A deal that defies conventional classification
Just last week, Canopy Growth Corporation (TSX: WEED, NYSE: CGC) and Constellation Brands, Inc. (NYSE: STZ and STZ.B) announced the completion of a transaction that was a hybrid: a very large private placement of equity combined with features of a public M&A transaction, as well as aspects of a strategic partnership or joint venture. This innovative transaction was notable for at least three reasons:
1. It was a Financing: the Largest Ever Cannabis Equity Issue. In what is believed to be the largest-ever equity financing in the cannabis industry globally, Constellation Brands, a leading international producer and marketer of beer, wine and spirits, invested more than C$5 billion in cash to acquire 104.5 million newly-issued common shares from Canopy Growth, a leading diversified cannabis and hemp company, based in Smith Falls, Ontario with operations in 12 countries. The targeted private placement was priced at C$48.60 per share, which represented an approximately 51% premium to the closing price on the day before announcement and an approximately 38% premium to the trailing 5-day VWAP.
A multi-billion cross-border cash investment by a seasoned, investment grade, Fortune 500® company into a relatively young company that has not so far achieved positive earnings may have served to legitimize the cannabis industry in the minds of many market participants. In the weeks following Canopy Growth’s August 14, 2018 announcement, not only did the trading price of Canopy Growth jump, but the entire cannabis sector appeared to benefit from a halo effect. Approximately six weeks after Canopy Growth’s announcement of its deal with Constellation Brands, 18 publicly-traded cannabis companies that had an aggregate market capitalization of approximately C$43 billion on August 14 were valued at over C$70 billion. Although more recently cannabis stocks, along with equity markets more generally, have traded down, the completion of last week’s all-cash investment may give some of the industry’s doubters pause and stimulate other strategic partnerships.
Following the announcement of Constellation Brands’ investment, there was also considerable speculation in the financial media about the possibility of other well-established food and beverage companies partnering with cannabis companies to offer new cannabis-infused products. One research firm has projected that the US market for cannabidiol (CBD), a non-psychoactive compound found in cannabis, could reach US$22 billion by 2022, assuming passage of the 2018 Farm Bill in the United States, fueling speculation that the Constellation Brands – Canopy Growth partnership could become a model for others.
2. It was a Public M&A Transaction. Last week’s transaction is also distinctive because Constellation Brands acquired a controlling interest in Canopy Growth by way of a treasury subscription, without making an offer to acquire any shares from existing shareholders.
Prior to the transaction, Constellation Brands owned approximately 8.5% of Canopy Growth’s common shares, plus warrants entitling Constellation Brands to acquire an additional 8% equity interest. As a result of last week’s transaction, Constellation Brands owns approximately 37% of Canopy Growth’s common shares, making it a “control person” under provincial securities laws. As a holder of more than a third of Canopy Growth’s outstanding common shares, Constellation Brands is also in a position, should it elect to do so, to veto “fundamental changes” that require approval by special resolution under Canopy Growth’s governing legislation, such as a sale, lease or exchange of all or substantially all of the corporation’s assets, an amalgamation (other than a short form amalgamation), a stock split, a stock consolidation or a continuance.
Constellation Brands has also acquired a defined path to acquire majority ownership of Canopy Growth. As part of the private placement, Constellation Brands acquired two tranches of warrants entitling it to acquire an additional 139.8 million common shares. If Constellation Brands exercises all of its warrants, it will own approximately 55% of Canopy Growth’s common shares. In addition, pursuant to the terms of an amended and restated Investor Rights Agreement, Constellation Brands has pre-emptive rights to participate rateably in any future Canopy Growth share issuances, conventional demand and “piggyback” registration rights, a right to nominate four out of seven directors on Canopy Growth’s board of directors and shareholder veto rights with respect to certain prescribed material transactions, including any business combination, change of dividend policy or acquisition with an aggregate value exceeding C$250 million. In return for providing Constellation Brands with governance rights and a path to control, Canopy Growth obtained, among other things, cost-effective financing and an exclusive strategic partnership with a prominent beverage alcohol company that enjoys a global brand.
The control aspect of the transaction might seem curious to persons familiar with the “Revlon doctrine,” which is a shareholder primacy model of jurisprudence espoused by Delaware courts and followed in many other jurisdictions. Under the Revlon doctrine, in the context of a transaction involving a potential change-of-control, directors’ fiduciary duties are automatically transformed from focussing on the long-term interests of the corporation to “maximizing shareholder value” in the near term. More specifically, the role of the board, when faced with the possibility of a change of control, changes from “defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.”
However, Canopy Growth is not governed by Delaware law. Since the 1990s, a number of Ontario decisions have expressly declined to follow Revlon in the context of change of control transactions, one of them even going so far as to declare that “Revlon is not the law in Ontario.” About a decade ago, in BCE Inc. v. 1976 Debentureholders, the Supreme Court of Canada weighed in on the topic, in the context of a proposed leveraged buyout of a public telecommunications company. In BCE, the Supreme Court’s main focus was to consider whether the company’s debentureholders were being oppressed in a proposed plan of arrangement that had been approved by an overwhelming majority of common shareholders. While the court did not expressly reject Revlon, it reiterated a finding in its earlier decision in Peoples that, under Canadian corporate law, the fiduciary duty of directors is always owed to the corporation and not to any particular stakeholder or group of stakeholders. As such, under Canadian law, an informed board that is free of conflict of interest has wider latitude to exercise its business judgment, even in the context of a prospective change of control, than may be the case in jurisdictions that follow the Revlon doctrine. In Canada, not every prospective change of control requires a board of directors to auction the company.
Moreover, in many respects, Canopy Growth’s board of directors took steps that may have satisfied the Revlon duties, even if those duties had applied. For example, the related Subscription Agreement included many of the same kinds of protections that one might expect to see in a typical merger agreement, including:
- a closing condition to obtain approval by a “majority of the minority” at a special meeting of Canopy Growth shareholders;
- a “fiduciary out” entitling Canopy Growth to terminate the agreement if, prior to the special meeting, the company received an unsolicited offer that the board determined was a superior proposal to the Constellation Brands investment;
- a conventional break fee; and
- a “standstill” that limited Constellation Brands’ ability to propose or participate in a take-over bid or similar transaction involving the company.
In addition, Canopy Growth’s board sought and obtained a fairness opinion from a reputable, independent financial advisory firm.
3. Floating Formula Price Warrants. Notably, the terms of the second tranche of warrants issued to Constellation Brands are unusual. The warrants are an important component of the transaction because, upon exercise of both tranches of warrants, Constellation Brands will own approximately 55% of Canopy Growth’s outstanding common shares.
Both tranches have a 3-year term, which is not unusual. The first tranche of warrants, for approximately 88.5 million shares, is conventional and has a strike price of C$50.40, representing an approximately 57% premium to the closing price on the day before announcement of the transaction and a 43% premium to the trailing 5-day VWAP. The second tranche of warrants, for approximately 51.3 million shares, are not exercisable until after the first tranche has been exercised in full and, unconventionally, has no fixed exercise price. Instead these warrants have a formula exercise price. Specifically, the strike price for the second tranche of warrants is the trailing 20-day VWAP for the common shares on the date of exercise. Assuming that Constellation Brands ultimately exercises in full both tranches of warrants to acquire an additional 139.8 million common shares, Canopy Growth will receive not less than C$4.46 billion in additional cash, making the total value of last week’s transaction at least C$9.55 billion.
Time will tell whether this innovative transaction becomes a model for other tie-ups between Canadian cannabis companies and companies engaged in more traditional businesses.