Cronos CEO: $1.8 billion from Big Tobacco is just a beginning for cannabis industry

Altria can help Cronos standardize its approach to marijuana, CEO says after announcing investment.

Marijuana companies and legacy businesses are playing a proverbial game of speed dating right now, according to a top cannabis executive who managed to land an attractive partner.

Cronos Group Inc. CRON, +0.39% CRON, +0.18%  Chief Executive Mike Gorenstein said in a telephone interview Friday that the $1.8 billion deal announced earlier in the day with Philip Morris parent company Altria Group Inc. MO, -1.51%  is just the start for his company, as well as for the industry.

“I’m still running on adrenaline,” Gorenstein said, explaining he had not slept much the night before the announcement. “We just got a new partner and now resources — but beyond that the network and support [Altria] can offer — being able to have that experience. It’s an alignment and a partnership but it’s not like the deal is over. We’re all very, very excited about the beginning, and we can now go and do the things we want to do.”

Gorenstein has good reason to lose sleep over the deal, as it was for big money. Altria promised a $1.8 billion investment in Cronos, which translates to a 45% stake that Altria has the option to increase to full ownership if it so chooses down the road. It is the second deal of its type, after Cronos rival Canopy Growth Inc.CGC, -1.21% WEED, -0.12%  made a pact with Corona maker Constellation Brands Inc. STZ, -0.69%  to invest $4 billion in the growing pot company.

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The Cronos-Altria agreement has granted further legitimacy, according to analysts, to an industry that has up until the 21st century was the purview of motorcycle clubs, smugglers and drug dealers. At the moment in the Canadian cannabis industry, most if not all major pot producers are talking with potential partners with deeper pockets and expertise outside of cannabis and evaluating the benefits and costs of a partnership or an outright sale, according to several sources within the industry.

Gorenstein acknowledged that meetings are happening across the industry, but said Cronos was systematic in evaluating its options for partnerships, going through meeting after meeting with other potential “strategic partners.” He found that Altria’s executives and his team said the words “we agree” and “we feel the same way” when discussing the future of the growing industry and how a partnership might look.

“The feel we had for each other was very important,” Gorenstein said.

Crucially, Altria is not looking for a hedge because it is in a business that Gorenstein says is “adjacent” to cannabis, not in direct competition. In its news release announcing the deal Cronos said that it sees opportunities to work with Altria on vaporization technology, as well as pre-rolled cannabis products and working with regulatory bodies, an area in which the Marlboro maker has significant experience.

Gorenstein says that Altria can help with the final step in Cronos’s process of turning marijuana into a standard consumer product. If Cronos can design a product in terms of its use-case and psychoactive effects, Altria has the expertise to transform the design into a product that can deliver consistent results, he said. In short, it can make every joint of a specific product line feel and taste the same.

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One aspect of the deal that could be a problem for cannabis consumers, especially of the medical variety, is Altria’s history as a tobacco company that has produced massive public health consequences through decades of producing and selling cigarettes. Cronos has a significant number of assets in medical marijuana both in Canada and the rest of the world, and the image it is trying to project as a purveyor of medicine could be hurt by a tie-up with a tobacco company.

Gornstein says that Altria is reducing risk and “increasing choice” and is moving away from combustible cigarettes.

“That’s something I think is pretty important,” he said. “I think it’s also a key point that [Altria] is encouraging about the medical business, they do have a lot of experience with the [Food and Drug Administration] and research.”

Whether consumers will turn away from a cannabis company because of a big stake from a tobacco company is difficult to gauge at this point, said Rebecca Brown, founder of Crowns Consulting, an advertising agency that is focused on cannabis.

“It’s inherently tension-filled for a tobacco company to have close to a majority stake in a medical cannabis entity,” Brown said over the phone. “It’s going to be interesting to see how they position and package that in a world where we have a certain amount of empathy for brands that admit to failure and mistakes.”

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Brown says that there might be a way to leverage a narrative that marketing professionals describe as “flawsome” — good because of its flaws — but she doubts it would be possible to leave behind cigarettes with just talk and not some actual sacrifice.

“I don’t think the way forward here is to ignore that smoking cigarettes is anything but what it is,” she said. “If Altria’s play is to sort of disavow that heritage, and instead to organize and rally around a better future and try and help people, could we feel empathy for a tobacco company leaning in to public health as a form of penance? I don’t know — but there is for sure a potential to win over consumers.”

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That is the kind of expertise cannabis companies need, analysts said, while describing Friday’s deal as a boon for the industry as a whole.

In a note to clients Friday PI Financial analyst Jason Zandberg said that the investment is a “significant vote of confidence” for Cronos executives and that it should have a positive and wide impact on the sector has a whole. Zandberg raised his Cronos price target to C$24 from C$15 and has a buy on the name.

“We believe Altria provides many benefits to Cronos Group including their experience in regulatory, compliance and government relations as well as their expertise in device technology, supply chain management and marketing,” Zandberg wrote. “We also believe the Altria benefits from Cronos’ expertise in cannabinoid-based products and is an immediate channel for product development in the Canadian marketplace.”

Canaccord Genuity analyst Matt Bottomley also said in a note to clients Friday that the Altria investment would be a boon to the entire sector and will push valuations higher. He called the C$16.25 per share Altria agreed to pay for the investment “a lofty” valuation based on his team’s estimates of future performance. Bottomley rates Cronos a hold with a C$13.98 price target.

Cronos stock rampaged Friday, gaining 22% to $12.74 after the company announced the Altria transaction. ETFMG Alternative Harvest ETF MJ, -1.11% rose 4.9% Friday as the S&P 500 SPX, +0.18%  declined 2.2%.