Leading Canadian cannabis and hemp producer Canopy Growth Corp’s (TSX:WEED)(NYSE:CGC) stock rallied on Monday after the company announced that it’s finally entering the United States market thanks to a recently signed Farm Bill of 2018 that federally legalized the farming of hemp, a cannabis family plant, as a crop.
The company will make a significant US$100-150 million investment in establishing large scale hemp production facilities (a Hemp Industrial Park) in the state of New York within the next 100 days, and it appears that this will be a green field venture.
I had expected Canopy to execute a quicker acquisitions-led growth in the recently opened U.S. hemp market by acquiring an ongoing hemp production or marketing firm with running and well-established operations south of the boarder, as an acquisition-led entry and growth strategy could have given the leading North American integrated cannabis and hemp producer a faster market exposure.
Rather, it has been the norm that Canopy makes an acquisition or a strategic investment when entering a new geographical market, as has happened in Germany, Australia, Latin America and into Africa via Lesotho’s Daddy Cann (renamed Spectrum Cannabis Lesotho).
This time, the company seems to have taken a direct, green field, start from scratch market entry strategy into the United States hemp market, a potentially high growth market that could at some point further federally legalize medical and adult-use cannabis sooner than expected.
Is it a better strategy?
There’s significant merit to the company’s chosen U.S. entry strategy.
In the spirit of helping American farmers, hemp plant production will likely be outsourced. The company doesn’t need to focus on growing hemp; it’s investing in extraction and processing plant technologies and will source product from local farmers (hence the massive support from New York State politicians).
Given the company’s already amassed marketing prowess and Constellation Brands’ expertise in distribution in the U.S. market, developing a vibrant hemp product, CBD beverages, edibles, and wellness products integrated operation in the new market may not be such an insurmountable task. Therefore, paying significant equity premiums for such a business may not be worth the cost even if the company has deep pockets after receiving a US$4 billion equity investment.
An organic growth strategy is usually cheaper than its acquisitions-led alternative, and the company may avoid the risk of overpaying for average or mediocre assets in an outright acquisition in which significant valuation premiums may be demanded in strategic transactions and massive sums of goodwill are paid over the fair value of tangible and intangible assets.
That said, an organic growth strategy may be slow in gaining market entry traction as more time is consumed in setting up systems and processes, whereas buying an already established, successful business with proven functional systems could generate quicker results.
The competition will respond soon
The market will be waiting for close competitor Aurora Cannabis Inc’s reply to the market leader’s first move. The aggressive growth company seemed to have replicated and refined Canopy’s earlier market moves, but I’m not sure the script will continue to play this tie, as speed has been of essence to Aurora.
On the other hand, Aurora doesn’t have as deep a wallet as that of Canopy Growth right now, so a cheaper strategy could be ideal, but an all-stock acquisition is still possible too.
Foolish bottom line
Canopy Growth could make new waves as it enters one of the biggest consumer markets on the planet with a seemingly organic growth strategy into New York. The stock could be further propelled by a good quarterly earnings report in February as new momentum returns to cannabis stocks.
Its close competitors may announce U.S. hemp market entry deals soon. Stay alert.
Fool contributor Brian Paradza has no position in any stocks mentioned.