29 September 2013 Jesse Redding | Cameron Kirby | Sam Johnson

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

Valuation Revenue = $530mm P/S = 3 Equity Value = $1.59 bn EBIT = $2.033bn EV/EBIT = 12 EV = $24.4 bn Equity Value = $1.59 bn + $24.4 bn - $3.1bn = $23 bn (35% upside) E-CigarettesTraditional

Opportunity in E-Cigs

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 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 2012 Cigarettes sold: 290b 4% Annual Volume Decrease ~8.5b fewer cigarettes sold in % of volume moves to ecigs ecig market grows by ~2.55b cigarette equivalents

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

E-Cig Economics

Razor/BladE Model RazorBlade $35

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

Distribution Channels Lorillard Retailers Customers

E-Cig 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

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

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

Legacy Business

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 Newports are the menthol brand Sustained dominance without discounting

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 No existing presence means easy market share gains Small upfront costs mitigate risk Much larger non-menthol market means small gains are profitable

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

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

Valuation

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 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 Lorillard can expand into: – Non-Menthol Non-Full Flavor – Non-Menthol Full Flavor

Valuation Revenue = $530mm P/S = 3 Equity Value = $1.59 bn EBIT = $2.033bn EV/EBIT = 12 EV = $24.4 bn Equity Value = $1.59 bn + $24.4 bn - $3.1bn = $23 bn (35% upside) E-CigarettesTraditional

Recommendation BIG should take a 5% position on Wednesday morning