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29 September 2013 Jesse Redding | Cameron Kirby | Sam Johnson. Thesis. Large growth opportunity in ecigs. Undervalued share price. Solid core business with room for expansion. Fundamental Undervaluation. Valuation. Revenue = $530mm P/S = 3 Equity Value = $1.59 bn. E-Cigarettes.

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29 september 2013 jesse redding cameron kirby sam johnson
29 September 2013

Jesse Redding | Cameron Kirby | Sam Johnson

thesis
Thesis

Large growth opportunity in ecigs

Undervalued share price

Solid core business with room for expansion

Fundamental Undervaluation

valuation
Valuation

Revenue = $530mm

P/S = 3

Equity Value = $1.59 bn

E-Cigarettes

Traditional

EBIT = $2.033bn

EV/EBIT = 12

EV = $24.4 bn

Equity Value = $1.59 bn + $24.4 bn - $3.1bn

= $23 bn (35% upside)

value proposition
Value Proposition
  • eCigarettes offer to the consumer:
    • Freedom to smoke whenever and wherever one chooses to
    • No smell
    • Decreased social stigma
    • Significantly reduced health risks
addressable market
Addressable Market
  • Almost 100% of ecig customers were or are smokers.
  • Total cigarette industry: ~$80b retail revenue, ~$30b manufacturer revenue
  • Total Volume of 290b cigarettes/year
  • 2012 ecig industry: ~$1b retail revenue
how we quantified market growth
How we Quantified Market Growth

~8.5b fewer cigarettes sold in 2013

2012 Cigarettes sold: 290b

4% Annual Volume Decrease

30% of volume moves to ecigs

~8.5b fewer cigarettes sold in 2013

ecig market grows by ~2.55b cigarette equivalents

competitors
Competitors
  • eCigarette industry is large and highly fragmented
  • Currently, Blu commands ~40% market share followed by NJOY which has ~30% market share
  • Quickly changing industry with recent entry of Reynolds and Altria
razor blade model
Razor/BladE Model

Razor

Blade

$35

margins
Margins

Low Margins on Starter Packs

High Margins on Cartridges

Margin Expansion as product matures

distribution channels
Distribution Channels

Lorillard

Retailers

Customers

regulation
Regulation
  • Currently, eCigarette regulation is state by state with the only restrictions being on sales to minors
  • FDA has them listed as tobacco products, and they are thus subject to fewer regulations
  • Since eCigarettes are under laxer FDA regulations, they can be advertised on television and radio
  • Due to the appeal of flavors to children, many have called for the ban of the different flavors of eCigarette cartridge
valuation of blu
Valuation of Blu

(Revenue) $530 mm * (P/S) 3

Equity Value = $1.59 bn

p s comps
P/S Comps

GMCR: 2.7

ISRG: 6.26

SODA: 2.68

SSYS: 12.50

cigarette industry
Cigarette Industry
  • The largest firms within industry are Altria, Reynolds, and Lorillard
  • Huge variety within cigarette industry, but menthol and regular are the most commonly used
  • Additionally, there are light and medium cigarettes which have less nicotine and tar than the regular
  • Decline within cigarette industry but slower within menthol category

2% annualized decline for Menthol vs. 4% for non-Menthol

lorillard is menthol
Lorillard is Menthol
  • Newports are the menthol brand
  • Sustained dominance without discounting
menthol is resistant
Menthol is Resistant
  • Menthol caters to a lower socio-economic demographic
  • More deeply embedded smoking habits
  • Little crossover between flavors
  • Minimal cannibalization from shift to ecigs
expansion into non menthol
Expansion into Non-Menthol
  • No existing presence means easy market share gains
  • Small upfront costs mitigate risk
  • Much larger non-menthol market means small gains are profitable
regulation1
Regulation
  • Menthol-specific regulation has been tossed around for a long time
  • Current efforts remain stalled
  • Science does not appear to support difference in damage between menthol and non-menthol
  • clearing of overhang would help stock
segment projections
Segment Projections

Proven ability to increase prices

Flat volume due to new markets

~1-2% annual revenue growth

segment valuation
Segment Valuation
  • Currently Trades at 10.6 EV/EBITDA
  • MO10.4 EV/EBITDA, RAI 11.9
  • We believe a fair valuation is 12x
variant perception
Variant Perception
  • Market sees E-Cigs as too small
  • This segment should be valued at a premium to the rest of the business
traditional metrics
Traditional Metrics
  • Other tobacco companies are trading at:
    • P/E (industry average): 14
    • P/CF (industry average): 16
  • On these metrics, LO should trade for:
    • $54 based on P/E (20% upside)
    • $58 based on P/CF (28% upside)
optionalities
Optionalities
  • Lorillard can expand into:
    • Non-Menthol Non-Full Flavor
    • Non-Menthol Full Flavor
valuation3
Valuation

Revenue = $530mm

P/S = 3

Equity Value = $1.59 bn

E-Cigarettes

Traditional

EBIT = $2.033bn

EV/EBIT = 12

EV = $24.4 bn

Equity Value = $1.59 bn + $24.4 bn - $3.1bn

= $23 bn (35% upside)

recommendation
Recommendation
  • BIG should take a 5% position on Wednesday morning