A U.S. alcohol giant's decision to buy a stake in Canopy Growth Corp., Canada's largest cannabis producer, sent marijuana stocks sharply higher on Monday and is expected to spur more cross-industry combinations as well as lure a new class of investors to the emerging industry.
Constellation Brands, a U.S.-based booze distributor behind brands such as Corona beer, Kim Crawford wine and Casa Noble Tequila, is buying a near 10-per-cent stake in Canopy for $245-million. The agreement also includes a plan to together develop and market cannabis-based beverages for adults in markets, where legal.
The deal is considered the first of its kind in the cannabis sector, which helped to drive up shares of Canopy and other pot stocks on Monday. Canopy shares closed up 19 per cent, while other large producers such as Aphria Inc. and Aurora Cannabis Inc., finished the day up 8 per cent and 5 per cent, respectively. The Horizons Marijuana Life Sciences Index ETF, Canada's first cannabis ETF, was up 5 per cent.
While the cannabis sector remains volatile, Constellation's stake in Canopy adds credibility to the fledgling industry and could be the lure for large institutional investors to get in, said Bruce Campbell, a portfolio manager at StoneCastle Investment Management. "It's one more thing that brings a long-term investor focus into the sector," said Mr. Campbell, who owns shares of Canopy and a handful of other marijuana stocks.
"I think if you took a snapshot of Canopy investors today and in six months, you'll see more institutional investors coming in."He also expects more "boardroom dating" between cannabis producers and alcohol and tobacco companies in the future. "Ever since the dawn of recreational marijuana, everyone has talked about alcohol and tobacco getting involved. Now we're seeing the first move by alcohol. It's huge from that perspective," Mr. Campbell said.
Constellation said the investment is part of its "long-term strategy to identify, meet and stay ahead of evolving consumer trends and market dynamics," but its focus will remain on its alcohol business.
Ryan Modesto, chief executive officer at independent research company 5i Research, said the investment is a drop in the bucket for Constellation, which has a market cap of $41-billion (U.S.).
"It's not like they're making a company bet on the industry. It's probably more defensive than anything," Mr. Modesto said. "They're getting a toehold in the industry in case it becomes something bigger. Then they'll already have a bit of know-how and a head start on potential competitors looking to get in as well."
Mr. Modesto believes the deal will also "light a fire" under the cigarette companies that are "looking to ensure they get a foothold as well before all of the companies get snapped up."
He said that could be appealing to higher-risk investors in the short term. "The trick is figuring out which companies will be the target," Mr. Modesto said.
Canopy CEO Bruce Linton said the Constellation investment signals confidence in his company and the potential for the sector.
"This is a pretty big deal for us, for Canada and for the sector to an extent," Mr. Linton said in an interview.
The investment will also help Canopy with its aggressive expansion plans.
"The money will be very helpful, but it's more about what we will be able to do together," Mr. Linton said. "It would be an outstanding association in the absence of any money."
Mr. Linton said Canopy reached out to Constellation about seven months ago and came up with the agreement that sees the liquor giant purchase a 9.9-per-cent stake at $12.98 (Canadian) a share. Canopy shares closed at $12.79 on Friday and soared to a record closing price of $15.22 on Monday. (The stock hit an intraday high of $17.86 in mid-November, 2016).
Beacon Securities analyst Vahan Ajamian has a "buy" on Canopy shares and raised his target to $16 from $14, calling the agreement a "game changer" for Canopy and the industry.
"In our view, this highlights the disruption that the alcohol companies are likely to face as recreational cannabis continues its global march forward – and how the leaders in the sector are looking to get in front of it," he said in a note.
PI Financial analyst Jason Zandberg has a "buy" on Canopy and increased his target to $18 from $13.25. "Canopy Growth trades among the highest multiples in the sector and Constellation's investment (at a premium to recent trading prices) validates cannabis trading valuations," he said in a note.
Echelon Wealth Partners analyst Russell Stanley increased his target price on Canopy to $13 per share from $10.50, calling the agreement a "validation of Canopy's strategy," but downgraded the stock to "hold" from "speculative buy" saying investors should wait for a pullback before stepping in.
Mr. Stanley also believes it's the first of many deals for cannabis companies with players in the alcohol, tobacco and pharmaceutical industries.
"The first in the pool is often followed by a number of others," Mr. Stanley said. "There is a tendency for other players to follow suit and not be left behind.