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opinion

Certain investors, like Warren Buffett, make money just being themselves. When his Berkshire Hathaway reveals an investment in a public company, investors rush in on Mr. Buffett’s imprimatur, driving the shares up and providing the Oracle of Omaha with a tidy profit.

Alcohol giant Constellation Brands Inc. does not have such a reputation, at least not yet. But its wildly successful investment in Canada’s Canopy Growth Corp. seems like a page out of the Buffett playbook.

Constellation’s $245-million investment in Canopy shares at the end of October was worth, at Wednesday’s close of $36.93, nearly $1.2-billion. That’s a gain of more than 385 per cent in less than eight months. At Friday’s 52-week high of $48.72, before Canopy’s tumble this week, the position was worth $1.6-billion and had gained almost $450-million in less than a month.

When Constellation releases its earnings on Friday for its fiscal first-quarter ended May 31, it’ll report a gain on its Canopy position for the three months of more than US$250-million. All of that flows to the company’s bottom-line net income, which has typically ranged between US$400-million and US$500-million in recent quarters.

The Constellation investment in Canopy was seen at the time as a savvy, long-term move, but few may have thought it would pay off so quickly. When Constellation, owner or marketer of brands such as Corona, Modelo, Robert Mondavi, and SVEDKA vodka, bought into Canopy, it offered a stamp of legitimacy to the cannabis business. Constellation benefited as well, demonstrating that it was keenly aware that legalized pot poses some risk to future growth in alcohol consumption.

The companies offered scant details of the transaction at the time, but the structure of the deal, and the value to Constellation, can be gleaned from the companies’ securities filings.

For its $245-million, Constellation got just under 18.9 million Canopy shares at $12.97 apiece, the average price of Canopy shares in the five days leading up to the transaction. That represented 9.9 per cent of the company’s share count at the time. It also got an additional 18.9 million warrants to purchase Canopy shares, at the same price of $12.97. The warrants expire in May, 2020, and are exercisable in two equal chunks, one no sooner than Aug. 1 and the other no sooner than Feb. 1, 2019.

The warrant portion is the little-known element of Constellation’s investment, but it brings significant value to the deal. At Canopy’s close on Wednesday of $36.93, the shares held outright were worth just less than $700-million and the warrants are worth just more than $26 apiece, per the Black-Scholes options-pricing model that Constellation is using to tell shareholders what the warrants are worth. On that basis, the warrants add nearly $500-million to the position. (The company declined to comment, citing its earnings release Friday.)

By owning 9.9 per cent of Canopy and not 10 per cent or more, Constellation is able to avoid the “equity method” of accounting, where it would take a proportional share of Canopy’s losses and place them in its income statement, says Robert Willens, a Wall Street analyst with an eponymous firm, who specializes in matters of U.S. taxation. Canopy posted a net loss of $70.4-million over the past 12 months, meaning Constellation would cut its earnings by about US$5.2-million if it owned just a bit more of Canopy.

An exercise of the warrants would increase Canopy’s share count by nearly 10 per cent, but in an interview Tuesday, Bruce Linton, Canopy’s CEO, said he was not concerned about imminent dilution of his shareholders.

“Why would you exercise a warrant before it expires when it sits in the money, and it would put you in a different reporting category?”

By the time the warrants mature and Canopy is, presumably, losing less money or is even profitable, and a dividend is in its future, Constellation could benefit by exercising the warrants. When U.S. corporations receive dividends from a foreign corporation, they are fully taxable in the United States at a 21-per-cent rate if the U.S. corporation owns less than 10 per cent of it. (Canopy does not currently pay a dividend.)

The Oracle of Omaha should admire how Constellation added this star to its portfolio.