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The Fundamental Valuation of Canopy Growth Corporation

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The Fundamental Valuation of Canopy Growth Corporation Norwegian School of Economics Bergen, Spring 2018 The Fundamental Valuation of Canopy Growth Corporation Finding value in the haze of legalization Olivier Côté Supervisor: Prof. Carsten Bienz Master thesis, MSc Economics and Business Administration, Finance NORWEGIAN SCHOOL OF ECONOMICS This thesis was written as a part of the Master of Science in Economics and Business Administration at NHH. Please note that neither the institution nor the examiners are responsible − through the approval of this thesis − for the theories and methods used, or results and conclusions drawn in this work. 2 Contents CONTENTS ........................................................................................................................................... 2 1. EXECUTIVE SUMMARY ........................................................................................................... 5 1.1 ACKNOWLEDGEMENTS: ........................................................................................................... 6 1.2 AUTHOR’S NOTE: ..................................................................................................................... 6 1.3 PREFACE ................................................................................................................................... 7 2. INTRODUCTION: ........................................................................................................................ 8 2.1 COMPANY PROFILE: ................................................................................................................ 8 2.2 CANNABIS INDUSTRY: ............................................................................................................ 12 2.3 HISTORICAL PERSPECTIVE OF THE MEDICAL MARIJUANA SEGMENT: ............................... 13 2.4 LEGALIZATION OF CANNABIS AND CAPITAL MARKETS: ...................................................... 16 2.5 SALE OF RECREATIONAL CANNABIS ..................................................................................... 17 2.6 MARKET DYNAMICS: ............................................................................................................... 21 2.7 MARKET CONSOLIDATION: .................................................................................................... 22 3. METHODOLOGY ...................................................................................................................... 23 3.1 ABSOLUTE VALUE APPROACH: .............................................................................................. 23 3.1.1 Dividend Discount Model ............................................................................................... 23 3.1.2 Discounted Cash Flow Model ........................................................................................ 24 3.1.3 Frameworks of DCF Valuation: ..................................................................................... 26 3.1.4 Weighted Average Cost of Capital (WACC – methods) ................................................. 26 3.1.5 Adjusted Present Value (APV – Method) ....................................................................... 26 3.2 RELATIVE VALUE APPROACH: .............................................................................................. 27 3.3 MODEL SELECTION: .............................................................................................................. 28 4. CANOPY GROWTH CORPORATION COMPANY ANALYSIS ........................................ 29 3 4.1 COMPETITIVE ENVIRONMENT: .............................................................................................. 29 4.2 SWOT ANALYSIS: ................................................................................................................. 29 4.2.1 Strengths: ....................................................................................................................... 29 4.2.2 Weaknesses: ................................................................................................................... 30 4.2.3 Opportunities: ................................................................................................................ 30 4.2.4 Threats: .......................................................................................................................... 31 4.3 PURCHASE ORDERS ................................................................................................................ 31 4.4 FINANCIAL SUMMARY ........................................................................................................... 33 4.4.1 Balance Sheet: ................................................................................................................ 34 4.5 KEY PERFORMANCE INDICATORS ......................................................................................... 36 4.5.1 Average Price per gram: ................................................................................................ 36 4.5.2 Cash Cost of Production per gram: ............................................................................... 37 4.6 ADJUSTMENTS TO FINANCIAL STATEMENTS ......................................................................... 38 4.6.1 Non-Cash Expenses – Fair Value measures of Biological Assets ................................. 39 4.6.2 Operating Expenses – Employee Stock Options ............................................................ 41 4.6.3 Adjustments to Net Working Capital .............................................................................. 42 5. FORECASTING .......................................................................................................................... 43 5.1 REVENUE – RECREATIONAL MARKET .................................................................................. 43 5.2 REVENUE – MEDICAL MARKET ............................................................................................ 46 5.3 REVENUE – CONSOLIDATED .................................................................................................. 46 5.4 COST OF GOODS SOLD ........................................................................................................... 47 5.4.1 COGS – Recreational ..................................................................................................... 47 5.4.2 COGS – Medical ............................................................................................................ 48 5.5 OPERATING EXPENSES .......................................................................................................... 49 4 5.5.1 Sales & Marketing Expenses .......................................................................................... 49 5.5.2 R&D Expenses: ............................................................................................................... 49 5.5.3 General & Administrative Expenses: ............................................................................. 49 5.5.4 Acquisition expenses: ..................................................................................................... 50 5.6 NOPLAT ................................................................................................................................ 51 5.7 FREE CASH FLOWS: ............................................................................................................... 52 5.7.1 Delta Net working Capital: ............................................................................................ 52 5.7.2 Capital Expenditures ...................................................................................................... 52 6. DCF VALUATION ...................................................................................................................... 55 6.1 DISCOUNT RATE ..................................................................................................................... 55 6.2 ENTERPRISE CASH FLOW DCF VALUATION: ....................................................................... 58 6.3 APV METHOD ........................................................................................................................ 59 6.4 ANALYSIS ................................................................................................................................ 60 6.5 RECOMMENDATION ............................................................................................................... 61 7. BIBLIOGRAPHY ........................................................................................................................ 62 8. ANNEX 1: IAS 41 REGULATION ............................................................................................ 65 8.1 ANNEX 2 .................................................................................................................................. 68 8.2 ANNEX 3 BASE OF FINANCIAL MODELS .................................................................................. 69 5 1. Executive Summary The purpose of this Master’s thesis is to perform a fundamental analysis of Canopy Growth Corporation (TSX: WEED), analyse the Canadian cannabis industry and provide a valuation of the company as at the 31.03.2018, and ultimately offer an investment recommendation for a hypothetically well-diversified investor. The Canadian government has announced that it will be opening the recreational marijuana industry by the summer of 2018. The prospect of legalization has cause a gold rush towards the industry, leading to high levels of investment
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