Riddle me this – How many Canadian cannabis companies can enter the U.S. market with size and scale to compete against existing MSO's when full legalization occurs?
On Monday, CRON said it agreed to make a "strategic investment" in U.S. cannabis company PharmaCann. Cronos paid $110.4 million for an option to acquire a 10.5% ownership stake in PharmaCann, once cannabis is federally legal in the U.S. PharmaCann is privately owned and operates in six states: New York, Illinois, Ohio, Maryland, Pennsylvania, and Massachusetts.
Cronos Group Inc. and PharmaCann Inc. announced that they have entered into an agreement under which a wholly-owned subsidiary of Cronos Group has purchased an option to acquire an approximately 10.5% ownership stake in PharmaCann on a fully diluted basis. The Option exercise will be based upon various factors, including the status of U.S. federal cannabis legalization and regulatory approvals, including the states where PharmaCann operates that may be required upon exercise. Under the Transaction terms, the total consideration paid by Cronos Group for the Option was approximately $110.4 million, which was deposited by Cronos Group with a third-party paying agent to be distributed directly to PharmaCann shareholders. In addition, the Option is subject to certain anti-dilution and other adjustments.
The deal is a milestone for multiple reasons, most important of which it gives a long, awaited sign of how CRON will begin to approach the U.S. market. Unlike 99% of all Canadian cannabis companies, CRON can approach the U.S. market from a position of strength. The company has the balance sheet, existing CBD infrastructure, and Altria as a strategic investor to navigate the opportunity. The company has said that Executive Chairman, Mike Gorenstein, is looking at U.S. opportunities and the best way for the company to compete in the U.S. We now have a small insight into his thinking.
CRON's first move is to buy a position in a robust US MSO with "no baggage." Meaning, all of the operations of PharmaCann are in limited license states with significant growth opportunities. Mr. Gornstein has said he does not want to be a farmer, so we suspect the PharmaCann brands and retail opportunities are what got the deal over the finish line. We would add that this validates our long-term thinking that some of our LONG MSO presents great buys at current levels. Especially GTBIF and AYRWF.
All the major Canadian companies have been vocal about their intentions to enter the U.S. market as soon as federal legalization occurs. However, investing in the U.S. is getting very expensive, and we see the CRON deal highlighting why it is becoming harder for most Canadian companies to enter the U.S. market. Most Canadian companies cannot afford to enter the market because they are unprofitable and don't have a balance sheet. Both CRON and CGC, have the balance sheet to invest in the U.S. and have the size and scale to compete against existing operators. CGC has investments with two U.S. cannabis companies Acreage Holdings and TerrAscend, that would let it target U.S. cannabis consumers once the market opens to it. Unfortunately, Acreage has baggage, while TerrAscend looks like PharmaCann, with significant assets and no baggage.
Thinking out loud, what US MSO would want to sell to an unprofitable Canadian Cannabis company with significant baggage and little financial controls? For example, after last quarter's performance, who will sell their us assets to HEXO and take that equity? A billion-dollar line of credit is not going to get HEXO very far.
One of the other attractive elements to the PharmaCann deal was the N.Y. license. We estimate once New York's cannabis market ramps up, annual sales could reach $4-$5 billion annually. GTBIF also has an investment in N.Y. and will be a significant player in the state. The Cronos-PharmaCann deal comes a few months after U.S. cannabis company Ascend Wellness said it would take a majority stake in MedMen's New York operations for $73 million.
