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