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29 September 2013 Jesse Redding | Cameron Kirby | Sam Johnson

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

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  1. 29 September 2013 Jesse Redding | Cameron Kirby | Sam Johnson

  2. Thesis Large growth opportunity in ecigs Undervalued share price Solid core business with room for expansion Fundamental Undervaluation

  3. 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)

  4. Opportunity in E-Cigs

  5. 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

  6. 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

  7. 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

  8. 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

  9. E-Cig Economics

  10. Razor/BladE Model Razor Blade $35

  11. Margins Low Margins on Starter Packs High Margins on Cartridges Margin Expansion as product matures

  12. Distribution Channels Lorillard Retailers Customers

  13. E-Cig Regulation

  14. 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

  15. Valuation

  16. Valuation of Blu (Revenue) $530 mm * (P/S) 3 Equity Value = $1.59 bn

  17. P/S Comps GMCR: 2.7 ISRG: 6.26 SODA: 2.68 SSYS: 12.50

  18. Legacy Business

  19. 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

  20. Lorillard is Menthol • Newports are the menthol brand • Sustained dominance without discounting

  21. 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

  22. 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

  23. 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

  24. Segment Projections Proven ability to increase prices Flat volume due to new markets ~1-2% annual revenue growth

  25. Segment Valuation • Currently Trades at 10.6 EV/EBITDA • MO10.4 EV/EBITDA, RAI 11.9 • We believe a fair valuation is 12x

  26. Valuation

  27. Variant Perception • Market sees E-Cigs as too small • This segment should be valued at a premium to the rest of the business

  28. 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)

  29. Optionalities • Lorillard can expand into: • Non-Menthol Non-Full Flavor • Non-Menthol Full Flavor

  30. 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)

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

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