July 29, 2021 - 9:24pm EST by
2021 2022
Price: 51.81 EPS 0 0
Shares Out. (in M): 19 P/E 0 0
Market Cap (in $M): 995 P/FCF 0 0
Net Debt (in $M): 273 EBIT 105 140
TEV (in $M): 1,268 TEV/EBIT 12.0 9.0

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I wrote up TPB two years ago on the heels of the bootleg THC vaping deaths. Since then, the company has been transformed by positive developments in both vaping and cannabis regulations as well as tailwinds from COVID behavior changes. The growth runway is improved and de-risked. I have done a deep dive into the Zig-Zag brand and have a better sense of its market position and growth prospects.

Why does it trade so cheap?
1) The number of diluted shares is mis-stated by 17% due to a GAAP peculiarity. There are 19.2mm diluted shares but management reports 22.5mm diluted shares due to the converts.
2) Management is sand-bagging EBITDA guidance, which they consistently do but this time is extreme. Their own EBITDA guidance is significantly out of step with their own revenue guidance.
3) The market is afraid they are over-earning due to COVID and channel dynamics as dispensaries open.
4) The market is giving TPB no value for its vaping business due to the uncertainty of the post PMTA/PACT world.
5) TPB cannot escape the gravitational pull of 12x unlevered FCF multiples for combustible companies ($MO, $BTI).
6) Overhang of Standard General selling. They still own 16% of shares.

TPB trades at 14x unlevered '21 FCF (including stock comp expense) from only the ZZ/Stoker's segments. And both of these segments have long runways of 15% bottom-line growth ahead. The vaping business should begin to contribute significantly to the bottom line in 2022, and TPB trades at 11x unlevered '22 FCF. And these numbers give little value to TPB cannabis investments; Fre; and Nu-X product development.  
TPB has two significant catalysts ahead in the next six months: (1) Post-PMTA world taking shape in vaping and (2) Re-rating as ZZ continues its strong growth through 2021. 
Assuming my fundamentals are correct, the trading question is whether we see a multiple re-rating and TPB is valued for its growth (a la $SWMA) or whether the stock keeps its low multiple and simply trades up with FCF + growth (FCF + growth will produce 25+% per annum price appreciation for years to come). Thus far, despite its proven growth, the stock has not seen a multiples re-rate and has been glued to the multiples given to tobacco combustibles (e.g., $MO and $BTI). Among U.S.-sold products, only $SWMA, with its fast-growing snus and nic pouches biz, has gotten a multiple re-rating.
Unfortunately, I do not expect a complete multiple re-rating until the Standard General overhang has been removed. They have sold over half their position over the past two years, and there is little doubt they are looking to exit. The good news is that it appears a reverse-inquiry (i.e. buyer interest) led to their selling 4.5% of total shrs outstanding at the market price on May 3. No 13d was filed by the buyer and the company did not buy the shares so I believe we have a new shareholder with just less than the 5% threshold.
Business Description
TPB has three 2022 profitable or near-profitable businesses: (1) Zig Zag rolling papers (ZZ); (2) Stoker's; and (3) vaping. It also has other NewGen products and investments of uncertain value. I detail these below.
Stoker's Segment
This has been the steadiest and easiest to understand of the three businesses.
Absent COVID, the Stoker's segment has performed in line with my bullish expectations for several years. The MST sub-segment has shown consistent unit growth while also taking industry-wide annual price increases and expanding margins. Management has repeatedly stated that this strategy has a long way to run. COVID has provided additional tailwinds as consumers have traded down brands (e.g., to TPB's Stokers or to SWMA's Longhorn) and tobacco/nicotine consumption has been boosted versus a no-COVID scenario. The loose-leaf sub-segment (now less than 40% of revenue) has had a steady-but-flat top-line for years as price increases offset volume declines.
Stoker's MST growth has and will continue to grow from following factors:
(1) Present in more stores -- still has +50% here (from 60% of doors to 90%)
(2) Higher share in stores where present
-- these two factors have provided about +10% annual gains in unit market shr (e.g., 5% to 5.5%), and I expect this to continue for another 5-10 years until unit market shr doubles and then this growth will slow.
(3) Industry price taking -- industry raises prices inflation + 3% annually -- about 6% annually
(4) Stoker's price taking over industry -- TPB has discussed this lever but has not exercised it. I expect them to exercise it only after the growth from (1) and (2) slows.
(5) Margin expansion
(6) These growth factors are weighed down by the industry 2% unit drops per year.
All these factors add up to 16% annual bottom-line growth over the next decade. Meanwhile, the loose-leaf sub-segment will remain flat. Combining the two sub-segments, we will see 13% EBITDA annual growth over the next decade with very little capital investment required.
One bearish argument is that the big guys will begin to fight back to stop Stoker's growth. The problem with this argument is they already have fought back, but they were unsuccessful. The time to put pressure on large c-store chains has passed. Must kill the baby in the crib. Stokers has momentum and credibility. If Sheetz/Circle-K/Speedway are carrying Stoker's, this makes it more likely that other c-stores in the same geography are going to start carrying it. And the big guys have a strong incentive to avoid all-out price wars. Longhorn ($SWMA) and Stoker's are the two lowest-priced brands, and $SWMA also has little incentive to begin a price war. All large players want "rational," oligopoly pricing in tobacco. This bearish argument has not resonated with me for a couple years, since Stoker's has gained traction in multiple large c-stores.
Another risk factor is alternative products (esp nicotine pouches) converting MST users. I have two thoughts on this: (1) It is not a zero-sum game. MST users might use nicotine pouches in settings where MST is not acceptable. Nicotine pouches may also be a gateway to new MST users. (2) The experience is quite different. Both deliver nicotine, but doing so with tobacco is different from the more medicinal nicotine pouches (or nicotine gum). But no doubt this bears further watching.
Finally, regulation. I discuss regulation issues below.
ZZ Segment
The biggest transformation has come in the ZZ segment. It was a sleepy, LSD unit growth niche roll-your-own tobacco and illegal cannabis brand. Now, it is a fast-growing cannabis-use brand with its new products and new distribution emphasis. I have spent a lot of time trying to understand this segment, and my view of it has changed.
Before recently, ZZ unit sales were flat in a growing market. ZZ was largely retaining historical users but not gaining new cannabis users. ZZ has made several significant moves to reverse this dynamic:
- E-commerce sales -- ecommerce has gone from non-existent to "double digit" percentage of sales
- Target distribution to dispensaries and head shops where the growth is
- Introduce hemp papers and paper cones; I expect hemp cones at some point in the future although mgmt mum on this notice-able hole in the product line
- and just this week, ZZ announced the acquisition of low-end cigarillos brands that are used as cannabis wraps
What I have learned from research, including visiting many dispensaries and smoke/head shops (mainly in CA and CO):
1) Contrary to expectations, legalizing cannabis has not shrunk the illegal cannabis market significantly. There are several reasons for this, but the phenomenon spans several states. For example, in CA, the black market is about 70% of the total market despite recreational legalization for over four years. And it is important to understand that the demographics of legalized cannabis are strongly skewed; in short, rich and young people use legal dispensaries. Further, the products are skewed. A far higher percentage of THC is being consumed in gummies in the legal market than the illegal market.
2) I discussed rolling papers with high-end CO dispensary employees. The 10th percentile comment is "Raw is slightly preferred to ZZ" and the 90th percentile is "Raw is gold; ZZ is trash." Magazine reviews echo this strong pro-Raw/anti-ZZ sentiment. But oddly, shelf space given to ZZ is about the same as given to Raw and much greater than the third-place brand (OCB or Elements or private-label store brand). And further, reviews on Amazon and online forums are much more balanced. So what is going on to explain this? It is all about demographics -- age and class (and probably race). Among young hipsters (the people writing magazine reviews and that work at high-end dispensaries and mainly shop there), they would not be caught dead rolling with ZZ or smoking a blunt. But aging hippies and urban users have been using (orange box or white box) ZZ's or wraps for decades and argue they are the best. Another of the issues is the focus on traditional orange-box ZZ's while ignoring the new product additions. There is a sincere belief that Raw is a superior product, but ZZ's recent product additions compete much better against Raw for the "snobs."
In CA, dispensaries rarely carry much selection of rolling papers for their flowers. Part of the reason is full taxes are charged. So they send you to the local gas station or smoke shop to buy rolling papers. I have visited dozens of SoCal smoke shops and gas stations and the story is consistent: equal shelf space for Raw and ZZ. These smoke shops are more demographically well rounded, and the results are obvious. Raw is still preferred by clerks (and customers) but not strongly. ZZ is the clear second choice in non-cone papers but still catching up to OCB in cones. 
3) The cannabis "covering" market is much bigger than simple papers. Again, this is where the hipsters drive a mis-leading narrative as they would never smoke a blunt. Also note that dispensaries do not carry tobacco wraps because, among other reasons, it would require a different license. 
There are essentially three binary variables (so 2x2x2=8 possibilities) to determine which "covering" one is using to smoke cannabis:
  (a) paper vs wrap -- paper is minimally invasive in taste/chemical/etc so get unadulterated experience of cannabis; wraps give a much stronger experience as THC/nicotine hitting you simultaneously.
  (b) non-hemp (wood paper or rice paper or tobacco wrap) vs hemp
  (c) non-cone vs cone -- ease of use
ZZ offers six (or seven) of the eight categories. For example:
- ZZ Orange is paper/non-hemp/non-cone.
- ZZ MYO Wraps are wrap/non-hemp (tobacco) and come in both non-cone and cone versions
ZZ does not offer paper/hemp/cones, and this is a big hole I expect them to fill soon. Obviously, Raw leads the way here, and this is a big opportunity ZZ is missing.
ZZ recently launched hemp wraps. I do not believe they have in cone form yet, but that is a small hole easily remedied going forward.
The price per joint of the "covering" is very different. Below are the SoCal pre-tax retail prices for a standard quantity (e.g., a single booklet of papers, etc) per standard size (1 1/4 inch) joint. I made an effort to adjust to a standard size and used the lowest regular price I found.
- ZZ/Raw non-cone papers (hemp or non-hemp): 7 cents
- low-end HTL cigarillos (e.g., the Hi-Fi brand TPB just acquired; or competing Show cigarillos): 20 cents
- ZZ/OCB/Raw cone papers (hemp or non-hemp): 42 cents
- Royal Blunts or ZZ Tobacco Wraps (non-cones): 42 cents
- High Hemp Wraps (non-cones): 67 cents
- ZZ Tobacco Wraps (cones): 67 cents
- Grabba Leaf Tobacco Wraps: 70 cents
(Only a wrap/hemp/cone price is missing as I cannot find them in stores. I know that High Hemp makes this product, and I believe that the price is about 90 cents per joint at retail.)
This is intended to give ballpark numbers. Of course, if a consumer buys large quantities online, prices are much cheaper, For example, if a consumer buys a standard retail box of 24 booklets (each with 32 sheets), the cost per joint dips below 2 cents. 
This retail price list gives an idea of how important cones and wraps are versus the traditional non-cone papers. There is tremendous opportunity in converting non-cone paper users to cones, and ZZ was a late arrival here. Raw and OCB entered the cone market ahead of ZZ, but ZZ has been clawing market share, and I expect them to match their non-cone paper market share over time.
But probably more importantly, ZZ is using its brand and distribution to push ZZ wraps. And its just-announced acquisition of Unitabac cigarillo brands is part of its strategy to build distribution power and cross sell these wrap brands. In many lower-end smoke shops, which are largely selling rolling papers and wraps for cannabis, ZZ is going to be their largest supplier by a wide margin with the acquisition of Unitabac.
4) What has been driving ZZ growth:
(a) filling new channels as states legalize -- this will not continue forever, but it probably has a year or two of legs
(b) conversion from rolling papers to cones -- both taking market share as well as the cone market growing; this has a long runway
(c) driving ZZ wraps (and now Unitabac) to more stores and taking market share/shelf space per store--this is the Stoker's strategy and this has a long runway
(d) driving papers to non-measured channels (dispensaries and head shops), which are under-served by ZZ. ZZ is never going to get the market share here that they have in the measured channels due to demographics, but management is confident they can drive significant growth from the current 10% market share in the non-measured channel
(e) increase in cannabis use as states legalize
So what does all this mean going forward? 
- The ZZ brand is strong and not going anywhere among non-hipster (broadly speaking) users. Raw is less of a threat than I had believed as they target different demographics. ZZ is a lower-end brand and the Unitabac acquisition only reinforces that. We will see higher growth in the rich/young market, but the ZZ target market is bigger and growing plenty fast. And selling a 5-pack of HTL cigarillos for $1.25 is a better business than selling a 50-pack of hemp papers for $3.
- The pro-Raw segment is growing faster than the pro-ZZ segment so I expect ZZ to grow slower than the overall market once its dispensary market shr gains (from distribution; product intro) and e-commerce gains stabilize. In short, ZZ is not going to capture anywhere near its current mkt shr with the incremental demo going to legal dispensaries; Raw is going to win this segment, and this segment is growing faster than the total market.
- In the medium run (next 2 years?), ZZ is going to grow faster than the overall market as it ramps up e-commerce and legal dispensary market share. As well, it is filling inventory at new channels for dispensaries and dispensary distributors. H1 '21 was an anomaly as there were some sales moved into H1 from other quarters, but even adjusting for this, we saw about 40% growth. Mgmt expects "strong dd growth" (over 20%) for rest of 2021, and they have stated confidence that both e-commerce and dispensary sales will continue recent growth through 2021.
- If I had to throw round numbers on it, I expect the 30+% growth to abate in 18 months. The papers business will settle into a sustainable 15+% growth due to (1) standard price increases (3%); (2) transition to cones (5%); and (3) more volume even if ZZ has much lower share among incremental users (5%). There will also be some margin expansion (esp from cones) and perhaps continued channel filling in states with newly legalized dispensaries. I am more optimistic on the wraps business as it follows a Stoker's-like strategy by getting in more doors and taking market share behind each door. The ZZ brand is powerful here, and TPB is well-positioned to drive market share gains.
I believe the biggest risk factor is that TPB does not own ZZ. Instead, they have a licensing agreement originally with Bollore that has been transferred to RTI. RTI owns the OCB brand, which is #3 in terms of shelf space in Colorado/California dispensaries/shops. This licensing agreement renews every 20 years and management has stated that the terms of this renewal is a technicality and this licensing agreement is de facto perpetual. The bigger issues are: (1) the pricing is renegotiated every 5 years and mgmt has been mum on the parameters of the repricing and (2) we do not know the ability of TPB to create new ZZ products. For example, was it the licensing agreement that explains why TPB was delayed in bringing hemp papers to the market? 
Management has told me they are "not worried" about this, and we have already seen several 5-year renegotiations without any hiccups in margins. But I would note we have not seen any renegotiations with RTI as the licensing counterparty. And mgmt has not shared the exact language or terms of this renegotiation or why RTI could not demand a huge increase in pricing that would effectively terminate the agreement. It seems unlikely such a large loophole could exist in the agreement, but I see the non-ownership of ZZ as the biggest risk factor for TPB. I have been asking TPB management to share more details on the ZZ Agreements as other investors also view this as an issue.
Vaping Business
The vaping business is currently shrouded due to a transformation in the industry due to regulatory changes. The business is currently flat EBITDA (negative in Q2), but that will change over the next twelve months. First, the government banned flavors in closed-pod systems like JUUL but continued to allow flavors in open-pod systems. Second, the government instituted a regulatory process (PMTA) through which all vaping products (devices and liquids) must pass. The market effects of this process have taken longer to materialize than I had hoped, but slowly but surely, smaller players are being forced out and the expected regulatory capture process is taking shape. Finally, the PACT Act (also delayed) is creating distribution hurdles that will raise shipping costs industry-wide but will disproportionately advantage scale players.
Management has been vague in discussing the net effects of all these changes except in saying that the sales of their own brands (e.g., Solace) should rise significantly from its current 20% of revenue. This effect should drive a 10-15% rise in margins over the next few years. This would get us $20mm EBITDA on current revenue. Further, we should also see margin expansion as the industry rationalizes to oligopoly. As well, the open-tank vape industry is filled with low-capex, run-down retail locations, but this is changing due to well-capitalized entrants. This will drive a narrowing to brands with credibility and distribution.   
Accurate open tank vaping industry numbers are tough to find, but I expect open tank systems growth to exceed the 15-20% growth expected for U.S. vaping as a whole. 
I expect $10mm EBITDA in 2022 with 40% growth for a handful of years until margin growth slows down. Then, we should see 20% EBITDA growth from there.
Other NewGen
Real Brands ($RLBD) -- TPB owns 23% (over 600mm shrs) of this penny stock. This is the result of TPB's investment in CASH, which did a reverse merger into RLBD. At mkt price, TPB's stake is worth $60mm. RLBD mkt cap is over $250mm with limited sales. I treat the market value of this holding with a grain of salt.
dosist (CBD) investment -- $15mm investment in Oct 2020
Wild Hemp (Hempettes) investment -- $3mm investment in Oct 2020
Fre -- Nicotine pouches; crowded field. (Zyn - $SWMA; On - $MO; and Velo - $BTI)
Nu-X Nutra/CBD products
Bob Marley Investment -- $9mm in April 2021
Old Pal -- $8mm in July 2021
Unitabac Cigar -- $10mm in July 2021
Except for the Q3 Unitabac investment, these investments are speculative and will not be producing significant profit soon. Value as you like. I value the Q2 (and earlier) investments at $50mm in the valuation below.
Other issues:

- Share buybacks -- TPB showing willingness to buy back shrs rather than make acquisitions. In H1, they bot back 300k shrs.

- Larry Wexler has proven himself, and I now view his acquisition strategy as a positive rather than a large risk. He is both commercial and strategic. His navigation of both the ZZ and the vaping business over the past 18 months has been impressive. And his add-on acquisitions have added value. He now has the mgmt team in place that he wants. Anecdotally, I have had three exchanges with Louie Reformina, and I view him as a big step up over Bobby Lavan.

- Standard General position down to 16%. This is certainly an overhang, and no large institution has stepped up to take out SG (which SG is clearly inviting). And SG has been ham-handed in its selling. They sold a big slug in low $20s and paid a handsome i-banker fee to do so. A big positive here would be a large buyer taking SG out of their shares. Until then, the overhang persists.

- The regulatory/legislative concerns are overblown and may aid the company rather than hurt it. I have read about four different changes: (1) proportional tax increases on all nicotine products; (2) disprop tax increases on MST/vaping; (3) menthol cig ban; and (4) nic limits on cigs.

The one of these that would hurt TPB would be #2 as it would raise taxes on MST and vaping relative to cigarettes. The Durbin Act proposes to do this. However, cooler heads will probably prevail because technocrats worldwide are trying to create the opposite effect . . . moving smokers to safer MST/vaping.

Tax increases across the board (which I expect) would have little effect as these tax increases are unlikely to have a material effect on demand and will be effectively passed through to the consumer.

The menthol cig ban and nic limits on cigs would aid all three of TPBs main biz (MST/ZZ/vaping). 

FWIW, my handicapping of the legislation/regulation is as follows:

I expect across the board federal tax increases, but they will not affect overall demand and will aid TPB slightly as we will see a trading down from premium brands.

I expect vaping taxes but not anywhere near the level of cigarette taxes (as Durbin plan proposes). I do not believe these will harm the vaping market. 

The menthol ban is tricky because it would reduce future addiction but would certainly lead to a large illegal market for menthol cigs . . . and this is dangerous as bootleg vaping deaths of 2019 show. As well, there is concern about how a menthol ban (combined with the bootleg market that will surely form) will be enforced. See Eric Garner. Civil rights and African American groups are split on the issue. I am a coin flip on whether a menthol ban is implemented in the next decade. There will be vigorous debate as to the proposed regulatory rule.

The nic limit on cigs is also very tricky as it runs counter to vaping movement, where the idea is to increase the nicotine/tar ratio (to infinity), not reduce it. Again, there is a tradeoff between preventing future addiction versus dealing with existing addiction. And again, there is a tradeoff between short-term safety of regulated product versus the bootleg illegal market. I do not believe a nic limit on cigs will be imposed.

One other regulatory issue, which has been implemented at the city level in a few jurisdictions, is the banning of all flavors (including mint) in all tobacco products, including nicotine pouches and MST. I have not seen this proposed at the national level, but it is an issue to watch. This would be a big negative for the RRP industry, and it would certainly hurt TPB. Again, I do not think this action would gain traction because the focus is on combustible tobacco and avoiding the pitfalls of illegal markets.



S=$51 * 19.2mm fully diluted --> $979mm

Net Debt: $273mm

TEV = $1,252mm

Value of RLBD/dosist/Wild Hemp/Bob Marley investments = $50mm

So Adj TEV = $1,202mm 

The ZZ/Stokers segments producing unlevered FCF (I include $8mm stock comp expenses) in 2021 of $85mm on $110mm EBITDA, and these segments will produce 15+% EBITDA/Unlev FCF growth for a long time. So trading at 14x the ZZ/Stokers segment unlevered FCF. These numbers do not include the Unitabac or other Q3 acquisitions.

In 2022, ZZ/Stokers will produce $135mm in EBITDA, and vaping will produce an additional $10mm. And this gives no consideration to the Unitabac acquisition, which will provide cross-selling opportunities.

I believe this should trade at high teens multiple (18x) of 2022 unlevered FCF of $110mm, or a TEV = $2.0bn, or a stock price of about $90. 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


TPB has two significant catalysts ahead in the next six months: (1) Post-PMTA world taking shape in vaping and (2) Re-rating as ZZ continues its strong growth through 2021. As well, Standard General exiting its position and removing the overhang would also provide a catalyst.

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