Canadian marijuana company Cronos Group has seen its stock rally by close to 25% over the last two days, amid reports that Tobacco major Altria is in early-stage talks to invest in the company. While Cronos confirmed the talks, it noted that there was no assurance that it would reach an agreement or that a deal would go through. In this note, we take a look at what these developments could mean for Cronos.

We have created an interactive dashboard analysis on what’s driving Cronos Group’s valuation, which allows users to modify any of our forecasts and drivers to arrive at their own valuation estimates for the company.

Why tobacco players are interested in marijuana

The discussions come at a time when interest in marijuana is soaring, amid legalization of recreational marijuana in multiple U.S. states and in Canada, as well as an increasing use of cannabis for medicinal purposes. Accounting for both legal and black market sales, the total demand for marijuana in the United States is estimated at $52.5 billion, per the Marijuana Business Daily. On the other hand, cigarette sales have been on the decline, as fewer young people have taken to smoking. Per the U.S. Centers for Disease Control and Prevention, last year cigarette smoking fell to its lowest level on record. This is likely causing tobacco companies to hedge their bets by looking at marijuana, which potentially has lower risks of causing diseases such as cancer, while also appealing to younger users.

What does Cronos bring to the table?

Although Cronos Group counts as one of the smaller publicly listed marijuana companies, with revenues of just about $3.8 million in its most recent quarter, the company is still likely to be an attractive target. While the company’s annualized capacity only stands at about 6,650 kilograms Cronos has taken steps to scale up capacity both in Canada and overseas via joint ventures. For instance, the company recently completed construction of a facility that can produce 40,000 kilograms of cannabis annually in Canada, while noting that it had forged a joint venture with a group of investors to put up a greenhouse that can produce up to 70,000 kilograms a year. The company is also focusing on improving its technology capability to gain a long-term edge in the market. In October, the company entered into a partnership with Boston-based biotech startup Ginkgo Bioworks to develop cannabinoids – which are the active ingredients of cannabis plant – artificially.