The company, which reported a smaller-than-expected third-quarter loss on Friday, is conducting a “thorough strategic review” of its production facilities as it seeks to cut costs and become profitable, executives said.

“There’s not a lot of market demand for cannabis production facilities,” David Klein, former finance chief of the company’s biggest shareholder Constellation Brands, said in an interview. “There’s a lot of capacity in Canada and no logical buyers.”

More than a year after Canada legalized recreational marijuana, producers are scrambling to turn a profit as lower-than-expected demand and exuberant expansion hit sales and lift costs, while a cash crunch threatens many companies’ survival.

Canopy first needs to ensure it generates as much cash as possible, said Klein, who became Canopy’s CEO last month.

“Then, what we do as a secondary step with the assets… we’ll figure that out over time,” he added.

Canopy shares were up 16.2 per cent at $30.10 in afternoon trade in Toronto, paring its one-year loss to 53%.

Canopy had cash and equivalents of $1.56 billion as of December, down from $2.48 billion at the end of March 2019.

“We will be pretty aggressive in managing capital expenditure going forward,” Klein said. “If we just take those measures, we have cash for the foreseeable future.”

Canopy also plans to expand in the U.S. cannabidiol (CBD) market, he said.

CBD is a non-psychoactive compound in cannabis, and is also derived from hemp, the production and distribution of which the United States legalized in late 2018.

“We’re in the process of building out a sales infrastructure in the U.S. so that we can call on the large retailers and get shelf placements,” Klein said.

The company could move some Canadian resources to the U.S. to enable the expansion, he said.

Canopy executives said they aim to lift gross margin to 40 per cent in the short term, from 34 per cent in the third quarter, and will reduce share-based compensation by as much as 40 per cent from the third quarter’s $56.8 million.

“They’re nowhere close to posting a profit… and their free cash flow is quite negative, but it’s going in the right direction,” said Jason Zandberg, an analyst at PI Financial, who expects Canopy to follow rivals Aurora Cannabis, Tilray and Hexo in cutting jobs.

— Reporting for Reuters by Shariq Khan in Bangalore and Nichola Saminather in Toronto.

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Klein was appointed Canopy chairman in October after Constellation booked a $430 million net loss related to the company (all figures US$). He replaces company co-CEO Mark Zekulin who took over the top job from founder Bruce Linton in July.

Linton had said that he was fired from the top job, days after Constellation expressed its disappointment over Canopy’s 2018 results.

Canopy’s U.S.-listed shares were up 3.3 per cent at $19.36 premarket, while Constellation shares were broadly unchanged.

Canada’s new brand of pot producers have all struggled to deliver in the first year of the legalization and shares in most have sunk since March. An ETF tracking Cannabis stocks has lost more than half its value since then.

Constellation Brands bought into Canopy’s shares and warrants in 2017, betting on the proposed legalization of recreational weed in several countries.

Canopy’s finance chief, Mike Lee, was previously senior vice-president and chief financial officer for Constellation’s wine and spirits unit.

Constellation said in October that it was “pleased with the progress of the Canopy team and what they have done in the last few months.”

Earlier in the day, Cantor Fitzgerald analyst Pablo Zuanic said he was surprised that it has taken this long for Constellation Brands to appoint a new CEO at Canopy, adding that there was more than a two-thirds probability to Constellation putting in a bid for Canopy in the near term.

Separately, Constellation said on Monday senior vice-president Garth Hankinson will take over Klein’s role at the company.

— Reporting for Reuters by Shanti S Nair and Shariq Khan in Bangalore.

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The world’s largest pot company announced earlier in the day that Linton was stepping down, leaving Mark Zekulin in charge of the company.

“I think stepping down might not be the right phrase,” Linton said in an interview with CNBC. “I was terminated.”

Linton also said he did not know why he was fired, adding, “At the end of the day I really think sometimes entrepreneurs are entrepreneurs because they’re not super employable.”

Last month, Canopy reported a net loss of about $323 million for the fourth quarter, attributing it to increased investments in expanding the business.

A week later, Constellation Brands, which has a stake in Canopy and four of its six board seats, said it was not happy with the Smiths Falls, Ont. company’s year-end results.

“We are working with Canopy almost on a daily basis to ensure that we are all focused on the right things,” Constellation CEO Bill Newlands had said on a post-earnings call with analysts.

On Wednesday, the brewer said it fully supported the decision made by Canopy’s board to appoint Zekulin as the company’s sole CEO.

“It is pretty clear that it was at the urging of Constellation Brands. At this point they have enough power on (its) board to make these kinds of decisions,” William O’Neil analyst Andrew Kessner said.

Linton’s strategy of chasing growth at the expense of near-term profits seemed to have fallen out of favor with top Constellation executives, who are under pressure to provide a clearer timeline on a return on investment in Canopy, Kessner said.

Linton founded Canopy in 2013 in an abandoned Hershey’s chocolate factory and has since been the face of the company. He took the company public in 2014 and has bolstered its operations with acquisitions worth more than $5 billion.

Under Linton, Canopy also raised over $6 billion since its founding in 2013, with the Corona beer maker agreeing to invest more than $4 billion in the company — the biggest such investment in the cannabis industry.

Linton did not immediately respond to a Reuters request for comment. Reuters’ calls and emails to Canopy seeking details on Linton’s departure were not answered.

While it was not clear what Linton’s severance package would be, company filings showed that his total compensation for 2018 was $2.46 million, a near six-fold rise from a year earlier due to $2 million of option-based awards.

Analysts at brokerage Stifel said they would not be surprised to see Linton take on another role within the cannabis industry, likely as an entrepreneur as his strength was in recognizing early stage value.

Rade Kovacevic, who currently leads the company’s Canadian operations and recreational strategy, will take over the role of president from Zekulin.

The company, whose cannabis retail brands include Tweed and Tokyo Smoke, also named John Bell, Canopy’s lead director of five years, as chairman, a decision that it said would be reviewed at the board’s annual meeting in September.

Earlier this year, Canopy also replaced long-term chief financial officer Tim Saunders with a former Constellation executive.

Shares of the company, which fells as much as 5.3% earlier in the session, reversed course to trade marginally up.

— Reporting for Reuters by Debroop Roy, Nivedita Balu and Shanti S Nair in Bangalore.

CORRECTION, Aug. 27, 2019: Reuters has removed a reference to the specific size of Constellation Brands’ stake in Canopy Growth.

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Marijuana companies in Canada have been pouring cash into their businesses to both fend off competition and open stores as the list of medical and recreational approvals for marijuana use globally grows.

In the reported quarter, Canopy’s operating expenses rose more than six times to $180.6 million from $27.7 million a year earlier.

Canopy has the money after drawing a multi-billion dollar investment from Corona beer maker Constellation Brands in August, a reflection of investors betting broader legalization in the U.S. may also be in the pipeline.

Chief financial officer Timothy Saunders said on a conference call with analysts that higher expenses are needed for brand recognition and for higher market share in the “new recreational market in Canada.”

Ever since Canada considered allowing adults to legally smoke recreational marijuana in April 2017, pot producers have been scrambling to keep up with anticipated demand.

Canopy Growth said it sold 2,197 kg and kg-equivalent of cannabis in the quarter at an average price of $9.87 per gram. That’s up from 2,020 kg and kg-equivalents sold at an average price of $7.99 in the year-ago period.

Canopy founder and chairman Bruce Linton said the company has also been investing more on training over 650 customer service representatives about its marijuana-based products so as to ensure that “when you win, it’s not a random lottery.”

But high investments led the company to report a bigger quarterly net loss of $330.6 million, or $1.52 per share, in the quarter ended Sept. 30.

Excluding items, Canopy lost $1.50 per share and missed analysts’ expectation of 12 cents per share loss.

“I don’t think analysts were wrong on the target number, but I think they were early on the quarter,” Linton said on a conference call with analysts.

Revenue rose 33 per cent to $23.3 million in the quarter, but the rate of growth was lesser than rivals Tilray and Aphria.

— Reporting for Reuters by Shanti S Nair in Bangalore.

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Constellation was among the first major alcohol producers to invest in marijuana production when it pumped about $245 million into Smiths Falls, Ont.-based Canopy last year, but the latest announcement makes it by far the biggest investment in the industry.

Canada, where 4.4 million people reported using the drug in the first half of the year, will fully legalize the recreational use of cannabis in October.

Constellation, Molson Coors and Anheuser-Busch are all using the move by the United States’ northern neighbour to hedge their bets for the future at a time when beer sales, roughly 60 per cent of Constellation’s business, are stagnating, particularly with younger Americans.

Constellation will buy 104.5 million Canopy shares at $48.60 a share, a 51.2 per cent premium to the stock’s Aug. 14 closing price.

The deal will take Constellation’s ownership in Canopy to 38 per cent from the 10 per cent it took last October. Constellation could also increase its ownership to over 50 per cent if it exercises warrants received as part of the deal.

“Over the past year, we’ve come to better understand the cannabis market, the tremendous growth opportunity it presents, and Canopy’s market-leading capabilities in this space,” Constellation CEO Rob Sands said in a statement.

Recreational use is also currently permitted in nine U.S. states and the District of Columbia, and sales in U.S. legal markets should nearly triple to US$16 billion by 2020 from US$5.4 billion in 2015, according to Euromonitor International.

Operating nationwide, however, is more problematic, and Constellation said neither company plans to sell cannabis products in the U.S. until it is allowed to do so at all government levels.

Other alcohol companies are also eyeing the weed market. Molson Coors Brewing earlier this month said its Canadian arm would make cannabis-infused drinks with Hydropothecary Corp.

U.S.-listed shares of Canopy Growth, whose brands include Tweed and Bedrocan, jumped about 37 per cent to US$36.20 in heavy premarket trading. Canopy had a market value of C$7.1 billion as of Aug. 14.

Constellation expects the investment in Canopy to add to earnings in 2021. The deal is expected to close in October.

— Reporting for Reuters by Uday Sampath Kumar.

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The move by the maker of Corona beer and Svedka vodka comes as Canada and a growing number of U.S. states move to legalize marijuana for recreational use, raising question marks over its illegal status at the U.S. federal level.

Constellation said it had no plans to market cannabis or lobby for its legalization in the U.S. in the near future and analysts said the relatively small stake would allow it to take advantage of any future boom — or to exit if one does not materialize.

“One of the hallmarks of our success over the years has been our commitment to identify and stay ahead of early stage consumer trends,” the company said in a statement on the deal.

“This is another step in that direction,” it added.

Eight states, including California and Nevada, have legalized marijuana, already widely approved for medicinal use, for recreational use and some studies show consumers would buy the drug instead of alcohol if it was freely available.

A number of pharmaceutical companies have products that are cannabis derivatives and smaller investors have poured money into Canadian producers this year: the index of Canadian marijuana stocks calculated by research house Canaccord Genuity rose 36 per cent in the month to Oct. 11.

But major firms in other sectors have kept their distance, worried by the connotations of involvement with a banned substance.

“We’re obviously trying to get first-mover advantage,” Constellation CEO Rob Sands told the Wall Street Journal, adding that he expects cannabis to be legalized nationwide in the U.S. in coming years.

Threat

Eight Capital analyst Daniel Pearlstein said that the move validated the cannabis industry as both a threat and opportunity for larger established companies in industries including alcohol and tobacco.

“This move is a complete game changer, not only for Canopy, but also for the entire industry,” he said.

Vivien Azer, an analyst at brokerage Cowen, said that data showed 18-25 year olds — a key market for spirit makers — perceived alcohol as increasingly risky compared with cannabis, for which risk perceptions have halved in a decade.

Industry watchers also say cannabis consumers have reduced their alcohol intake in U.S. states following legalization.

“We were … able to show in our research in Colorado, Washington and Oregon that there has been a negative impact in alcohol consumption … post the legalization of adult-use cannabis,” Azer said.

Analysts said a more immediate option for Constellation could be to develop non-alcoholic cannabis-infused beverages for the Canadian cannabis market, which consultants estimate could be worth around $5 billion to $10 billion.

The deal also comes ahead of the widely anticipated move by Canada, to legalize cannabis for recreational use nationwide by July 2018. The following year, edible and drinkable products are expected to become legal.

Canopy Growth is the biggest licensed producer of medical marijuana in Canada and is publicly traded (TSX: WEED) a market capitalization of $2.2 billion.

Constellation said the deal also gives it the option to purchase an additional ownership interest in Canopy in the future.

The two companies said Monday they also plan to enter into an agreement to “exchange knowledge and expertise.”

— Reporting for Reuters by Siddharth Cavale and Gayathree Ganesan; additional reporting by Ankur Banerjee and Manas Mishra in Bangalore. Includes files from AGCanada.com Network staff.

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The unit, which includes eight wineries and 160 retail locations across Ontario, is expected to list in Toronto as early as the fall, Bloomberg reported, citing people familiar with the matter.

Constellation produces the Jackson-Triggs and Inniskillin wine brands in Canada.

The company, which owns major brands such as Corona beer and Robert Mondavi wines, is working with Goldman Sachs Group, TD Bank and Bank of Nova Scotia on the offering, Bloomberg reported.

Constellation Brands and the banks could not be immediately reached for comments.

— Reporting for Reuters by Nikhil Subba in Bangalore.

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