Trading Nation

Constellation Brands just dropped $4 billion on pot. Here’s why that could be a bum deal.

Trading Nation: Constellation's pot play panned
Constellation's pot play panned

Constellation Brands just spent billions on pot. The wine and spirits company increased its investment in cannabis company Canopy Growth by $4 billion.

Markets weren't buying it. Constellation's stock plummeted 6 percent on Wednesday in its worst daily performance since January 2017.

"Here's why the market hates it. They paid $4 billion for a company that was worth $5 billion and got about 38 percent of it, so the market thinks they just sort of paid too much," Boris Schlossberg, managing director of FX strategy at BK Asset Management, told CNBC's "Trading Nation" on Wednesday.

Constellation, which owns the Corona and Modelo beer brands, increased its stake to 38 percent from the 9.9 percent holding it had in October. The deal also includes new warrants that it can use to build a 50 percent stake. Constellation's increased investment priced Canopy's shares at a 51 percent premium to their Tuesday close.

The opportunity for a larger footprint in the fast-growing pot business is not as great a reward to Schlossberg as to justify the price.

"They certainly paid rich," said Schlossberg. "Pot is certainly the next frontier for growth, but it's also fraught with risk."

On top of regulatory risk, the industry has low barriers to entry, he said.

"I view it almost like coffee. It's a plant-based product that is very ripe for price competition. Basically, anyone can produce it," he added. "Could they be undercut through prices by somebody else once pot goes essentially global in the marketplace?"

The publicly traded pot industry is still mostly concentrated among small- to mid-cap companies. Competitors Cronos Group, Aurora Cannabis, and Emerald Health trade with less than a $5 billion market cap.

Like Schlossberg, Stacey Gilbert, market strategist at Susquehanna, is cautious on Constellation Brands. Gilbert says their shared view is considered out of the ordinary on the Street.

"Obviously if you look at what the market is rating this, what analysts across the Street are rating this, they definitely have more buys than sells here," Gilbert said on Wednesday's "Trading Nation." "We tend to be in the neutral camp here."

The majority of analyst ratings compiled by FactSet have an overweight rating on Constellation and an average price target of $248.57. That price target implies 19 percent upside from current levels.