Why Altria Will Not Be Acquiring Any Cannabis Companies Anytime Soon

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About: Cronos Group, Inc. (CRON), MO, Includes: APHA
by: Grant Beaty
Summary

Twice now, there have been rumors of Altria buying out a Canadian cannabis company. This is unlikely to happen in the foreseeable future.

Substantially, all of Altria's revenues come from the U.S.

Cannabis is prohibited under federal U.S. law. A publicly-listed U.S. company selling cannabis within the U.S. would risk many penalties, including de-listing.

Altria's management has repeated said it would not enter the cannabis space unless it became federally legal.

Canadian cannabis companies trade at huge valuations relative to the value they'd likely offer Altria.

Altria Group (MO) is one of the world's largest producers and marketers of tobacco products. They operate almost exclusively within the United States and have annual revenues of $25.5 billion and a market cap of $105 billion.

On October 10th, The Globe and Mail reported Altria Group was in buyout talks with Aphria (APHA), citing "unidentified people familiar with the matter". Shares went from $12.82 to as high as $15.89. As of this writing, Aphria has received no investment from Altria and recently closed at $4.51.

On December 3rd, Reuters reported Altria was in talks to acquire Cronos Group (CRON). This sent CRON up as much as 30%. Later that day, Cronos made the following announcement, suggesting the talks were not related to a potential acquisition (emphasis mine):

Cronos Group Inc. (NASDAQ: CRON) [TSX: CRON] (“Cronos Group” or the “Company”) today confirmed that it is engaged in discussions concerning a potential investment by Altria Group Inc. (NYSE: MO) (“Altria Group”) in Cronos Group. No agreement has been reached with respect to any such transaction and there can be no assurance such discussions will lead to an investment or other transaction involving the companies.

I believe Altria is extremely unlikely to acquire a cannabis company until it is federally legal in the United States and that investors should sell any news to the contrary. My reasoning is presented below:

Management has repeatedly said it won't enter the Cannabis space until it's federally legal

From their May 17th conference call, edited for brevity, emphasis mine:

Michael Hilton

As you may know, it's been growing and the legality of recreational marijuana has been increasing. And so my question is very simply, how do you and your board feel about this growth into that section of the industry?

Martin J. Barrington, Altria Group, Inc. - Chairman, CEO & President

The answer on cannabis is no. It's true that some states are experimenting, but it's, I'm sure you know, it's illegal at the federal level. And indeed, it's impossible even to have bank accounts or accounting relationships or legal relationships. And as long as it's illegal, we're not -- that's not a category we're interested in. I appreciate your question, and welcome to the meeting.

From the Barclays conference, September 5th:

Gaurav Jain, Barclays Bank PLC, Research Division - Research Analyst

And there has been quite a bit of interest in the cannabis space, especially given recent news from several large beverage companies. Can you remind us of your thoughts on cannabis?

Murray R. Garnick, Altria Group, Inc. - Executive VP & General Counsel

As you know, cannabis remains illegal under federal law, and we intend to continue to comply with federal law. Having said that, we are exploring options, and we're mindful of the possibility that in the future, cannabis may no longer be illegal under federal law.

From their October 25th call:

Bonnie Lee Herzog, Wells Fargo Securities, LLC, Research Division - MD and Senior Beverage & Tobacco Analyst

Okay. That's actually really helpful. And then I have a question on a completely different topic. On cannabis, you've recently commented that you guys might be exploring this category. So maybe first, confirm this. And then second, could you share for us why you see this as a potentially interesting opportunity, and then how you might approach the category, what competitive advantages that you might have?

Howard A. Willard, Altria Group, Inc. - Chairman, CEO, COO & Executive VP

Yes. I think I can confirm what we said at the Barclays conference, which is that we are exploring opportunities in the category. And we acknowledge that it is currently federally illegal in the U.S., but I think we think it's worth exploring the category because that might change in the future. And I'll hold back on explaining in more detail kind of how we view the category because we're relatively early in our exploration.

Selling cannabis in the U.S. could result in de-listing from U.S. exchanges

Edit 2018-12-06: The article originally and mistakenly stated Altria could be de-listed by Nasdaq, when it is a NYSE listed company. However, either exchange seems prohibited from listing companies which violate federal prohibition.

If Altria were to purchase Cronos, they could not do any cannabis business in the U.S. until it was federally legalized. If they did they'd risk being de-listed, or worse:

In the US, medical marijuana is legal in 30 states, and recreational is legal in 10. But US cannabis companies can't list on US stock exchanges or even get basic financial services, because marijuana is prohibited by the federal government.

Needless to say, Altria is not going to do anything with cannabis which gets them de-listed.

Altria does substantially all its business in the United States

Their last 10-K has a section titled "Financial Information About Geographic Areas". It contains only this sentence:

Substantially all of Altria Group, Inc.’s net revenues are from sales generated in the United States for each of the last three fiscal years and substantially all of Altria Group, Inc.’s long-lived assets are located in the United States.

Ergo, it seems unlikely Altria would purchase Cronos in order to do business outside of the United States.

Philip Morris International (NYSE:PM) split off from Altria in 2008 and took its international sales with it. There may be a contract between the two companies preventing Altria from pursuing international opportunities, but I cannot find any evidence of this in the filings. Can someone more familiar with Altria shed some light on this?

It doesn't look like there's much of value to acquire

The Canadian cannabis stocks are very generously valued, to say the least. This year, Cronos reported quarterly revenues of $2.3, $2.6 and $2.9 million USD. As of this writing, their market cap is $1.9 billion.

Could these companies have valuable land and production facilities? Cannabis would not have a long growing season in Canadian climates. From the Wikipedia article on the subject:

The optimal day temperature range for cannabis is 24 to 30 °C (75 to 86 °F). Temperatures above 31 °C (88F) and below 15.5 °C (60F) seem to decrease THC potency and slow growth. At 13 °C (55F) the plant undergoes a mild shock, though some strains withstand frost temporarily.

Though I don't claim to be very knowledgeable about cannabis, from a cursory glance, the Canadian companies don't seem to have much value to Altria.

What about Cronos Group's IP?

Cronos could be an exception here, as it has IP other cannabis companies do not: with Ginkgo bioworks, it is attempting with produce some cannabinoids using modified microorganisms such as yeast. Cannabinoids are natural compounds and aren't patentable, but Cronos could patent the production processes used (such as a strain of yeast).

However, I cannot find any mention of a patent application for this purpose. In fact, I cannot find any mention of U.S. patents or patent applications belonging to Cronos, except for a provisional application mentioned in their last earnings call: Plant Extract and Methods for their Production. Unfortunately, provisional patent applications are not publicly available.

While it is possible Cronos has IP valuable to Altria, I'd be very surprised it was worth a substantial portion of its $1.9 billion market cap.

Conclusion

In conclusion, there is no reason to suspect Altria would acquire any of these Canadian cannabis companies before weed is federally legalized in the U.S. Investors ought to treat claims to the contrary with extreme skepticism.

Disclosure: I am/we are short CRON.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.