Big Tobacco’s Electronic Shock: Lorillard Makes Another Bet on E-Cigarettes With Skycig, and Industry Risks Suggest Such Deals Could Also Be Worthwhile for Altria and Reynolds American

October 3, 2013 Leave a comment

October 2, 2013, 2:56 p.m. ET

Big Tobacco’s Electronic Shock

Lorillard Makes Another Bet on E-Cigarettes With Skycig, and Industry Risks Suggest Such Deals Could Also Be Worthwhile for Altria and Reynolds American

JOHN JANNARONE

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Big Tobacco has largely stayed on familiar turf in recent years. Now, it is expanding its horizons. Lorillard, LO +0.60% the No. 3 U.S. tobacco company by market value after Altria Group MO +0.12% and Reynolds American, RAI -0.16% has agreed to pay up to $100 million for Skycig, a U.K.-based maker of electronic cigarettes. That follows a $135 million deal last year to buy blu eCigs, a big U.S. brand.While the deals may not look huge, they are the two largest acquisitions by any of the Big Three U.S. tobacco companies since Altria Group bought smokeless tobacco firm UST Inc. in 2008.

Lorillard is sticking its neck out. While Altria and Reynolds American have experimented with small e-cigarette brands internally, they are available only in a few U.S. test markets. Electronic cigarettes are nicotine-delivery devices that look like the real thing but contain no tobacco.

The likely reason for Lorillard’s move: pressure on it to diversify. Its main product is Newport, a menthol cigarette that U.S. regulators have recently considered controlling more tightly.

Lorillard shares, which for years traded at a premium to peers, have dropped to a multiple of 13 times forward earnings, compared with 14.3 times for Reynolds and 13.8 times for Altria.

Yet the entire industry could use some insurance. The Food and Drug Administration has signaled a desire to reduce the level of nicotine in cigarettes. That would make them less addictive, creating an incentive for smokers to find a replacement.

Retailers have reason to put more e-cigarettes on their shelves in place of traditional products. Thilo Wrede of Jefferies says the industry has raised traditional cigarette prices in recent quarters, but retailers weren’t able to pass this on to consumers. That has squeezed their margins.

And there are plenty of independent e-cigarette players chasing the opportunity. The likes of NJOY and FIN already have brick-and-mortar distribution in 50 states.

The opportunity cost for big tobacco isn’t that high. As with rivals, Lorillard directs a large percentage of its available cash to dividends and share buybacks. But the cash needed from the latest deal would hardly move the needle for a company with a market value of $17 billion. Altria and Reynolds are even bigger.

It is easy to brush off e-cigarettes, with Morgan Stanley estimating they will take just 0.5 percentage point of market share from traditional tobacco in 2013. But with few other ways to protect traditional tobacco, Lorillard could soon look like the brighter bulb.

Filed under Macro Trends

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Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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