While I don't see the acquisition of the four subsidiaries of Redwood Holding Group by Cronos (CRON) having a major impact on the performance of the company in the near term, there are a couple of things that come with the acquisitions that could be solid long-term catalysts for Cronos, although there's no guarantee they will.
At this time I'm neutral concerning the future impact on the company because it has yet to be proven the assets and brands will be able to leveraged in a way that justifies the hefty price Cronos paid for them.
As with other similar moves, in the sense of cannabis companies gaining access to the U.S. markets getting an initial hefty dose of immediate optimism, it can easily backfire as it has with Canopy Growth in my opinion.
Another factor is the market is giving a premium valuation to companies like Cronos that have received a big cash infusion from a large company, even though it's obvious over the long term it really doesn't play much of a factor in how it performs.
For that reason, when these companies make a move they get a lot of media attention that is usually disproportionate to the actual event. Consequently, it also gets a big upward move in its share price in response.
But as we're quickly finding out as the dust settles, the share price of Cronos has rapidly fallen back, suggesting to me the market really doesn't know how to value the acquisitions Cronos made.
All that said, there are a couple of things I see that could end up being significant additions to Cronos' business, and we'll look at them in this article.
The two major catalysts
The most obvious value of the acquisitions is that the company has gained access to the U.S. market; the largest cannabis market in the world.
This isn't necessarily insignificant, but it really doesn't add a lot to the potential growth of Cronos just because it has a built-in product portfolio with the subsidiaries it bought.
Second, even though sales could easily disappoint going forward, the reality is there are some recognizable CBD brands that that come with the companies. Because of that, it's possible that at least at a moderate level, the company will be able to leverage some of those brands across Altria's vast distribution network in the U.S. That's really where the potential of this deal lies.
When taking into account the company specializes in beauty, wellness and skincare products that are sold at above-average prices, it's not a certainty that Altria will be able to attract that clientele to many of the retail outlets it distributes through.
The primary brand that is now within the stable of Cronos companies is Lord Jones, which was launched in 2017. It operates within the hospitality and retail space in the U.S. market.
Whatever market penetration the company gets from the deal, it'll be far more than what it had before the acquisition. Even so, the $300 million it paid for the companies could end up being more than they are worth.
Many consider the U.S. market to be the holy grail of the cannabis industry, but it's also rapidly becoming the most competitive. For that reason I think the optimism that has been associated with gaining entrance into the U.S. market is starting to fade, and the former boost and support of a company's share price is no longer ensured.
The co-founders of Redwood will remain with the company after it's closed, at least giving continuity to the brand.
One of the major problems I see Cronos facing is its premium valuation over the majority of its peers. Almost all of that comes from the $1.8 billion investment from Altria, which as mentioned earlier, includes a massive distribution network.
But that's no guarantee of performance as Canopy Growth has learned after the billions Constellation Brands invested in that company. One positive going for Cronos is at least it acquired a company that has the potential to boost sales immediately, and has some brand recognition in the U.S.
Acreage Holdings on the other hand will only be beneficial to Canopy if the U.S. legalizes pot at the federal level.
Even though Altria has given some investors a sense of safety in relationship to Cronos, as well as a confirmation it has a business model it believes in, it remains to be seen whether or not the business model is one that is sustainable, and the cash invested in it doesn't add value to Cronos over the long haul.
"Cronos is trading at 19x our revised 2020 revenue estimate, which is at the high end of the peer range. In addition, we note that the following developments must occur in order to achieve our 2020 revenue projection: timely and meaningful roll-out of value-add products by the company and overall rec industry sales volumes expanding significantly from current levels," Chen noted.
The major element in the performance of Cronos will be whether or not it can buy or develop a product line that can be successfully leveraged and distributed across Altria's distribution network.
It's one thing to have places products can be sold, it's quite another to successfully market them in a way that they gain mind share among customers.
For the price Cronos paid for access to the U.S. market via a company with the Lord Jones brand, moderate brand recognition at best, it remains to be seen if this is going to pay off for Cronos.
As it stands today, this is probably going to take a long time to unfold, and the success or failure will be determined by whether the numerous outlets the company can sell through will have customers embrace the higher-priced products against less expensive items.
Strong and growing competition, risk of commoditization if the brands aren't able to sustainably command higher prices, and the uncertainty of whether or not they can be scaled at the national level remains to be seen.
This has potential for Cronos, but it is far too soon to reward it a higher valuation because of it.