0:00

A quick announcement: head of the episode.

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0:06

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there's one thing that you learn from

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studying these businesses, from studying founders just

0:15

existing in the business community, It's.

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world. And. This is gonna be an event.

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significant time for one on one conversations.

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0:59

I'll leave you with this. I attended David's

1:01

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1:03

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spoke to yesterday. That. I had met

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the past in a podcast. This podcast

4:01

is for informational purposes only and should

4:03

not be relied upon as a basis

4:05

for investment decision. Welcome

4:09

back to business breakdowns

4:11

Today We are covering

4:13

British American Tobacco. My.

4:15

Guess for today is Evan Tyndall. Cofounder.

4:18

And see, I owe a Bireme capital. And.

4:20

Regardless of your views on the actual

4:22

product of tobacco, The. Market is

4:25

one of the oldest in the world.

4:28

Evan helps us cover how that tobacco

4:30

market of all and we go way

4:32

back in time. How the

4:34

product itself has evolved from smoking

4:37

pipes, two cigarettes to what we're

4:39

seeing today. That nicotine patch market

4:41

all the craze around it. And.

4:44

We cover how you evaluate a

4:46

company where the market outlook is

4:48

so uncertain. My. Favorite part

4:51

of this conversation may be getting some

4:53

background as to the name of British

4:55

American Tobacco. It's always one that has

4:58

stood out to me. and the dynamics

5:00

of international vertices domestic are truly unique

5:02

in this market, so a lot to

5:04

consider here. Please Enjoy! display. Then of

5:07

course at sunset. All

5:10

right Evans, I'm excited we are finally

5:12

breaking down British American Tobacco. It's been

5:15

a name on our wish lists for

5:17

quite awhile, really since the beginning of

5:19

business breakdown. So excited to get to

5:21

it here! And I think

5:23

we start at the top. It's a

5:25

very obvious industry in terms of what.

5:28

Tobacco. Is but I think understanding who

5:30

British American tobacco is a good place to

5:32

start to. Maybe you could just walk us

5:35

through. What? They're actually selling what

5:37

Beatty I is made up of and anything

5:39

else eating is really important. It is have

5:41

right off the top. British. American

5:43

tobacco is primarily selling tobacco

5:45

surprise surprise and they are

5:48

roughly sixty percent, forty five,

5:50

fifty percent U S, a

5:52

third Europe and the rest

5:55

Asia and profits or play

5:57

a little bit more. With.

5:59

It. The Us, they've have

6:02

about twenty four billion

6:04

pounds of traditional tobacco

6:07

sales that's primarily cigarettes

6:09

office, some cigars, also,

6:11

some suing tobacco, and

6:14

then they house. Three.

6:16

Billion have what's called

6:18

reduce risk or new

6:20

category. Products. Which

6:23

are. Modern. Oral.

6:25

Products. Which are And the nicotine patch

6:27

that delivers the nicotine directly to your

6:30

mouth. Vp products which people

6:32

in the Us are probably familiar

6:34

with and then a heated but

6:36

not burns tobacco product as well

6:39

which is. Technically. Tobacco.

6:41

But it's not burning. The tobacco in

6:43

your mouth is just eating it up

6:45

just enough. And. So within those

6:47

twenty four, twenty five billion of traditional

6:49

tobacco revenue, they have some pretty well

6:52

known brands, specially in the Us. most

6:54

of the top brands that are Marlboro

6:56

or British American brands. It's New Port

6:59

Campbell and Stonehill Pall Mall Lucky Strike.

7:01

Those are some of the main brands

7:03

and will get into the history, but

7:06

a bunch of those they acquired via

7:08

their acquisition of Rj Reynolds between Two

7:10

Thousand and Four and Two Thousand Seventeen

7:13

is when they slowly consolidated control of

7:15

of Rj Reynolds. Over time. I

7:18

know we're going to get into that

7:20

innovative product category for just to hear

7:22

the split of twenty four vs three

7:24

is interesting. I can imagine what ones

7:26

growing faster at this point, but let's.

7:29

Get. Into that history a bit from

7:31

my sense of the research. Looks like

7:33

this is be com a consolidated industry

7:35

over the years and you have major

7:37

players. What does Beatty I look like

7:40

basically start to finish and maybe in

7:42

the context of the industry as well.

7:44

If you have any general market share

7:46

numbers or anything you could share on

7:48

that. Thing. With tobacco as you

7:50

have to go. Kind of back a long

7:53

time. So British American was formed and Nine

7:55

Chino. Ominously. Got

7:57

back to. Thousands of years.

7:59

B. You don't mind? Oh

8:01

yes, we love history. Yeah,

8:03

so so back go was

8:05

use amongst Native American tribes,

8:07

but the North American in

8:09

South American tribes for thousands

8:11

of years before Columbus got

8:13

there. Was. Used for all

8:16

sorts of. Different. Reasons.

8:18

As. A various rituals as a community building

8:21

just to get high risk. Everything that you

8:23

can think of that you might use or

8:25

products like nicotine for when Columbus first landed

8:27

in the New World is actually given some

8:29

dry tobacco leaf when he first got there

8:31

is kind of like a presence or you

8:34

can see how kind of important it was

8:36

in some of those societies. By.

8:38

As far as the company and commercialization

8:40

history, it's sort of European focused on

8:43

really started. Especially. In

8:45

the Colonies with John

8:47

Ross who planted the

8:49

first tobacco plant and

8:51

Jamestown and sixteen Twelve

8:53

and. It's sort of

8:55

of may be under appreciated How

8:57

important that was? Further development of

8:59

the colonies because it's turn Jamestown

9:01

from a ragtag group of people

9:04

who like in one year only

9:06

forty people at Jamestown survived. but

9:08

then with tobacco use turned into

9:10

an actual like financially sustainable. Colony

9:12

and then basically tobacco was off to

9:15

the races in the Us. came side

9:17

by side. the slave trade as well

9:19

for the next by couple hundred years.

9:22

Belfast, For us to hundred fifty

9:25

years, the tobacco industry grew. Primarily.

9:27

Loose Leaf Tobacco Sales suing tobacco

9:30

and pipe smoking or Com and.

9:32

But. Then is eighteen eighty a

9:34

device was created called the Been

9:37

Sacked Device which took the production

9:39

of cigarettes from a couple hundred

9:42

per day to seventy thousand per

9:44

day. So. Busy decrease the

9:46

cost of producing. These things are more than

9:48

fifty percent. And.

9:51

The guy that on the first machines

9:53

decided his name was book do with

9:55

it. Sounds like a. Guy.

9:57

from the eighteen hundreds course bucks going

10:00

to try to create a tobacco monopoly, right? Like just sounds

10:02

like what he would do, right? And he

10:04

did it well. He did it well. He bought

10:06

these devices. He spent a bunch of money on advertising,

10:08

which was an innovation back at that time, creating

10:11

some of the first early brands. And

10:13

in 1889, he formed something called the

10:15

American Tobacco Company, which was

10:18

essentially a monopoly on tobacco production and

10:20

sale in the US. You'll

10:22

notice we're getting kind of close to 1901 or 1902 when VAT was created.

10:27

And so in 1901, this guy Buckduke decided

10:30

he was going to take his business and

10:32

try to go compete with the British manufacturers

10:34

in England. And they didn't

10:36

like that, unsurprisingly.

10:39

So they kind of circled the wagons

10:41

and 13 British companies

10:44

formed what's still known as Imperial

10:46

Tobacco. And they

10:49

decided to fight off ATC from the

10:51

US in every way possible by

10:53

pressuring UK retailers not to sell their stuff. They

10:55

actually came over to the US and tried to

10:58

start buying stuff in the US just to like

11:00

mess with them on their home turf. And

11:02

they spent a year doing that. And then pretty

11:05

quickly they decided, you know what, instead of fighting

11:07

each other, let's just agree

11:09

to have our own monopolies on our own

11:11

domestic turf, and then create a

11:13

third business, a joint

11:16

venture that would sell our products overseas.

11:19

And that was British American Tobacco. So you can

11:21

kind of understand now where the name comes from.

11:23

It literally was American Tobacco

11:25

and Imperial Tobacco, creating a

11:27

combined company. For a

11:29

long time, British American Tobacco was,

11:31

that was their thing. They were

11:34

selling Imperial and American

11:36

Tobacco brands overseas. And

11:39

it took them a few decades before they

11:41

started to get back into, they're still not

11:43

a major player in the British market. But

11:45

over time, they did enter the US market.

11:48

And they did that by buying a company called

11:50

Brown and Williamson. I think

11:52

that was in the 60s or 70s. But By

11:54

then, the US had become a more competitive market because

11:57

in 1911, the Supreme. Court

12:00

ruled that American Tobacco wasn't illegal monopoly

12:02

and broke it up into three different

12:04

companies. The. Lesser discussed yeah of

12:07

the Standard Oil versus the American

12:09

Tobacco. It wasn't the first company

12:11

that this happened to, but it was the

12:13

had this playbook for kind of breaking things

12:15

into it. it's parts American tobacco, it eating

12:17

Eighty Nine and the Sherman Antitrust Act was

12:19

passed in Eighty Nine. So. I

12:22

don't think that was a coincidence. But.

12:24

Over the decades you in the Us

12:26

you had various. Brands. That

12:28

were introduce more. The first successful

12:31

brands was introduced by our journals

12:33

would later become on by British

12:35

American and that was Camel and

12:37

Eighteen Thirteen which was like one

12:39

of the first national brands. So

12:41

overtime Rj, Reynolds, and then later

12:43

Philip Morris became like really strong

12:45

competitors and came to dominate do

12:48

really well in the Us market.

12:50

They began to navigate a sort

12:52

of increasing regulatory environment because in

12:54

the nineteen fifties. A bunch

12:56

of studies came out and that was also

12:58

when the Surgeon General first sort of declared

13:00

that there was a strong correlation with lung

13:02

cancer. is hop easy to to where it.

13:05

It without that time and the

13:07

nineteen fifties that Marlboro decided to

13:10

switch from being a. Women:

13:12

Focused brands. To. Being

13:14

a men's cowboy brand and

13:16

obviously. That. Is like a

13:18

case study in itself of sort of

13:21

marketing prowess in Nineteen Seventy Two for

13:23

more. Speaking that the largest tobacco companies

13:25

in the Us. But. Basically

13:27

the eighties and nineties were. Decades.

13:30

Of. Be. A T,

13:32

but mostly Rj Reynolds consolidating the

13:34

U S industry the non Philip

13:37

Morris Us industry. It emerged with

13:39

American Tobacco and if igniting, Ninety

13:42

Four did emerge with Brown and

13:44

Williams, and in Two Thousand and

13:46

Four isn't by Lorillard which made

13:49

Newport in Twenty Fourteen and so

13:51

increasingly Are Journal sort of gobbled

13:54

up the second and third players.

13:57

And. Meanwhile British American. Based.

13:59

On the. Your to merge

14:01

with Brown and Williamson in chosen for

14:03

the own forty two percent of that

14:05

company. So. This was largely driven by

14:07

be a T kind of strategy. Innovative technically

14:09

control the business. I see the on forty

14:11

two percent of something of a big same

14:14

what goes on and then finally and twenty

14:16

seventeen they pulled the trigger to by the

14:18

rest of that so be a seat for

14:20

gonna big chunk of death to do that.

14:22

but than. That. If we became

14:24

the very strong. Number. Two

14:27

player in the Us number

14:29

two to out for ya

14:31

witches. And. A so many company

14:34

names and mergers and acquisitions. It's

14:36

so complicated but alters the company that

14:38

took over the Marlborough brands because after

14:40

the Us really started cracking down from

14:43

regulatory standpoint. Philip. Morris split

14:45

in Sir Philip Morris International. And.

14:48

Altria. Which. Kept the

14:50

Marlborough Man bread other lesser Philip

14:52

Morris friends. Part of that I

14:54

should mention was the Ninety Ninety

14:57

Eight Master Agreement where the big

14:59

manufacturers agreed to pay. Two

15:01

hundred billion over twenty five years to

15:03

the states. I think that continues to

15:06

this day. Nine billion a year or

15:08

something is paid out as part of

15:10

this agreements. One of the big changes

15:12

that that agreement resulted in was the

15:15

split off of Philip Morris. So today

15:17

you have From a combustible standpoint, you

15:19

have still altria of the number one

15:21

Us company and and strong number two.

15:24

Is. Be a T and so more.

15:26

says the biggest competitor elsewhere and

15:28

certainly in terms of next generation

15:30

products there I Coast brand is

15:33

the largest. actually. recently passed Marlboro

15:35

for them as their largest friends.

15:37

There. Is a lot of interesting dynamic fair

15:39

that I want to hit on terms of

15:41

branding when it comes to these companies at

15:43

the highest of level but also the individual

15:46

brands as well. But. one

15:48

thing that you mention throughout that

15:50

history was the involvement of government

15:53

involvement of regulation a few key

15:55

milestones there in that history can

15:57

you just give us a sense

16:00

of what the in industry looks

16:02

like in terms of regulation today,

16:04

whether it's the taxing, the limitations

16:07

on advertising, anything else that

16:09

you can point to because it's a much

16:11

different playing field when it comes to tobacco

16:13

products versus others. The biggest thing

16:15

is the companies

16:17

are basically not allowed to

16:20

advertise in the US

16:22

or in most developed countries,

16:24

whether that's on TV or

16:26

radio or prints or really

16:28

anywhere. They're really banned from

16:30

advertising. In some ways that

16:32

creates a stagnation amongst

16:35

these brands, which from

16:38

a business perspective, think, well, stagnation might not

16:40

be such a great thing, but stagnation, if

16:42

you're the number one or number two company,

16:45

is not such a bad thing

16:47

because it's basically a guarantee that

16:49

there won't be upstarts

16:51

trying to break into this industry. The

16:54

idea of trying to create a new cigarette

16:57

brand, I mean, I would guess

16:59

you'd get laughed out of a room if you tried

17:01

to pitch that to a venture capitalist because it's just

17:04

such an obviously terrible idea. You can't

17:06

advertise the declining population of users. There's

17:08

going to be all sorts of pushback

17:11

and so it's just simply not possible.

17:13

It is taxed very heavily, primarily by

17:15

the states, at least in the US. Of

17:17

course, internationally, there's

17:20

various tax regimes internationally, but a big

17:22

trend or chunk of the price that

17:24

you actually pay for a pack of

17:26

cigarettes at the store is

17:29

actually tax money. I've

17:31

read somewhere, I think the industry was

17:34

$800 billion-ish within the

17:36

past few years in terms of total

17:38

market size and 25% of

17:40

that was going to taxes,

17:43

so immediately out the door. Yeah,

17:46

that sounds about right. Quite a unique dynamic when

17:48

it comes to operating a business.

17:51

On the market size and just some of the trends

17:53

that you mentioned there in terms of people

17:56

that actually buy cigarettes today, it's

17:58

a much different area. than

18:00

what it was like when actors and

18:02

actresses were seen everywhere with cigarettes in

18:04

their hand. It was almost a status

18:07

symbol. In addition to the product

18:09

being hard to quit, what

18:12

has that trended like in recent

18:14

years? And you can split that

18:16

up however you like. If you want to mention what

18:18

the new products are doing in terms of total market

18:20

size, but how has that

18:23

market size trended, especially recently?

18:25

The thing that we have the best data

18:28

on and also probably the most interesting

18:30

dynamics is probably the US. Historically

18:33

for British American, what

18:35

they've seen the past probably

18:37

five to ten years on average

18:40

is low single-digit declines

18:42

in volume and

18:45

roughly similar net price

18:48

increases in terms of price

18:50

per pack, which is very convenient way to

18:52

think about the business. And it ends up

18:54

that the traditional business has been amazingly

18:57

flat the last few years. Although 2023

18:59

was actually a larger down year than

19:01

some of the past ones in terms

19:03

of volumes with volumes down roughly 10%

19:06

in the US. But prior to that, 2, 3, 4%

19:10

volume declines were common and it was

19:12

actually not difficult for them because of

19:14

this kind of dynamic of it really

19:17

being an oligopoly, a lot

19:19

of brand loyalty. They're historically

19:21

able to raise prices to kind of

19:23

offset that pretty easily. Altria

19:26

had a slide recently that they presented at

19:28

a conference that showed that they

19:31

think in terms of the volume

19:33

of cigarette equivalent packs,

19:36

if you include basically

19:38

all forms of nicotine, has

19:41

actually been growing 1% per year

19:43

over the past five years because

19:45

you have this dynamic where the

19:47

traditional volume is declining, but

19:49

increasing number of people are using vapes

19:52

or using nicotine pouches or

19:54

using some other form of oral tobacco on

19:57

their numbers. They have a 1% actually growth.

20:00

in volumes in the US. It gets

20:02

even trickier though to actually figure out what's

20:04

going on because around 50% of

20:07

the volume in vapes

20:10

is disposable non FDA

20:13

approved vapes that

20:15

can't aren't tracked so easily. Like

20:18

if Nielsen comes in and says, hey how many of

20:20

these vapes did you sell? At that point they definitely

20:22

know that they're not supposed to give them data. It's

20:25

a little bit tricky to figure out exactly what's

20:27

going on but rough numbers it's sort of low.

20:29

It seems like it's either flat to

20:32

slightly increasing overall volume with

20:34

the traditional combustible products falling

20:36

low single digits. Elsewhere it

20:38

seems like it's outside

20:40

of the US except for a few

20:42

places. There hasn't been quite as quick of an uptake

20:45

on faping for example. So in a lot of

20:47

places volume is kind of flattish and

20:50

price increases there can result in

20:53

actually relative increases. One

20:55

other interesting market to talk about is Japan

20:58

because there you've actually seen almost

21:00

30% of revenues now

21:02

are coming from next generation these

21:05

heated but not burned products primarily

21:07

icos and that market

21:09

the overall market has been growing very low

21:11

single digits but the overall market has been

21:13

growing. That's like another story that

21:16

I think eventually is gonna be told

21:18

and people are gonna realize is that as

21:21

people move to less harmful

21:23

products the market may actually grow.

21:26

We have yet to mention the name

21:29

Zinn. We've alluded to the pouches and

21:31

I know Zinn is not a British

21:33

American tobacco brand. Certainly all

21:36

of the craze and media

21:38

headlines and there's some similarities

21:40

to what was happening with

21:42

vaping years ago but when

21:45

you frame the actual market

21:47

sizes or market shares split

21:49

between that traditional tobacco and

21:52

the new wave of products

21:54

you gave some sense for BTI. Do you

21:57

have a sense for the market overall are

21:59

they a reasonable price? proxy in terms of

22:01

their mix. It kind of depends on

22:03

exactly what you mean. For

22:05

everyone except for Philip

22:07

Morris, they have the

22:09

highest penetration of I think it was like 16 or

22:11

17% in 2023. It's

22:14

going to be like probably more than 20% this

22:16

year in terms of next

22:18

generation products. And

22:20

for everyone except Philip Morris, that's a very

22:22

high number. I think Philip

22:24

Morris is roughly 30% of

22:27

next generation products and going towards 40%. That's

22:30

sort of ex-China, I think, because China has a

22:33

huge industry and I don't think they have any

22:36

significant next generation. Although some of the companies that manufacture

22:38

these things are actually in Hong Kong, which is kind

22:40

of ironic. But yeah, Japan is like

22:42

almost 30% share. Europe

22:44

is much lower. In the US

22:46

and other places, it's 10%, 15%, 20%. I

22:50

think Zinn is a super interesting case study. Philip

22:52

Morris is guiding for 60% volume

22:54

growth. And I think what people are

22:56

discovering is that obviously people have known

22:59

for thousands of years that nicotine is kind

23:01

of an enjoyable drug to consume. And

23:05

what the companies are realizing is that people can do it

23:07

in a way that's harmful, there's just going to be much

23:09

more demand. So I think that

23:11

is maybe the canary in the coal mine for

23:13

kind of the long term growth of the industry.

23:16

And BAT's Zinn-like brand in

23:18

Europe, which is Velo, grew

23:20

35% last year. And

23:22

I think it has a good chance to continue on sort of a

23:25

Zinn-like trajectory across Europe,

23:28

and maybe eventually the US. They have a

23:30

Velo 2.0 product that they're going to be

23:32

launching in the US at some point once it gets approved,

23:34

but it's not approved yet. With

23:36

something like Pouches, it's something where,

23:38

I mean, almost 20 years ago

23:40

at college, I would go

23:42

to a party and there would be some

23:44

rep from a tobacco company giving out these

23:46

pouches for free. So they were

23:48

around then. Can you point

23:51

to what has actually led to the

23:53

inflection of interest and the demand? I

23:55

think it's a combination of things. I

23:58

think one... Back

24:01

in the day, back when we were

24:03

in college. The. Modern World products

24:05

have not been released so

24:07

there was like Snooze products

24:09

that were busy. Pouched tobacco

24:11

products. Actually, Within tobacco

24:13

products there are cancer causing chemicals.

24:16

It's not just burning it in

24:18

your mouth. they're called tobacco specific

24:20

nitrosamine cycle. I'm pronouncing that read

24:22

and while it's definitely a lower

24:25

risk products for sure relative to

24:27

and healing a bunch of smoke,

24:29

there is Stephanie Risk their a

24:31

lot of that risk I think

24:33

goes out the window with the

24:36

modern products which are just pure

24:38

nicotine in a pouch and most

24:40

of those did not get released.

24:42

Until around and years ago. So.

24:45

There was that and and I think. Also.

24:48

Similar to the popular developing in the

24:50

U S. Once you have. A.

24:52

Product that is of fire nicotine.

24:54

It's not. Tobacco doesn't have an

24:57

inherently any sort of tobacco flavor.

24:59

You can put other flavors in

25:01

it. So. You can have

25:03

a main goes in or amid

25:05

zen or whatever and that's it.

25:07

I think inherently up more does

25:09

Apple products that are tobacco flavor.

25:12

House. Setting. Of the combination

25:14

of the things, the health aspect in the

25:16

ability to more easily put in flavors that

25:19

probably is causing growth business. And.

25:21

Then in terms of those products

25:23

and the regulation around those, it's

25:25

interesting because seemed like there was

25:28

an upstart or part of a

25:30

much smaller company before being acquired.

25:32

which shows that there can be

25:34

this path for new products outside

25:36

of the traditional cigarettes space. or

25:38

they regulated significantly differently in terms

25:40

of whether you can advertise for

25:43

them or anything else along the

25:45

lines. Zenith. Basically.

25:47

Regulated. Similarly, to any

25:49

other tobacco or nicotine products, they're

25:52

not advertise. They're not allowed to

25:54

do all the things that a

25:56

normal company could in terms of

25:58

a marketing. The products. Which honestly

26:00

makes it's growth all the more amazing.

26:02

It's not even fully approved actually. in

26:05

the U S, there's sort of like

26:07

two buckets of these reduced risk products

26:09

are sexy. Three buckets. one bucket is

26:12

actually approved products which I think views

26:14

enjoy and self serve you liquid products

26:16

were yup, your own personal tank and

26:18

you refill it, etc. which is like

26:21

a tiny percentage of the market. Those.

26:23

Products are like actually approved and then there's a

26:26

trunk of products were they. Are. Not

26:28

approved, but. They're. Still in

26:30

litigation and the courts have said that it's

26:32

okay for them to be sold as in

26:34

it's one of those And then there's a

26:36

whole group of products that are like actually.

26:39

Not. Approved and not under any

26:41

type of holding pattern where they're

26:43

still love to be sold. That

26:46

applies Select pretty much all of

26:48

their disposable. Reading. Products in the

26:50

U S. Or. Their limits

26:52

on distribution as well because

26:54

when I think of where

26:56

you can actually buy cigarettes,

26:58

gas stations and airports duty

27:00

free areas are there other

27:02

t distribution points for these

27:04

businesses. I

27:06

think as far as I know. I'm

27:08

you know you just after the

27:10

the retailers have to be licensed

27:13

and typically so that the regulations

27:15

or beef with similar to traditional

27:17

tobacco products you have to have

27:19

like a license. To

27:22

actually selling arguably the distribution.

27:24

Prowess. of Philip Morris is actually

27:27

is you know what some people went to

27:29

as sort of fueling the the the growth

27:31

of. Of is in, in, in in

27:33

the Us. Over the

27:35

last of the last few years, Getting.

27:38

To the point of brand which mention there's a

27:40

lot of brand loyalty. From. Centuries

27:43

ago, many names like Camel

27:45

and Marber all bought When

27:47

you flash forward to today.

27:49

When. You have a products like as any

27:51

are trying to compete with that and the

27:53

media coverage that it's getting which is. And.

27:56

some ways likely to just attracts

27:58

more attention potential users unless there's

28:00

actually regulation enforced. How does a

28:03

business like British American Tobacco try

28:05

to get more loyalty towards their

28:07

own brands and their own products?

28:11

In the US, they've had a really tough

28:13

time breaking into Zinn's stranglehold on the US

28:15

market. And if anything, when

28:17

people ask, because sometimes there's some pushback

28:20

around sort of the brand loyalty of

28:22

vaping, for example, people think that people

28:24

will just use whatever product. When you

28:27

look at Zinn, I think what Zinn shows is

28:29

that once brands are well established, and people started

28:31

using the same thing and they like it, it's

28:34

actually pretty tough to break into that

28:36

stranglehold. And so what British American Tobacco

28:39

has done so far is actually

28:43

refocused on the markets where they're

28:45

the Zinn, which is

28:47

most of Europe that has sort

28:49

of a material, modern oral business.

28:52

They're by far dominant in

28:54

the Scandinavian countries, for example,

28:57

which is where the product originated. I

28:59

don't think they've explicitly said this, but I

29:01

think that they're waiting for the approval of

29:04

their Velo 2.0 products

29:06

in the US before they

29:08

really put marketing dollars behind

29:10

it because that's the product that

29:12

they're selling in Europe. That's the best products. And so they had

29:14

the Velo 1.0 here, but not the 2.0. And

29:18

so I've actually heard of Canadian

29:21

hockey players that

29:23

import this Velo 2.0

29:25

product from Europe. They like it better

29:27

than Zinn, supposedly. That

29:29

might just be me searching for a sign of

29:31

an anecdote that matches my bias. I think it's

29:34

a good sign for the long term ability to

29:36

compete. That anecdote, I

29:38

think, is just interesting in this

29:40

day and age in terms of who influences

29:42

the purchase of things and avoiding

29:45

the word influencer, particularly in an

29:47

industry where advertising is difficult. You

29:49

did mention the distinction there that

29:52

they would spend marketing dollars. Can

29:54

you just differentiate what marketing dollars

29:56

mean when advertising is so restricted?

30:00

primarily in discounts

30:02

to retailers. You can

30:04

also put people out into the field. You

30:07

can put physical bodies out there to carry

30:09

packs of Velo and say, go to convenience

30:11

stores and say, hey, you should be selling

30:13

this, that have better product placement,

30:15

etc. You can like have

30:18

them put something in like the window of the

30:20

convenience store or whatever. You can pay for that

30:22

type of advertising. That's common. Almost

30:24

giving the retailers free

30:26

products is one of

30:28

the common ways that they spend marketing dollars.

30:31

There's an interesting category of businesses where I

30:33

think you see that, you see the reps

30:36

on the field. Again, I'm going to bring

30:38

up the college party example where Red Bulls

30:40

and pouches were not too

30:42

uncommon to see out there. In

30:45

Europe, what Icoast did, which was genius, was

30:47

they would have like sponsored events. I

30:49

think they still weren't allowed to do traditional

30:51

advertising in many places, but they would sponsor

30:53

events. They would lease these retail spaces

30:55

where it would be like almost like an Apple

30:57

store to get people to come in and

30:59

try the thing. No one in the US has

31:02

tried anything like that. With the success of

31:04

Zen, it doesn't seem like it's necessary, probably.

31:07

I want to transition a bit into

31:09

the financial model of this business. I

31:11

think we've touched on a few of

31:14

the dynamics with the top line and

31:16

whether that's flat because it's neutralized by

31:18

price and volume or maybe steady growth,

31:20

slight incremental growth in the future. We

31:23

hit on the tax that is very

31:25

common on these businesses. But just if

31:28

you step back and look at the overall

31:30

margin profile of this business, what does that

31:32

look like and where has that trended

31:34

over time? The margin

31:36

profile of the business

31:39

is remarkably stable.

31:41

That's one of the nice things about

31:44

these tobacco businesses. On

31:46

a gross margin basis, the

31:48

company basically has been making in 2013, they

31:50

were a 78% gross margin and in 2024, it's going to be an 83%

31:53

gross margin. In

31:57

terms of operating margin, it's going to be an 80% gross margin. It's

32:00

basically been around 40% for

32:02

a really long time. That's

32:05

one of the attractive things about these businesses is that

32:07

the margins are super stable. Obviously,

32:09

the customer base is coming back sort of a

32:11

daily consumption product. And

32:13

the combination is a business that just throws

32:15

off cash and can use that to pay

32:17

dividends and buy back shares and do all

32:19

the rest. One of the

32:21

most commonly referenced things with

32:24

investors is the free cash flow yield. Can you

32:26

talk a little bit about earnings conversion in terms

32:28

of how much is actually dropping through to free

32:30

cash flow? One of the great

32:32

things about the tobacco businesses is that they

32:34

don't require a ton of capital to grow

32:36

or to sustain itself.

32:38

So with British American, this is

32:40

the company that did 9.2 billion

32:43

of operating cash flow last year and only

32:45

required 500 million of CapEx. So

32:49

what that means is basically all of

32:51

the 8 billion of income

32:53

is falling to free cash flow. So

32:56

what that does is it allows them to

32:58

pay down debt because they bought R.J. Reynolds

33:00

in 2017 and that time they had 50

33:03

billion of debt. They've been slowly paying that

33:05

down. But then primarily, they pay a gigantic

33:07

dividend. So last year, they paid out 5

33:09

billion of dividends, which on the stock price,

33:11

I mean, for 50 billion market cap, that's

33:14

basically going to be a 10% yield this year. And

33:18

contrast to a lot of 10% yielding

33:20

companies, this is not like some oil

33:22

driller that's paying you out the last drops

33:25

of profit before the futures curve collapses or

33:27

whatever. This is what I think is probably

33:29

going to be a stable to slowly growing

33:31

business that just has a 10% dividend

33:34

yield. Not a cigar, but...

33:36

Exactly. I'm sure it's not the first

33:38

time that has... I

33:41

actually had not made that connection. That's

33:43

interesting. Yeah. I think it's

33:46

a name that you often hear

33:48

from investors as screening attractive from

33:50

a valuation standpoint. They have

33:52

the free capital yield. There's been

33:55

a steadiness in terms of the actual

33:57

earnings stream as well. But

33:59

if... It hasn't quite responded to any

34:01

of that. So I

34:04

think it gets this designation as a

34:06

value trap. Are there catalysts

34:08

that you see that could unlock a

34:10

change in the actual perception of the

34:12

stock or investment of the stock or

34:14

stock performance? The first thing to understand

34:17

is I think the valuation itself actually

34:19

at this point, in 2017,

34:21

it traded at 15, 16, 17 times earnings. The

34:26

valuation can decline at that point. But

34:28

from six times earnings, six times free

34:30

cash flow, it's just a lot harder

34:32

for it to decline, I think. That's

34:35

the first thing. The second thing is that,

34:37

honestly, the dividends and the growth in the

34:39

dividend can just create its own return at

34:41

this point. I don't necessarily agree with

34:43

him on all that much, but this is something that

34:45

David Einhorn was talking about recently and how he views

34:47

some of the stocks he holds. It's a

34:49

great way to just have the downside protected

34:51

because you can just collect a 10% dividend

34:54

that's probably going to grow, in which

34:56

case you're going to earn a double digit return and then some.

34:59

The biggest thing is as

35:03

people start to realize that

35:06

these tobacco companies, they're not melting ice

35:08

cubes anymore because they have this business

35:10

which is going to replace all of

35:12

the traditional tobacco revenue

35:15

that they're going to generate. It's going to take

35:17

years. It's going to take 10 years to get

35:19

to 50% of revenue, but it's going to happen.

35:22

As they start to realize that and that

35:24

it's going to be the case for BAT, I think there's a

35:27

good chance that the stock could rerate. Then

35:29

you're talking about taking a 10% plus

35:31

return into could be anything. It just

35:33

depends on what timeframe you're talking about.

35:36

If you look at Philip Morris, I mean, Philip Morris trades for like

35:38

14 times. Philip Morris might even be cheap.

35:41

Philip Morris trades for 14 times earnings.

35:43

If BAT traded for 14 times

35:45

earnings, it would have to more than double. That's

35:49

the third potential as people

35:51

realize that not only is it

35:53

not a melting ice cube anymore, it really shouldn't be

35:55

viewed as such

35:57

a negative ESG. company,

36:01

full stop, traditional products do still kill

36:03

people. But there's something to be

36:05

said for a company

36:07

where all of the future efforts are

36:09

going towards switching people off of that

36:11

product and onto something that's way less

36:13

harmful. And it's not because it's

36:16

the goodness of their heart, they're just trying to

36:18

make money and protect themselves for the long term.

36:20

But I think there's a chance that results in

36:22

a change of perception in the market. And then

36:24

actually, the fourth thing is, once

36:27

reduced risk products really take off,

36:30

like we're seeing zen in the

36:32

US, the market overall may grow.

36:34

Because if these products are really

36:36

90 to 95 to whatever percent

36:39

less harmful than traditional

36:41

cigarettes, you're left with a

36:43

drug that has some interesting

36:45

properties and might be just like caffeine, where like

36:47

a huge chunk of the people take it. I

36:50

mean, think about the fact that after World War

36:52

Two in the US, 50% of people smokes. In

36:54

the UK, 80% of men smokes.

36:58

I don't necessarily know that I

37:00

want to go back to a world where

37:02

80% of people are taking nicotine, but it's

37:04

certainly plausible, in my view, over a long

37:06

enough period of time. John Greenewald

37:08

Yeah, there's a lot of interesting parallels

37:10

when you look at, as

37:12

you mentioned, caffeine, to the other

37:15

extent, alcohol, we have legalization of

37:17

cannabis, all different properties, all different

37:19

addictive traits in them, all different

37:21

health concerns. So there's other

37:24

industries that you can look at, but

37:26

at least from my perspective, it feels

37:28

like these brands have

37:30

the most negative visceral

37:33

association with them today. John

37:35

Greenewald In the UK, I don't know if they've done

37:38

this survey in the US, I think in

37:40

the UK, 80% of people still think that

37:42

nicotine is the primary cancer

37:45

health problem causing agent

37:47

in tobacco, despite

37:50

the fact that that's pretty settled science

37:52

that it's not the case. John Greenewald

37:54

Just from your sense of talking to

37:56

other investors, as you mentioned, whether

37:58

it's ESG or just funds out

38:01

of principle, not wanting to

38:03

own this type of product. Do you have a

38:05

sense of how big that

38:07

represents in the market? Like how many

38:10

buyers just have ruled themselves out? What

38:12

I think you find it, I mean, it's just in the

38:14

world in general, but especially investing is

38:16

market prices are kind of

38:19

dominated by the largest players,

38:21

how they feel. And I think if you look at

38:23

a lot of the

38:25

largest investment businesses in Europe and

38:27

certainly pension funds and everyone in

38:29

Europe is like really devoted

38:31

to ESG. And there's a lot of

38:34

great causes behind ESG, but I don't

38:36

know if divesting tobacco is

38:38

going to remain at the top of the

38:40

ESG list in 10 to 15 years. And

38:44

I don't think it helps VAT actually

38:46

that its primary trading ticker is in

38:48

London, as opposed to Philip Morris,

38:50

where the primary trading ticker is in the

38:53

US. So it's kind of weird

38:55

that the international business trades in the US that

38:57

trade at 14 times earnings. It's kind

38:59

of an interesting dichotomy, which can

39:01

partly be explained by Philip Morris's

39:04

how much further they are down the road of the

39:06

journey toward reduced risk products. But I think part of

39:08

it is probably also explained by European

39:11

investors, like stronger focus on ESG

39:13

and related shunning of tobacco stocks.

39:16

One of the points on capital allocation,

39:18

which we didn't hit on, was the

39:21

M&A activity, which historically has been a

39:23

lot of acquisitions. I think

39:25

there's something interesting about Zinn

39:28

being an upstart, them being acquired, I

39:30

think, parallels to something like cosmetics, where

39:32

L'Oreal and some of the bigger players

39:34

can buy up these upstarts and have

39:37

this success before they get too big. Is

39:39

that something that you expect to continue

39:41

in the future as part

39:44

of the thesis in one direction or

39:46

the other? Is M&A activity something that you expect to

39:48

happen on the horizon? I

39:50

don't. I do not. I

39:53

think that for the

39:55

most part, these companies

39:57

have Really gobbled up.

40:00

The up everything that could. Barely.

40:02

Move the needle and also be

40:04

regular. Torelli approves but I think

40:06

so more. Scott an amazing deal

40:08

with it. Turns out with Swedish

40:10

match the people with like a

40:13

premium to. Traditional. Tobacco

40:15

multiples by really did not compensate them

40:17

for the growth of they were going

40:19

to see a nurse and business. I

40:21

think they would pay many more multiples

40:23

now that it's twenty two times. He

40:25

the topic they were sitting on a

40:28

rocket ship. Basically I don't expect it

40:30

to be a big part. It's

40:32

possible we could see. Upstarts.

40:35

He kind of revolves around the regulatory structure.

40:37

Honestly, it's in a world where any type

40:40

of disposable vapours can be sold on stores

40:42

and there are there of sorts all the

40:44

time of France changing have left and rights.

40:46

but in a world where you. Actually,

40:49

Need F T A or other

40:51

regulatory know whatever country approval to

40:53

sell out nicotine products. Which.

40:55

Is the world I think we're moving towards

40:57

slowly. I. Think it's going to

41:00

continue to be dominated by the companies that

41:02

have the money and the time and the

41:04

regulatory prowess actually navigate that like I think

41:06

it's telling that. Seems. As one

41:09

of the only actually approved products in

41:11

the Us. At this point like

41:13

to ft a is it's own monster. Only.

41:15

Gasquet knows that it's policies

41:18

have or the time. Messages.

41:20

The have to read. It's like advertising bands and all

41:22

the things. I don't have to. Will

41:25

really understand how much did french the existing

41:27

tobacco companies and kind of benefitted them. But.

41:29

It's just kind of part of the deal with

41:31

Us federal regulation. Yeah. Regulatory

41:33

capture and it's worth. And when

41:36

you'd think about other industries something

41:38

like cannabis which I mentioned before,

41:40

is there any possibility that there's

41:42

an extension into cannabis? Be

41:45

a C has made I think

41:47

a couple hundred million pounds investment

41:49

into a Canadian. Basically like almost

41:51

penny stock. Now. Comedian:

41:53

Obliterated. Can have a company. You.

41:56

Can close your eyes and imagine

41:58

a world where the distribution. In

42:00

and regulatory prowess and all that.

42:02

Allows. Them to. Add

42:04

value to a cannabis company and potentially like

42:06

try to acquire one. Any type

42:09

of profitability and that businesses seems

42:11

likely to be a rounding error

42:13

on any of the eighties business.

42:15

I mean it's hook decades for

42:17

most of the cigarette brands to

42:19

kind of be develops. And.

42:21

So I think probably cannabis my be

42:24

similar. But. We'll see I'm

42:26

not holding my breath. I

42:28

think we've touched on most of the risks.

42:30

There's just the obvious industry in general and

42:32

trend lines had been happening over a long

42:34

time. There is there anything else we haven't

42:36

touched on that you think is important. Know.

42:39

The. Other is actually the major

42:41

risk that we haven't assad is

42:43

the potential for a menthol cigarettes

42:45

to get banned in the Us.

42:48

So. British American when

42:50

they thought. Reynolds.

42:53

Reynolds had to divest. The. Cool.

42:56

Brands. Of menthol cigarettes

42:58

Imperial when they acquired Lorillard but

43:01

the Newport Lorillard brand which is

43:03

the largest came in to brush

43:05

American students may finally acquire or

43:08

journals. And. To. This

43:10

day. Mental. Cigarettes in the

43:12

Us are a huge percentage of their

43:14

business the on the order of forty

43:16

two percent of the U S combustible

43:18

business, And that means have seen around

43:20

a quarter of their revenue. Let's.

43:23

Take a step back. So the runway

43:25

that matters is because the Sta under

43:28

the by the restriction has made a

43:30

bunch of noise. About. Banning

43:32

mental cigarettes and tired across

43:35

the Us. Now. This

43:37

is. A little bit controversial. would

43:39

definitely get caught up in a legal battle

43:41

for years of it did come to pass.

43:44

It's a big risk for them because we

43:46

think that some consumers would probably stick with

43:48

their branded a non menthol version, but some

43:50

consumers are going to choose another ran some

43:53

consumers are going to quit smoking. One upside

43:55

could be that some consumers will choose one

43:57

of be a T V being friends because.

44:00

The largest a friend in the Us

44:02

so that would make sense but Net

44:04

net we think that they could lose

44:06

and to fifty percent of their profits

44:08

on a menthol been and in the

44:10

Us which is. A. Lot. Of

44:12

billion dollars. basically a profit. Now.

44:15

I think it's six times earnings.

44:17

For. A business or otherwise gonna grow we

44:19

think low single digits. Death. Big dinner ready.

44:23

And. Would you of multiply

44:25

that on I expected value basis

44:27

by the percentage chance that either.

44:30

Trump wins the election. I don't think they

44:32

care about this or. Biden.

44:34

Decides not to do it. For whatever

44:36

reason. I think it's a risk that's

44:38

me. well baked into the price. but

44:40

it is a risk. Definitely. One.

44:43

Thing you mentioned there which I

44:45

wanted to touch on earlier was

44:47

the V being. Phenomenon.

44:49

Which felt like it was really powerful.

44:52

By. Ish may a little bit longer

44:54

than that years ago, but the crazy to

44:56

have died down now. don't know if that's

44:58

been reflected in the numbers as well. But.

45:01

Can you point anything just about

45:03

that real euphoria run up around

45:05

beeping, I. Think because it

45:07

with starting from nothing and the

45:09

percentage change was just so huge

45:12

that it really kind of took

45:14

the world by storm. It was

45:16

also under regulated offered jewel with

45:19

everywhere and he had all these

45:21

flavors and kids are smoking and

45:24

go watch the Netflix documentary on

45:26

July and kids are talking about.

45:29

How. They got addicted in high school and they

45:31

didn't know. That. It had nicotine and.

45:34

They. Thought it was just air. And that

45:36

is so crazy to me now and I think

45:38

probably high school kids are. Unfortunately some of them

45:40

are so they thing, but I think they know

45:43

kind of what's going on now. But.

45:45

The I think it was just such

45:47

a big explosion from nothing that it

45:49

seems like a reseller waves a national

45:51

news the center of more quickly. but

45:53

since ended the industry have continued to

45:55

grow. The same shirt that Altria put

45:57

up. you have a steady sixteen bills.

46:00

In fact, equivalence in

46:02

the Us in overall

46:04

sort of nicotine market.

46:06

But. You basically have the easy

46:08

for the vapor market growing. By.

46:12

Five acts since twenty eighteen. Something like

46:14

that, and like twenty or thirty percent

46:16

last year. The. Problem is.

46:19

It's not all in Santa that are like

46:21

well tracks so it's harder to kind of

46:23

keep track of. Whereas. when it

46:25

was just a few or alter it was invest

46:27

in july weekend a new or was going on which

46:30

will with for whereas with the chinese companies selling

46:32

disposable to fool bit. More. Under the

46:34

radar in terms of business news, but it's so

46:36

growing very strongly. like twenty thirty percent in the

46:38

U S. Good. Example of where

46:40

my perception is not equivalent to

46:42

reality they're both has been an

46:44

excellent conversation. We close these out

46:47

with the lessons that you can

46:49

apply elsewhere. What would you point

46:51

to is just a lesson from

46:53

diligence on British American tobacco that

46:55

you think is. Cross.

46:57

Applicable to other investment opportunities. I.

46:59

Think the biggest. Lesson

47:02

I've learned from them studying brush

47:04

American Tobacco in investing in the

47:06

company is to always look under

47:08

the hood. And make

47:10

sure. He. Really understand what's

47:12

going on with the company? Because

47:15

a business might be flat at

47:17

twenty six or twenty seven billion

47:19

of sales over a long period

47:21

of time. And. It might have

47:23

a lot of shareholders complaining about why it's a

47:25

value trap. But. Under the hood,

47:28

a lot of people aren't paying attention to

47:30

what's going on, and if you peel back

47:32

the layers than usual, you can find a

47:34

strong investment opportunity that's not reflected in the

47:36

current share price. so. The investing process

47:38

is always a battle between how much time

47:41

to spend on a given name and when

47:43

to move on and he will lessen. Its

47:45

You have to spend enough time to really

47:47

figure out what's going on. Good.

47:50

With them there and I think completely

47:52

appropriate this is been not an excellent

47:54

conversation. Haven't really appreciate you sharing the

47:56

detailed history and bring us up to

47:58

today which is is. detail about the

48:00

recent years. Thank you for coming on. Thanks

48:03

Matt, appreciate it.