'An investment of this magnitude provides overall legitimacy to the sector': Here's why Wall Street is bullish about the largest tie-up yet between the tobacco and pot sectors

Cronos Group

Michael Gorenstein, Cronos Group CEO.

• Altria, the tobacco-maker behind popular brands like Marlboro, announced on Friday it intends to invest $1.8 billion for a 45% stake in marijuana cultivator Cronos Group.
• Wall Street reacted favorably to the news, as both companies' stocks were trading higher on Friday.
• "We believe an investment of this magnitude provides overall legitimacy to the industry as a whole and should represent a positive catalyst for the sector," Canaccord Genuity analysts wrote in a note to clients.

Tobacco is going to pot.

Altria, the tobacco behemoth behind Marlboro, announced on Friday it intends to invest $1.8 billion for a 45% stake of Cronos Group, a NASDAQ-listed Canadian marijuana cultivator. As part of the deal, Altria will also be able to nominate four directors to Cronos' expanded seven-member board.

Wall Street analysts reacted favorably to the news, with Canaccord Genuity saying the investment provided "overall legitimacy to the industry as a whole."

The deal was announced after rumors emerged on Monday that Altria and Cronos were engaged in early talks. Both stocks were lifted by the news: Cronos jumped over 21%, and Altria was up over 1% on Friday, following long declines amid lagging tobacco sales.

Read more: Marijuana companies are using a 'backdoor' strategy to tap the public markets - and it's fueling an M&A boom

Having access to Altria's deep pockets - and expertise in navigating the complicated regulations in the tobacco industry - could give Cronos a leg-up over its competition as it looks to build out its international presence, the Canaccord analysts said.

Michael Gorenstein, Cronos Group's CEO, said Altria was an "ideal partner" on a Friday morning call.

"The proceeds from Altria's investment will enable us to more quickly expand our global infrastructure and distribution footprint, while also increasing investments in R&D and brands that resonate with our consumers," Gorenstein said.

AP Photo/Ted S. Warren

In this Sept. 25, 2018 photo, a worker holds a marijuana plant leaf in a massive tomato greenhouse being renovated to grow pot in Delta, British Columbia.

The long-term winners in the cannabis industry 'are not yet clear'

Piper Jaffray analysts said in a note that the deal could "position both companies for better growth," giving Cronos "financial and regulatory resources" while providing Altria with access to the rapidly-growing cannabis industry.

"With a rapidly evolving cannabis landscape in which long-term winners are not yet clear, Altria's $1.8B stake seems more reasonable to us than a comparable recent deal activity that has exceeded twice that amount," the analysts said. In August, Constellation Brands - the beermaker behind brands like Corona and Modelo - sank $4 billion into a 38% stake of Canopy Growth, a Canadian LP.

Piper Jaffray's analysts added that while Altria has room to pursue more deals, depending on the size, the Cronos investment suggests that the tobacco company won't pursue a similar deal with the vaporizer company Juul, as has been previously reported.

Viven Azer, an analyst at Cowen, said the deal was proof that cannabis could offer "incremental growth" for tobacco companies like Altria as they face severe headwinds from increased regulation and slowing tobacco sales.

Read more: Big asset managers like BlackRock are sitting on the sidelines of the $75 billion US marijuana industry because of one big pain point

Altria isn't the first major corporation to push into cannabis.

Molson Coors entered a joint venture with HEXO to produce cannabis-infused beverages for the Canadian market in August.

Coca-Cola is also reportedly eyeing a deal with Aurora Cannabis to produce beverages infused with cannabidiol (CBD) for the Canadian market, though neither company has confirmed a deal was in the works.

The cannabis sector as a whole has this week seen a pullback after short-sellers targeted Aphria, one of the largest Canadian cannabis cultivators, or licensed producers (LP), by market cap. News of the tie-up between Altria and Cronos lifted the North American Marijuana Index on Friday.

• Read more:
• A top cannabis CEO talks about what's next following a $300 million merger, saying he's playing 'Risk' while his competitors are playing 'Monopoly'
• 'Everybody thinks they're going to make billions overnight': Mexico's former president says the cannabis industry isn't a gold rush
• Big law firms are building out specialized pot practices to chase down a red-hot market for weed deals