The Founders mentality
CRON is a LONG (with this note, we are merging the Cannabis Position Monitors and moving CRON up the list)
We will be hosting a call live in the Hedgeye TV studio with Mike Gorenstein, CEO of CRON on 5/20 @ 2 PM. Topics for the call:
- The Founders Mentality and Cronos 2.0
- The significance of 1Q22 results and Spinach market share strength in Canada
- The importance of the Israel market and Crono's position in-country
- Borderless Products and the importance of Biosynthesis
- Why the focus on rare cannabinoids?
- During your time as Executive Charman, what did you learn about how you want to enter the US market?
- How do you want to deploy your $1B in Cash and equivalents?
On the company's recent earnings call (the first earnings call for the new CEO's second term) I was struck by the following opening comment; "As CEO, I am committed to re-instilling a startup culture with the founders' mentality; across all levels of the organization." We first wrote about the principles of the book 'The Founders Mentality" in April 2018 when we went long CMG for around $300. The Founders Mentality book discusses the Principles for Managing and avoiding growth problems and why profitable growth is so hard to achieve and sustain. Most executives manage their companies as if the solution to that problem lies in the external environment: find an attractive market, formulate the right strategy, and win new customers. The book's authors, Chris Zook and James Allen, researched this question and found that when companies fail to achieve their growth targets, 90% of the time, the root causes are internal, not external, increasing distance from the front lines, loss of accountability, increasing processes, and bureaucracy.
Moreover, companies experience a set of predictable internal crises (CRON was not immune to this) at predictable stages as they grow. Even for healthy companies, these crises, if not managed properly, stifle the ability to grow further and can actively lead to decline. The critical insight from Zook and Allen’s research is that managing these choke points requires a “founder’s mentality” behaviors typically embodied by a bold, ambitious founder to restore speed, focus, and connection to customers.
How does this apply to CRON? In November 2018, we were initially attracted to CRON due to its asset-light business model as the company had limited exposure to growing plants. Its its early years CRON demonstrated conservativism in deploying capital but lost its way following the Altria investment. This asset-light model can also be seen in its JV with Ginkogo Bioworks, which attempts to leverage existing fermentation infrastructure to produce large volumes of the targeted cannabinoids from the custom yeast strains without incurring heavy CapEx to build new cultivation and extraction facilities – a process called biosynthesis. CRON will have a royalty-free license to critical technologies to produce and commercialize eight significant cannabinoids. As flower drifts away and alternative consumption methods grow share, CRON will be at the leading edge. The current success of introducing the Spinach edibles brands in Canada is a clear example of this strategy.
In December 2018, Altria made a strategic investment in Cronos Group at C$16.25 per share to acquire 45% ownership via private placement. CRON also issued warrants to Altria to acquire an incremental 10% interest at C$19.00 for total targeted ownership of 55%. The company said at the time "the cash infusion positioned CRON to boost cannabinoid innovation, and recreational and medicinal brand development, expand its global footprint and grow production capacity," but not all of that was good news. CRON ended 1Q19 with $1.811 billion in cash and, as of 1Q22 it had $981 million in cash burning $830 million in cash with very little to show for it. In 3Q19, CRON spent $382 million buying California-based Redwood Holdings. The goal of the transaction was to provide "Cronos Group with a leading U.S. hemp-based products platform, including hemp-derived cannabidiol (CBD) infused skincare and other consumer products that are sold online and through retail and hospitality partners channels in the United States under the brand Lord Jones." Two years later, CRON impaired the assets of its US unit by $236 million. Since closing the Altria transaction, the company has incurred $444 million in operating losses, including 1Q22 results. Time for a change!
a strategic pivot to focus on growth and profitability
- Delivering top-line growth in the core markets of Canada and Israel. The old CRON talked in the past about being okay with having higher OpEx and variable costs at the beginning of the product launch cycle to prove out the demand and get to critical mass. The new CRON and its current success with 98% revenue growth can start focusing on margin accretive growth.
- Increased operational efficiencies, disciplined expense management, and a more agile supply chain. The company is winding down its Peace Naturals Campus, which further aligns the priorities of focusing on brands and R&D.
- Borderless investments. Invest in its innovation pipeline to bring consumers branded products that can consistently replicate, produce and distribute in multiple jurisdictions as they open up in the future. The success of the Spinach FEELZ platform is the beginning that the fundamentals of the borderless are winning in Canada. The company will continue to drive rare cannabinoid development and commercialization, which gives CRON the ability to differentiate its products by delivering unique effects that hit specific consumer needs. The cultured CBD gummy and vape product lineup is doing well in Canada. The goal is to be ready to execute on bringing these and other products in the pipeline to new markets with speed and efficiency.
- Positioning Cronos to win in the US cannabis market ultimately. CRON continues to conduct extensive consumer insights in all the regions in which they operate, with a specific focus on the adult-use market in the US. While the new CEO was serving as Executive Chairman, he was focused on assessing opportunities in the US. The PharmaCann transaction set the strong foundation for entry into the US and will continue to foster potential strategic relationships that will enable adult-use success in the US. The growing product portfolio and cash-rich balance sheet put the company in a solid position to execute a US strategy.
THE UPCYCLE
The CRON realignment of the business is intended to position Cronos better to drive profitable and sustainable long-term growth, with brands and products at the focal point. The company announced some immediate changes to the organizational structure:
- Centralize functions under shared leadership to drive cost savings and driving faster decision-making.
- The planned exit of the Peace Naturals Campus in Stayner, CA, to further drive the asset-light model
- A substantial portion of CRON Canadian manufacturing is moving to Cronos GrowCo while maintaining other third-party manufacturing relationships. Cronos GrowCo is a joint venture between the Cronos Group and a group of investors led by Bert Mucci, owner, and operator of Mucci Farms. Located in Kingsville, Ontario, GrowCo has an 850,000 square foot, custom-built greenhouse facility. CRON is working to build out our own space within GrowCo to support the company's needs moving forward. The shift to GrowCo marks a significant milestone in the evolution of the company's supply chain, which will show up in better COGS. At a high-level, CRON can purchase high-quality flower from GrowCo for less than the internal cost of cultivation at the Peace Naturals Campus. CRON owns 50% of the GrowCo equity, so there is an additional upside to the margin improvement from shifting to GrowCo. Over time, GrowCo will become a significant asset with real value at CRON.
Israel UPSIDE
For Cronos, Israel is a core market for CRON (with a top-three market share) to deliver branded products that meet the needs of consumers. The company invested early in Israel back in 2017 and has boots on the ground actively manufacturing and selling Peace Naturals products. The company reported revenue within Israel of $9.1 million in 1Q22, up approximately 90% from 4Q21 and up approximately 260% from 1Q21. The company reported that the overall Israeli market experienced an approximate 40% year-over-year growth in kilos sold in the first quarter.
