF when it began trading last Wednesday. It’s comprised of a basket of 38 companies, including Acreage, Harvest and Canopy.

Taylor’s rival Purpose Marijuana Opportunities Fund (MRJOF) is about 27 per cent invested in U.S. cannabis, including Harvest and Acreage.

He said while U.S. cannabis firms are establishing solid brands in states where weed is legal, their Canadian peers are falling behind on that front due to restrictive regulations.

Meanwhile, he said he struggles to see the Canadian cannabis edge show up in the quarterly earnings.

“They don’t have big earnings numbers. They don’t have huge top-line revenues. Really, they are focusing on growing and not creating brands. At the end of the day, that’s where the value in the sector is going to be. In the brands and the retail,” Taylor said.

“Really, the Canadian advantage is shrinking, and the window is closing quite quickly.”

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