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Canopy Growth (TSX:WEED): Beware the Disruptive Cronos Group (TSX:CRON)

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Cannabis producer Cronos Group (TSX:CRON)(NASDAQ:CRON) is going ahead with a disruptive competitive strategy for the pot industry after announcing a planned strategic acquisition on Thursday. The company is evidently demonstrating a serious commitment to a new technology that could smear mud in Canopy Growth’s (TSX:WEED)(NYSE:CGC) face and ravish the stock.

What’s new on Cronos Group?

The company announced an agreement to acquire a large, GMP-compliant, state-of-the-art fermentation and manufacturing facility in Canada with fully equipped laboratories and large-scale microbial fermentation production areas with a combined production capacity of 102,000 litres.

This is in line with the company’s earlier announced partnership with Ginko Bioworks to produce cannabinoids like CBD and THC and their rare variants more cheaply from biological fermentation than from the more expensive conventional cultivation and extraction processes.

As highlighted earlier, current market leaders should be concerned.

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Why should Canopy Growth be worried?

The cannabis market leader has invested billions in infrastructure and processes towards the cultivation and extraction functions, and everyone else in the industry has been going after its market share in recent quarters.

The company incurred increased production costs per gram of cannabis produced until management ultimately stopped reporting on cash costs per gram last year, with then-CEO and now ousted chairman Bruce Linton’s comments implying that the non-standardized cost measures were not that relevant, and proposing that the industry should instead move towards reporting on cost per measure of THC or CBD — a more pure cost measurement metric for produced ingredients.

Canopy is yet to give us an alternative cost measure since abandoning the cost per gram numbers months ago. Given the significantly shrinking gross margins before fair-value adjustments to 16% recently, one can only suspect that the cost per gram produced in-house by the leading giant is awful.

Then here comes a smaller competitor that is making some serious moves to directly produce essential and critical cannabinoids without the massive investment that current leaders have made, and Cronos intends to do this at a large scale, and at a fraction to current average industry production costs.

And the company “intends to use existing cash on hand to fund the acquisition, which is not expected to be material to Cronos Group’s cash position.”

The industry could see early disruption

The move by Cronos to acquire fermentation assets instead of outsourcing the service from established beer brewers as previously hinted could be a significant sign that the trials and research at Ginko Bioworks is close to a commercial breakthrough, and this could be big and unsettling news.

CRON may soon be able to mass produce pure cultured CBD, THC and the other cannabinoids “with greater efficiency than is currently possible with traditional cultivation and extraction” and at lower costs by using biological fermentation processes and use them as ingredients in cannabis-infused products and medical offerings.

The company could be able to undercut the competition before it can make a profit and realize returns on investments on the millions invested over the years.

The industry peers should indeed take notice.

That said, we don’t know whether Health Canada will approve and license the technology and processes yet, and the Ginko partnership hasn’t achieved its set milestones yet.

It’s too early to call, and I will be watching.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Brian Paradza has no position in any of the stocks mentioned.

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