How Big Of a Deal Could Marijuana Be for Constellation Brands?

Marijuana stock investors were surprised last month when beverage giant Constellation Brands (NYSE: STZ) announced it's paying nearly $4 billion to acquire a 35% ownership stake in Canada's market-share leading cannabis company, Canopy Growth (NYSE: CGC). The multibillion dollar deal suggests cannabis could be a once-in-a-generation investing opportunity, but just how big could the marijuana market be?

Bigger than beer

In a presentation to shareholders this week, Constellation explained its decision to acquire a big stake in Canopy Growth. Constellation highlighted Canopy's 30%-plus market share in Canada, its market-leading marijuana grow capacity, and the fact that it's secured marijuana supply contracts with more Canadian provinces and territories so far than any other producer. And that's all ahead of recreational marijuana laws going into effect next month.

Cannabis potential in Canada, however, is dwarfed by the opportunity to produce, distribute, and market pot products globally. According to Constellation Brands number-crunching, retail marijuana sales could top $200 billion worldwide in 15 years. For perspective, Americans spend $117 billion on beer and $77 billion on cigarettes every year, and over the past 12 months, revenue at Constellation Brands, a leading beer, wine, and spirits maker, totaled just $7.5 billion.

Building a global brand

Canopy Growth generates most of its sales in Canada, and that's going to continue because sales of recreational marijuana begin in Canada next month. According to Deloitte, Canadians will spend $7 billion on cannabis in 2019, only about $1 billion of which will be spent on medical marijuana.

Although Canada will be the driver of Canopy Growth's revenue next year, the company has its eyes set on other important markets, too. It's establishing footprints in Germany, Spain, Brazil, Australia, and elsewhere to win what Constellation estimates will be $120 billion in marijuana sales in markets other than the U.S. and Canada in 2033.

Canopy Growth's experience so far in Germany suggests Canopy Growth's global expansion plans are on point. Germany's medical marijuana market only opened for business last year, yet it already accounts for 14% of Canopy Growth's 26 million Canadian dollars in quarterly revenue. Exiting 2017, Germany contributed 10% of Canopy Growth's sales.

The pace of legalization worldwide will vary, but Canopy's experience in marijuana production, export, import, licensing, taxation, product development, and compliance is positioning it as the go-to company that countries turn to first.

Profiting from marijuana's potential

Constellation Brands already has a lot of exposure to this market opportunity through its 35% ownership stake in Canopy Growth, but it could wind up owning more than half of the company someday.

If it exercises warrants it acquired in 2017, then it's ownership would climb to 38%, and if it exercises warrants it's getting in this latest deal, then it will own over 50% of Canopy Growth. Last year's warrants expire in April 2020 and since their exercise price is C$12.98, it's a good bet that those will be cashed in. The warrants it's getting this year include two tranches, both of which will expire three years after this deal closes. The first tranche can be exercised at C$50.40 and the price of the second tranche will be the volume weighted average price of shares over the preceding five days.

Anything can happen, but if Constellation's projections for how big this market can be are anywhere close to correct, then its investment in Canopy Growth could be very profit-friendly. Canopy Growth's projected gross margin is above 50% and its operating margin is projected to be between 20% and 30%. If Canopy Growth secures 10% of Constellation's $200 billion global market estimate in 15 years, then its profitability would translate into $4 billion plus in profit that year.

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Todd Campbell has no position in any of the stocks mentioned. His clients may have positions in the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.