Part of cannabis and investing
Goodbye, Bruce Linton. Hello, the new Canopy?
When Canopy Growth Corp. fired Mr. Linton as its co-chief executive officer this week, the move surprised nearly everyone – especially investors who had long viewed the executive as crucial to the company’s future.
Mr. Linton was much more than the co-founder of Canada’s largest cannabis producer. He was the most recognizable executive face of the pot industry and a superstar to the retail investors who made piles of money as he turned Canopy into an $18-billion company.
But investors don’t appear to be panicking. After initially selling off on Wednesday morning, the stock rebounded quickly and ended the week slightly higher than before the announcement.
Could the market be suggesting the departure of Canopy’s charismatic founder, far from disastrous, might actually be good news for a company that seeks greater respectability among institutional investors and stable financial performance?
If so, it certainly wouldn’t mark the first time a company has prospered after its founding leadership has been replaced by professional management. Indeed, some who have studied these transitions say they tend to serve companies – and their investors – well.
“A lot of the folks who start businesses do it for reasons other than to run the business as efficiently as possible,” Victor Bennett, an associate professor at Duke University’s Fuqua School of Business who has done academic research on management transitions, said in an interview.
Founders typically like being their own boss and making their own decisions, he said. But a lot of companies run by their founders fail to employ the typical policies of mature, efficient businesses – such as promoting people based on performance. “Putting in place controls and professionalizing the place by making yourself less necessary does not go hand-in-hand with giving yourself as much control as you want,” Dr. Bennett said.
According to his research, founding CEOs often don’t make the best top managers, simply because the skills needed to create a company aren’t always compatible with the skills required to lead a company in its more advanced stages of development. Often, the founder’s departure is good news for the company if it has grown to the point where it needs professional management.
In a paper Dr. Bennett co-authored in 2017, he argued founder-led firms were less productive and had lower management scores – until the CEO was replaced: “Firms led by founder CEOs experience significant improvements in their management practices upon a change of ownership, and these improvements are generally much larger than what is found for other ownership transitions.”
Noam Wasserman, a professor at the University of Southern California Marshall School of Business, discovered through his research that four out of five founder CEOs are forced to step down from their positions. This makes executives such as Bill Gates, who led Microsoft Corp. from its inception in 1975 until 2000, a rarity in the corporate world.
Often, founders have undesirable leadership traits, such as overconfidence and an overemotional attachment to their companies, Dr. Wasserman found, putting their jobs at risk when they are no longer in control of their company’s board.
Mr. Linton’s rise and fall at Canopy followed the typical path of ousted CEOs.
First, he lost control of the company. Actually, he sold it. New York-based Constellation Brands Inc., which markets and produces wine, beer and spirits, initially bought a 9.9-per-cent stake in Canopy in October, 2017, for about $245-million. Constellation Brands then increased its stake to 38 per cent last August in a deal valued at $5-billion.
Both investments were heralded as major breakthroughs for Canopy and the cannabis sector, giving the legalized marijuana industry a dose of legitimacy that would help attract money from other consumer-products companies and well-heeled institutional investors.
Such a large investment from Constellation, a company that generated a profit of US$3.4-billion in its most recent fiscal year, suggested that cannabis stocks were no longer the sole domain of punters.
“Canopy Growth has been the poster child of the cannabis space, having gotten the Constellation investment as one of the first validations of the space,” said Amy Freedman, CEO of Kingsdale Advisors, a shareholder services and advisory firm.
But validation came with a price: Constellation gained control of four of Canopy’s seven board seats, which meant Mr. Linton no longer called all the shots. His leadership skills were now being judged by new masters, who were less enamoured with relentless deal-making and more focused on financial performance.
These new masters didn’t like what they were seeing. Bill Newlands, Constellation’s CEO, said on a recent conference call: “We were not pleased with Canopy’s recent reported year-end results.”
Mr. Linton was bent on global domination of the cannabis market; Canopy now operates in 15 countries on five continents. The company grows a lot of weed through 11 licensed sites with more than 4.7 million square feet of production capacity. But it also sells cannabis under its Tweed banner through 20 stores across Canada. Canopy sells devices through its Storz & Bickel GMbH & Co. KG subsidiary and has a medical division called Spectrum Therapeutics. For a company so young, it’s sprawling.
Mr. Linton didn’t want to slow down: In April, he struck a US$300-million deal for the right to acquire New York’s Acreage Holdings Inc. should the U.S. federal government legalize cannabis.
In spite of its industry-leading size and early-mover advantages, Canopy has struggled to turn a profit. In its latest quarter, Canopy reported a loss of $323-million – four times what analysts had expected, and operating margins narrowed.
While cannabis legalization was once touted by management as the starting point for strong financial performance, the company has encountered a number setbacks related to hefty operating expenses and supply-chain bottlenecks. The Canadian cannabis industry struggled to meet early demand.
Mr. Linton blamed the weather, after a heavy snowfall in British Columbia damaged a greenhouse, when announcing the company’s latest financial results. As for the elusive profits, he said the coming launch of edibles – higher-margin foods, drinks and vape products – will lead to profitability down the road.
Still, investors can point to a number of positives for which Mr. Linton deserves credit.
He made long-term investors rich: Under his leadership, the share price has increased more than 1,780 per cent over the past three years, easily outperforming the Horizons Marijuana Life Sciences Index ETF, an exchange-traded fund that tracks the North American publicly traded marijuana industry.
He gave the company blue-chip respectability: It was the first cannabis producer to be included into the S&P/TSX Composite Index, in March, 2017. (It joined the more exclusive S&P/TSX 60 Index in April, 2019.)
He generated industry-leading sales: Canopy reported revenue of $94.1-million in its fiscal fourth quarter ended March 31, a 313-per-cent increase over the previous year and well above rivals. The company’s revenues account for more than 25 per cent of the total quarterly sales among Canada’s top 15 producers.
All of that has allowed Canopy to attract a sky-high valuation: The stock recently traded at 51.6-times enterprise value to consensus estimates of 2021 EBITDA (earnings before interest, taxes, depreciation and amortization), according to a recent analysis by Echelon Wealth Partners. That’s about double the average valuation for the top nine cannabis producers and reflects confidence in the company’s long-term prospects.
Some observers are already bemoaning the loss of Mr. Linton. John Chu, an analyst at Desjardins Securities, now expects that Canopy shares will trade at $59 in 12 months, down from a more bullish price target of $63 previously, based on his belief the stock will trade at a lower valuation multiple without the founding CEO at the helm.
“The surprising loss of co-CEO and chairman of the board Bruce Linton is a blow to the company, in our view, and likely creates near-term uncertainty with respect to the company’s leadership and direction,” Mr. Chu said in a note.
But other observers point out Mr. Linton’s departure can bring much-needed improvements.
For one, corporate governance needs a boost. In the Report on Business annual evaluation of Canada’s corporate boards, Canopy placed second-last (above Aurora Cannabis Inc.) out of 237 companies, owing partly to issues related to board composition and financial disclosure.
“If you’re an entrepreneur in this space and you’ve created value, it becomes a question of, how do you get the right board in terms of skill set, and hopefully checking off some governance boxes. All the studies show that proper governance leads to true value creation," Ms. Freedman said.
Jettisoning Canopy’s co-CEO structure might also help. Although Mr. Linton was the company’s most vocal executive, he actually shared the CEO role with Mark Zekulin.
“I feel that co-CEO arrangements are inherently unstable and undesirable," said Hugh Arnold, a leadership consultant and adjunct professor at the University of Toronto’s Rotman School of Management. “It leads to indecisiveness, some things falling between the cracks or irresolvable conflict.”
And lastly, more professional leadership at Canopy could bring greater stability to a share price that – as with much of the cannabis sector – has been exceptionally volatile, soaring and plummeting with promotional hype that often descends from the corner office.
Mr. Linton was no stranger to hyperbole. In an interview with The Globe and Mail this week after his firing, he described Canopy in terms that would make most seasoned executives blush: "This is a rocket ship fuelled up and moving and all you have to do is hold on,” he said.
Trouble is, many investors are going to need to see financial consistency to encourage them to hold on – and consistency has been lacking under much of Mr. Linton’s leadership, highlighted by the surprisingly large loss in Canopy’s latest quarter.
“Entrepreneurs burn through cash,” Dr. Arnold said. “Losses themselves aren’t a reason to fire the CEO.”
But, he added, losses that go beyond the expectations of investors and are not part of the business plan can provide a reason for termination, which is why founders frequently move on. Mr. Gates and, more recently, Facebook Inc.’s Mark Zuckerberg are rare examples of CEOs who stayed with their creations. Most don’t – and that’s not a bad thing.