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Kyle Jeffers/Rodeo Production/The Globe and Mail

When David Klein became CEO of Canopy Growth Corp., the New York State resident got an apartment in Toronto. His plan was to bounce between there and Smiths Falls, Ont., where the cannabis producer is headquartered. In March, he was in Toronto as coronavirus cases surged in Canada and the U.S., and authorities mulled a border shutdown. Instead of spending the weekend, he hightailed it back to his home outside Rochester. “I just decided it was starting to get a little dicey,” he says. “I haven’t been back to Canada since, which is not ideal.”

For months, Klein has been running Canada’s largest cannabis producer from the home office he shares with his wife. That he’s stuck in upstate New York, though, is somewhat fitting. That’s where Constellation Brands Inc. is headquartered. The alcohol giant is Canopy’s largest—and most vigilant—investor. It’s the place Klein hails from (he spent roughly 15 years there), along with four other members of Canopy’s 11-person C-suite. And it’s the place from which Klein draws at least some inspiration.

Klein inherited a mess when he took over Canopy in January. It grew too big, too fast, and in all directions. The company’s approach was to be first to market, spend lavishly and dominate. It gained share, but lost gobs of money in the process. Klein himself has been mildly critical of Canopy’s past approach, saying that being first does not amount to a sustainable strategy. He has a background in numbers—his last job was chief financial officer at Constellation—and he has been clinical in shuttering facilities and laying off hundreds of workers in a bid to remake Canopy into a slimmer, more focused producer. Analysts are impressed with his swiftness. “He bit the bullet, to a degree, with a lot of the things that just needed to happen,” says Matt Bottomley, director of equity research at Canaccord Genuity.

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But there’s a lot of work to do. Canopy is still bleeding money, its stock price is down some 60% since legalization, and cannabis remains a commodity product facing stiff competition from the illicit market. Owing to restrictions around advertising and how pot is sold, producers are hamstrung trying to make their products stand out with consumers. A big part of Klein’s plan also happens to generate significant skepticism with some analysts. Canopy is determined to make cannabis beverages a bona fide consumer product in the belief that the public will want to drink their way to a high. With backing from Constellation, which invested $5 billion in Canopy in 2018, the company built a 125,000-square-foot bottling plant in Smiths Falls capable of pumping out more than five million beverages every month. The first two drinks were released in March and April, and have been followed by a handful more. So far, Canopy has shipped about two million units in total.

Beverages containing THC have been available in some U.S. states for a while, but they account for only a tiny percentage of overall cannabis sales. Canopy believes the market can be much, much bigger and that beverages will appeal to people unlikely to consider smoking or vaping. Klein, who is partial to Canopy’s lemon-flavoured THC-infused sparkling water, admits he could be an outlier in his bullishness, but says, “There are just so many benefits that come from the product, and we can bring those products to people who’ve been afraid to try them.”

If he’s right, Canopy could dominate an entirely new category, expand the market for cannabis, slow the cash bleed, and make its largest shareholder very happy. If he’s wrong, the worrying question is just how much money Canopy will lose to figure that out.

Canopy started life in 2013 as Tweed Marijuana, and its corporate face was co-founder Bruce Linton. It’s hard not to notice the differences between Linton and the guy who replaced him. Linton is a floppy-haired, gap-toothed dynamo who sometimes showed up on television in a black Canopy T-shirt, projecting a weird combination of goofy hockey dad and jubilant stock promoter. His relentless hustle helped turn Canopy into the biggest cannabis company in the world. Klein is more reserved, opting for the jacket-and-no-tie look favoured by executives wanting to look casual. When he appeared on Mad Money a few months ago opposite the steroidal Jim Cramer, he was a study in restraint. He’s an athletic guy who pushes himself through long bike rides while pounding energy gels, and whose hair is closely shorn, as if any excess strands would create drag.

Linton has said he has never used cannabis recreationally; Klein is exceedingly careful when answering the question. When in Canada, he finds it “really interesting” to walk into a dispensary and test different products. When he’s in the U.S., where recreational cannabis is not legal at the federal level, he’s a “big proponent” of CBD products, including a line of gummies Canopy launched with Martha Stewart.

Klein studied economics and got an MBA at the State University of New York, and eventually took a job as director of mergers and acquisitions at Xerox Corp. He and two colleagues hatched an idea for a new business that would provide professional internet services to underserved small and mid-sized companies. The trio quit their jobs to launch a startup in 1999, and while it wasn’t a dot-com company per se, it was buoyed by the froth and done in by the pop. “It didn’t end terribly, but it didn’t end well,” he says.

Still, Rob and Richard Sands, the brothers who built Constellation into a beverage giant whose portfolio in the U.S. now includes Corona and Modelo, were intrigued by the story of entrepreneurial grit when they later met Klein. He joined in 2004 as vice-president of corporate development, and over the next decade, made his way to CFO. Bill Newlands, Constellation’s CEO, found Klein was concerned about a lot more than whether the numbers added up. “I always relied on him if I needed good advice, because he thinks broadly about issues,” Newlands says. When Klein investigated buying a Mexican brewery a few years ago, Newlands was impressed at how he thought beyond economics, considering how the operation’s employees would react to a takeover.

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Klein also led a group at Constellation hunting for business lines to complement alcohol, an industry dogged by slow growth. Wine consumption in the U.S. dipped 0.9% in 2019 for the first time in 25 years, while beer dropped 2.3%, marking four straight years of decline, according to research firm IWSR. Constellation’s wine and spirits business actually shrank 6.4% between fiscal 2020 and the previous year.

Kyle Jeffers/Rodeo Production/The Globe and Mail

Constellation considered energy drinks, but research kept pointing to cannabis as a way people were managing stress, anxiety and general well-being. While Newlands says Constellation’s involvement in the space was not a defensive move, others view legal weed as a threat to the alcohol business. A separate IWSR report last year noted that 37% of alcohol drinkers in states where cannabis is legal also consume cannabis.

Constellation made an initial investment in Canopy in 2017. “That’s when the light bulbs went on across Constellation’s leadership team and board of directors that this is a place where we want to play,” Klein says. It followed up with a $5-billion investment the next year, paying a 50% premium on the stock.

By 2019, cannabis companies weren’t faring well. Legal sales got off to a slow start, owing in part to the glacial rollout of stores and cheaper weed on the illicit market. Stock prices crashed and investors bailed. Constellation executives were fretting over its stake in Canopy, which is now 38.3%. (That October, Constellation reported a US$839-million decrease in the fair value of its investment.) In July of that year, a few days after Newlands said on a conference call that Constellation was “not pleased” with Canopy’s performance, the company announced Linton was stepping down as co-CEO. Linton himself dispensed with euphemisms and told reporters he was fired. (Co-CEO Mark Zekulin said he’d resign after a replacement was found.)

The board, of which Klein was then chair, started hunting for a new CEO. He had no interest in the role for himself, but as he was interviewing candidates, he began thinking about it. “I just started to get more excited about what Canopy was,” he says. Late in the process, he put his own name forward. For Constellation, having someone they knew and trusted in the role was important, according to Newlands, who also sits on Canopy’s board. “We’ve got a big investment, and we’d like to see it do well.”

Klein’s arrival was, for some, a chance to take a pause after years of rapid growth. “We got to a place where we had the fundamentals that let us take that breath and really assess where we were,” says Rade Kovacevic, Canopy’s president. When Kovacevic, Klein and a handful of other executives were delayed at the Calgary airport earlier this year, Klein used the opportunity to start a discussion about what Canopy should look like in the future. “David pushes and embraces those discussions out of a very honest belief that they lead to a better result,” Kovacevic says.

The future, at least in the near-term, meant getting smaller. Klein has closed two large greenhouses in British Columbia, which eliminated 500 jobs, and scaled back operations to focus on recreational and medical markets in Canada, the U.S. and Germany. He pulled out of pharmaceutical research and renegotiated a deal with Acreage Holdings Inc., a U.S. cannabis firm, that gives Canopy the right to purchase the company upon federal legalization in the U.S.

Even with those cuts, Canopy’s selling, general and administrative expenses totalled more than 100% of sales in the last quarter, miles away from the company’s loose target of about 30%. It commands a $10-billion market cap, but only made $119 million in revenue in the quarter, with a $128.3-million loss.

As for when Canopy will turn a profit, Klein demurs, saying the company is working on a “financial algorithm” that will provide more clarity. The company does have the advantage of a sizable balance sheet—as of the end of December, it had $1.56 billion in cash—putting it in a better position than some of its peers.

Klein still has a slight bias toward growth, he says, and that means turning a profit may depend less on wrangling with costs and more to do with just selling more cannabis. To do that, Klein realized the company needed to better understand its customers, rather than trying to appeal to everyone. He reorganized the C-suite to focus more closely on consumer preferences, installing a chief insights officer (from Constellation), a chief innovation officer (also from Constellation) and a chief product officer (Kovacevic, in addition to his role as president). “You can innovate your product portfolio to very closely meet the needs of those consumers,” Klein says.

Some analysts are doubtful any producer can truly set its products apart. This past year, consumers flocked to cheap cannabis flower, which producers see as crucial to battling the illicit market; Canopy introduced its own value brand in the spring. Tamy Chen at BMO Capital Markets wrote earlier this year that the popularity of the value segment shows price might be the only thing consumers care about. “We continue to believe longer-term differentiation and profitability will be elusive for Canopy and the industry for some time,” she wrote.

Canopy’s approach to CBD products in the U.S. is more promising, says Owen Bennett, an analyst at Jefferies Group. “This is what investors should be using as a template for what the new management team may ultimately be able to deliver,” he says. The company offers products under five different brands, including “wellness gummies” and oil drops bearing Martha Stewart’s name; “hydration mixes” under the BioSteel brand; and skin-care “boosters” from a line called This Works. The CBD market is cluttered and fragmented, and research into its effectiveness is ongoing. Not all of Canopy’s products may be winners. But Bennett is encouraged by the thought put into branding and consumer segmentation, which didn’t happen to nearly the same extent with cannabis in Canada.

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The product Klein seems most excited about, though, happens to be the one others find the most perplexing: cannabis beverages. The concept of a drink that gets you high might seem strange at first, but Klein sees it this way: We’re all familiar with drinking, but many people view smoking as intimidating or just plain gross. Not only can a beverage produce a high, but it also comes with no hangover and can contain zero calories, depending on the variety. Most important, Klein is confident Canopy’s drinks don’t taste like bong water.

The explosion in popularity of alcoholic seltzers such as White Claw is proof there’s an appetite beyond beer, wine and spirits, in Klein’s view. So-called hard seltzers accounted for just 0.9% of the U.S. alcoholic beverage market in 2018, but soared to 2.6% a year later, according to data from IWSR. The research firm expects sales of hard seltzers will more than triple by 2023. Part of the reason for their popularity, says Klein, is they can be flavoured to taste like just about anything—also true of cannabis drinks, which he insists taste better. (Molson Coors has launched a line with Hexo Corp., while Anheuser-Busch InBev set up a venture with Tilray.)

What’s concerning for some analysts is that cannabis beverages have already been available in some U.S. states but make up only a small percentage of total cannabis sales—just 5% of total edible sales in the second quarter of 2020, according to BDS Analytics. “Canopy has been so bullish on the space, when everything we hear in the U.S. would suggest that’s not going to be the case,” says Bennett. (He concedes he could be wrong.) He suggests the money could be better spent on more promising products.

But American companies are constrained, given recreational cannabis is legal in only a handful of states. “The beverage market hasn’t taken off in the U.S. more as a function of regulation and the inability to efficiently produce at scale, given they can’t move things across state borders,” says Rishi Malkani, a partner at Deloitte. Canopy doesn’t have that problem because of Canada’s federal framework. Deloitte estimated last year that the Canadian market for cannabis edibles and other products could someday be worth $2.7 billion, with beverages accounting for $529 million, or 20%.

Canopy has so far released nine different drinks. There’s a THC-infused soda water and a ginger ale under its Tweed brand; lemon- and grapefruit-flavoured sparkling waters under its Houseplant label; and a high-THC carbonated drink called Deep Space. In November, Canopy introduced four more sparkling waters as part of its Quatreau brand. (Next year, the company will launch its drinks in some U.S. states through Acreage.)

Canadian regulations limit the THC content in edibles to 10 milligrams, so the odds of someone chugging a drink and ending up incapacitated are greatly reduced. Most of Canopy’s beverages contain 2.5 milligrams of THC or less, which is supposed to mimic the experience of drinking a standard alcoholic drink. Klein says Canopy has paid extra attention to the time it takes someone to feel an effect, too. When cannabis is smoked, THC enters the bloodstream rapidly through the lungs, while edibles take longer. The danger for the uninitiated is they can feel completely fine after half an hour and assume they should take more—only to be knocked on the floor later on. Klein says Canopy’s drinks have an onset time of seven to 15 minutes, similar to alcohol, so that people are at less risk of overconsumption.

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But Jason Zandberg, an analyst at PI Financial Corp. in Vancouver, says he’s tried a lot of gummies and beverages available on the market, and has yet to see any of them come close to those onset times. You might feel something at 15 minutes, but the peak high still comes after 45 minutes to an hour. “A lot of companies have tried to fix that onset problem,” he says, “but it hasn’t been fixed yet.”

When Klein talks about a large potential market of people out there who wouldn’t ordinarily smoke cannabis but would be enticed by drinking it, he could be talking about me. I’m well past the age of wanting to inhale anything, but the promise of a beverage that contains no calories, produces no hangover, and can soothe all pandemic-induced anxieties? Yes, please.

I first tried a THC-infused soda from Canopy’s Tweed brand. Unfortunately, it tasted faintly like a skunky Perrier. The Tweed ginger ale was an improvement, though it did carry a mild aftertaste that’s hard to identify. It also contains a full 29 grams of sugar and 130 calories. So much for health and wellness. The best-tasting Canopy beverages, in my opinion, are under the Houseplant brand. The sugar-free, THC-infused sparkling water actually tastes as billed. After a few sips, it’s easy to forget the drink contains any cannabis at all. In fact, it doesn’t have much THC at all—just 2.5 milligrams.

The last one I tried is the dark, syrupy carbonated beverage called Deep Space, which packs the maximum 10 milligrams of THC. The taste is a cross between cola and root beer, though that doesn’t quite describe its confounding flavour. About an hour after finishing the can, I didn’t feel anything. I was about to write it off when I soon found myself laughing hysterically while reading my son’s Winnie the Pooh book. Zandberg’s criticism of the claims around onset time suddenly felt very accurate.

After I experimented with cannabis beverages, including half a dozen from competitors, the challenges facing the category were more apparent. Most of the drinks in Canopy’s arsenal, including the best-tasting ones, contain little THC. Not everyone’s tolerance is exactly the same, but it could take at least a couple to feel much of anything. Deep Space, the one that delivered, packs 22 grams of sugar. Despite claims to the contrary, the onset time was similar to any other edible—and very unlike alcohol.

It’s possible that cannabis beverages might just be an acquired taste. After all, who among us truly enjoyed beer or wine upon first sip? But for the new user, cannabis drinks require a fair amount of experimentation. You have to find a flavour you like, figure out the optimal dose of THC and determine whether the high is even enjoyable. It takes commitment, and that’s not a word associated with leisure. In the end, it might be easier for some to stick with what they know—or pop a gummy or chocolate in search of a high.

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When I asked Chris Edwards about this, Canopy’s chief insights officer didn’t necessarily disagree that consumers will have to experiment, but he doesn’t think they’ll be dissuaded. “We believe this is a pretty compelling consumer proposition. There are just a lot of benefits to cannabis beverages,” he says. Canopy could still make any number of changes, he adds, tweaking the flavouring, packaging or THC content in response to consumer feedback.

So far, Klein is pleased: Early research has shown around three-quarters of consumers who tried Canopy’s beverages would do so again. “That’s very high by consumer packaged goods standards, especially for new-to-the-world products,” he says. Data from the Ontario Cannabis Store shows Canopy had two of the top-selling beverage brands online and three of the top brands sold through legal retail stores between April and June. (Beverages only made up 1.2% of sales during that time.)

It’s a start. But it could be years before drinks make up a meaningful component of sales, if ever. For all his enthusiasm, Klein is hesitant to say just how big the segment could get, though he allows cannabis drinks could eventually account for 5% of the beer market, a US$110-billion industry in the U.S. “That’s a massive number,” Klein says—$5.5 billion. It will take millions of cannabis drinkers to get even close to that. Constellation is betting on it.

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