Equity Research
`
`September 22, 2016
`
`Cannabis
`Tobacco
`
`Vivien Azer
`646.562.1351
`vivien.azer@cowen.com
`
`Aaron Grey, CFA
`646.562.1421
`aaron.grey@cowen.com
`
`Industry Update
`
`PAX Finds its Crown JUUL
`
`The Cowen Insight
`We recently met with privately held PAX Labs CEO and CFO. The company s portfolio
`spans nicotine and cannabis vapor delivery, which we view as a key competitive
`advantage, reflecting the benefits of leveraging cross-over IP. With a planned ~5x
`increase in manufacturing, the capacity-constrained JUUL should see continued
`robust market share gains in nicotine vapor.
`
`Key Highlights:
`
`Last week we met with PAX Labs CEO Tyler Goldman and CFO Tim Danaher. PAX
`is generating robust growth by leveraging technological expertise in vapor delivery
`across nicotine and cannabis. Historically best known for its premium vaporizer
`PAX (and Ploom, which was sold to JT, and is now sold in Japan), the company is
`increasingly optimistic on its opportunity in nicotine vapor with JUUL. After initially
`launching JUUL in June 2015, the companys nicotine delivery system is expected to
`make up ~33% of sales 2016, and ~50% of sales in 2017.
`
`PAX Vaporizer
`As discussed in our Ahead of the Curve Report, The Cannabis Compendium: Cross-
`Sector Views On A Budding Industry, we believe the current $6 bn legal cannabis
`market (and $25 bn illicit market) could grow to a $50 bn legal market by 2026
`(assuming federal legalization). PAX brand vaporizers leverage the large and growing
`cannabis market, as the device can be used to vape tobacco, cannabis or other loose
`leaf products. As the market leader in super premium vaporizers, with a ~60-70%
`share, the current PAX 2 vaporizer retails for $280. Despite this premium price
`point, PAX has sold over 1 mm units to date, which is particularly impressive as U.S.
`government survey data suggests that there are ~33 mm annual cannabis users in the
`U.S. (though that could admittedly understate the market, given response bias around
`a product category that is federally illegal).
`
`www.cowen.com
`
`Please see pages 7 to 12 of this report for important disclosures.
`
`JLI Ex. 2040, Page 1 of 12
`
`

`

`Cowen and Company
`Equity Research
`
`September 22, 2016
`
`The company will further increase its exposure to the cannabis category with their
`upcoming launch of PAX Era: a super-premium THC vaporizer, combining JUUL
`technology and the PAX equity. Expanding into THC vapor leverages current consumer
`trends, as vaping has been gaining share among cannabis users (as well as young
`adult tobacco consumers). We believe this is a textbook example of the opportunity
`to leverage vapor IP across cannabis and nicotine, as our Cowen survey found that
`20% of vapers were using THC in their vaping devices. What is more, it offers an
`incremental margin benefit for PAX as they transition their cannabis-focused business
`away from only selling hardware, to also selling higher-margin cartomizers (which
`have better velocity, mirroring the razor and blade model).
`
`JUUL Nicotine Vapor
`Since its initial launch in June 2015, JUUL has been a standout performer in a
`category plagued by trial and rejection. Indeed, the absence of consumer adoption
`has resulted in notable shifts in the competitive landscape, as the category (largely
`
`2
`
`www.cowen.com
`
`JLI Ex. 2040, Page 2 of 12
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`

`

`Cowen and Company
`Equity Research
`
`September 22, 2016
`
`closed-end, in Nielsen-tracked channels) has seen five different market share leaders
`since 2011. Given consumer dissatisfaction with many of the products in the market,
`it is encouraging to see that new products are largely responsible for the categorys
`having returned to growth (driven by JUUL and MOs MarkTen XL). For JUUL, we
`have seen the products outsized growth result in an increasingly notable contribution
`to overall category growth, having contributed more than a 400 bps benefit to sales
`growth in the most recent Nielsen data.
`
`In fact, JUUL has gained more than 300 bps of share in 2016 alone, including a
`near 100 bps gain sequentially in the most recent 4-week period. Despite this data
`excluding kit sales, JUUL has nonetheless achieved a ~4% share of the overall
`category, and a 6% share of cartridges. What is more, JUUL has achieved this success
`with a retail footprint of just ~12,000 stores (~7% ACV). This robust trajectory has
`resulted in growing pains, as the company is currently experiencing supply issues,
`despite producing ~1 mm cartridges per month. PAX Labs is quickly working to
`resolve these issues though, having expanded its third party manufacturing network,
`and investing behind higher-speed, automated filling equipment. As such, by early
`2017, the company should have capacity to produce ~5 mm units per month. Once
`production issues are resolved, wed expect JUUL to expand distribution, driving
`further share gains.
`
`www.cowen.com
`
`3
`
`JLI Ex. 2040, Page 3 of 12
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`

`

`Cowen and Company
`Equity Research
`
`September 22, 2016
`
`As noted above, given Nielsens methodology, this share only represents sales of
`cartridges, and does not include starter kits (which retail for $50), such that the $2.5
`mm in sales in the most recent period is likely understated. That said, cartridge sales
`have consistently grown sequentially, averaging double digit growth in 2016, and
`accelerating in recent periods.
`
`Given that the category is now dominated by big tobacco (MO, RAI, JT, and IMB),
`who hold more than an 80% share in Nielsen-tracked channels, JUULs success is
`particularly impressive. Indeed, retailers have been reducing the number of brands /
`SKUs offered, reflecting continued share consolidation, as the top five players make
`up nearly 90% of dollar sales, compared to ~80% two years ago, making it particularly
`tough for new entrants. The big 2 (MO and RAI) have driven these share gains, as
`we continue to see share shakeout among the rest of the top 5. Indeed, we ve seen
`notable share losses for JTs Logic (from 19% to 12%) and IMBs blu (from ~40% to
`17%) since MO and RAIs national launches. This heightened competitive landscape
`is best exemplified by the challenges seen for NJOY, which filed for Chapter 11
`
`4
`
`www.cowen.com
`
`JLI Ex. 2040, Page 4 of 12
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`

`Cowen and Company
`Equity Research
`
`September 22, 2016
`
`bankruptcy earlier this week. While the Big 2 have established dominant positions,
`market share dislocation outside of the Big 2 leaves ample share opportunity for JUUL.
`
`In addition to these competitive headwinds, JUULs success is also particularly
`noteworthy given the products premium positioning. Retailing at $50 for a starter
`kit, JUULs price point is ~5x that of competitors (though we would note that JUULs
`startup kit includes four cartridges, while competitors generally come with one). The
`barrier to entry for initiation though has a fairly quick payback, as JUUL cartridges
`(called pods) retail at prices comparable to competitors.
`
`www.cowen.com
`
`5
`
`JLI Ex. 2040, Page 5 of 12
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`

`

`Cowen and Company
`Equity Research
`
`September 22, 2016
`
`JUULs traction with consumers, despite its premium pricing, reflects the products
`differentiated technology. As opposed to using free-based nicotine, like its
`competitors, JUUL leverages IP-protected nicotine salts, where nicotine delivery
`closely mirrors that of a conventional cigarette. The brands resonance with consumers
`was also reflected in our Cowen Vaping Survey (link) which showed JUUL with among
`the highest conversion rates. In a post-deeming environment, providing consumers
`with a product currently on the market that meets consumer needs, could not only
`drive share gains, but also continue to fuel category growth.
`
`6
`
`www.cowen.com
`
`JLI Ex. 2040, Page 6 of 12
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`

`

`Cowen and Company
`Equity Research
`
`September 22, 2016
`
`Ticker
`KSHB
`RAI
`2914.JP
`
`Rating
`Outperform
`Outperform
`Market Perform
`
`Price*
`$2.13
`$48.44
`¥4,048.00
`
`Price Target
`$3.00
`$57.00
`¥4,350.00
`
`Ticker
`MO
`IMB.LN
`
`Rating
`Market Perform
`Outperform
`
`Price*
`$63.50
`3,929.00p
`
`Price Target
`$67.00
`4,390.00p
`
`*As of 09/21/2016
`
`Valuation Methodology And Risks
`
`Valuation Methodology
`
`Cannabis:
`Our valuation methodology is primarily based on DCF, followed by Price-to-Sales. In
`cases where GAAP net income includes large, non-cash items (e.g., restructuring
`charges), we may use non-GAAP EPS.
`
`Tobacco:
`Our valuation methodology is primarily based on Price-to-Earnings (P/E), followed
`by Relative Price-to-Earnings (vs. the respective relative index) as well as Enterprise
`Value to EBITDA (EV/EBITDA). In cases where GAAP net income includes large, non-
`cash items (e.g., restructuring charges or the resolution of disputed MSA), we may
`use non-GAAP EPS.
`
`Investment Risks
`
`Cannabis:
`Cannabis is an emerging industry and is subject to regulatory headwinds. While
`over 50% of the population is in favor of legalization, only a few states have thus far
`legalized cannabis for recreational use and the product remains illegal at the federal
`level. Looking forward, much work and change still needs to occur in order for this
`industry to realize its full potential.
`
`Tobacco:
`Global tobacco demand is subject to a number of potential headwinds. Most notably,
`increased awareness of the risks associated with traditional tobacco use, and
`resultant regulatory actions (e.g., indoor smoking bans, enlarged textual or graphic
`warnings, and / or plain packaging) can negatively impact smoking incidence and/or
`per capita consumption, and thus industry volumes. What is more, the industry is also
`subject to risk from disruptive tax increases, which result in higher prices, and can
`also depress consumption. Further, while diminished, litigation risk also exists.
`
`www.cowen.com
`
`7
`
`JLI Ex. 2040, Page 7 of 12
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`

`

`Cowen and Company
`Equity Research
`
`September 22, 2016
`
`Addendum
`
`Stocks Mentioned In Important Disclosures
`
`Ticker
`MO
`IMB.LN
`2914.JP
`KSHB
`RAI
`
`Company Name
`Altria Group
`Imperial Brands
`Japan Tobacco
`Kush Bottles
`Reynolds American
`
`Analyst Certification
`Each author of this research report hereby certifies that (i) the views expressed in the research report accurately reflect his or her personal views about any and all of the subject
`securities or issuers, and (ii) no part of his or her compensation was, is, or will be related, directly or indirectly, to the specific recommendations or views expressed in this report.
`
`Important Disclosures
`Cowen and Company, LLC and or its affiliates make a market in the stock of Kush Bottles, Altria Group, Reynolds American, Imperial Brands and Japan Tobacco securities.
`Cowen and Company, LLC compensates research analysts for activities and services intended to benefit the firm's investor clients. Individual compensation determinations for
`research analysts, including the author(s) of this report, are based on a variety of factors, including the overall profitability of the firm and the total revenue derived from all sources,
`including revenues from investment banking, sales and trading or principal trading revenues. Cowen and Company, LLC does not compensate research analysts based on specific
`investment banking transactions or specific sales and trading or principal trading revenues.
`The Nielsen material contained in this report represent Nielsen s estimates and do not represents facts. Nielsen has neither reviewed nor approved this report and/or any of the
`statements made herein.
`
`Disclaimer
`Our research reports are simultaneously available to all clients are on our client website. Research reports are for our clients only. Not all research reports are disseminated,
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`
`The information, opinions, estimates and forecasts are as of the date of this report and subject to change without prior notification. We seek to update our research as appropriate,
`but various regulations may prevent us from doing so. Research reports are published at irregular intervals as appropriate in the analyst s judgement.
`
`Further information on subject securities may be obtained from our offices. This research report is published solely for information purposes, and is not to be construed as an offer
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`into account individual client circumstances, objectives or needs and are not intended as recommendations of investment strategy. The recipients of this report must make their
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`reliable information about the value or risks related to the security or financial instrument may be difficult to obtain. To the extent that this report discusses any legal proceedings
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`For important disclosures regarding the companies that are the subject of this research report, please contact Compliance Department, Cowen and Company, LLC, 599 Lexington
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`website at https://cowen.bluematrix.com/sellside/Disclosures.action.
`
`Equity Research Price Targets: Cowen and Company, LLC assigns price targets on all companies covered in equity research unless noted otherwise. The equity research price
`target for an issuer's stock represents the value that the analyst reasonably expects the stock to reach over a performance period of twelve months. Any price targets in equity
`securities in this report should be considered in the context of all prior published Cowen and Company, LLC equity research reports (including the disclosures in any such equity
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`research report publishing such targets.
`
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`Trading research reports do not assign ratings and price targets and may not be continuously followed. Accordingly, investors must regard such branded report as providing
`stand-alone analysis and reflecting the analysts opinion as of the date of the report and should not expect continuing analysis or additional reports relating to such issuers or debt
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`
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`Notice to European Union Investors: Individuals producing recommendations are required to obtain certain licenses by the Financial Regulatory Authority (FINRA). You can
`review the authors current licensing status and history, employment history and, if any, reported regulatory, customer dispute, criminal and other matters via Brokercheck by
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`available for each Research Analyst at www.cowen.com.
`
`8
`
`www.cowen.com
`
`JLI Ex. 2040, Page 8 of 12
`
`

`

`Cowen and Company
`Equity Research
`
`September 22, 2016
`
`Additionally, the complete preceding 12-month recommendations history related to recommendation in this research report is available at https://cowen.bluematrix.com/sellside/
`Disclosures.action
`
`The recommendation contained in this report was produced at September 22, 2016, 09:39 ET. and disseminated at September 22, 2016, 09:39 ET.
`Copyright, User Agreement and other general information related to this report
`© 2016 Cowen and Company, LLC. Member NYSE, FINRA and SIPC. All rights reserved. This research report is prepared for the exclusive use of Cowen clients and may not be
`reproduced, displayed, modified, distributed, transmitted or disclosed, in whole or in part, or in any form or manner, to others outside your organization without the express prior
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`in this report are owned by Cowen and may not be used without its prior written consent.
`
`Cowen and Company, LLC. New York (646) 562-1000 Boston (617) 946-3700 San Francisco (415) 646-7200 Chicago (312) 577-2240 Cleveland (440) 331-3531 Atlanta
`(866) 544-7009 Stamford (646) 616-3000 Washington D.C. (202) 868-5300 London (affiliate) 44-207-071-7500
`
`COWEN AND COMPANY EQUITY RESEARCH RATING DEFINITIONS
`
`Outperform (1): The stock is expected to achieve a total positive return of at least 15% over the next 12 months
`
`Market Perform (2): The stock is expected to have a total return that falls between the parameters of an Outperform and Underperform over the next 12 months
`
`Underperform (3): Stock is expected to achieve a total negative return of at least 10% over the next 12 months
`
`Assumption: The expected total return calculation includes anticipated dividend yield
`
`Cowen and Company Equity Research Rating Distribution
`
`Distribution of Ratings/Investment Banking Services (IB) as of 06/30/16
`IB Services/Past 12 Months
`Count
`Ratings Distribution
`Rating
`Count
`15.68%
`69
`59.22%
`Buy (a)
`440
`4.44%
`13
`39.43%
`Hold (b)
`293
`0.00%
`0
`1.35%
`Sell (c)
`10
`(a) Corresponds to "Outperform" rated stocks as defined in Cowen and Company, LLC's equity research rating definitions. (b) Corresponds to "Market Perform" as defined in Cowen
`and Company, LLC's equity research ratings definitions. (c) Corresponds to "Underperform" as defined in Cowen and Company, LLC's equity research ratings definitions. Cowen
`and Company Equity Research Rating Distribution Table does not include any company for which the equity research rating is currently suspended or any debt security followed by
`Cowen Credit Research and Trading.
`
`Note: "Buy", "Hold" and "Sell" are not terms that Cowen and Company, LLC uses in its ratings system and should not be construed as investment options. Rather, these ratings
`terms are used illustratively to comply with FINRA regulation.
`
`Kush Bottles Equity Research Rating History as of 09/21/2016
`powered by: BlueMatrix
`
`I:(1):$3.00
`09/12/16
`3.50
`3.00
`2.50
`2.00
`1.50
`1.00
`0.50
`Oct 2013
`
`Jan 2014
`
`Apr 2014
`
`Jul 2014
`
`Oct 2014
`
`Jan 2015
`
`Apr 2015
`
`Jul 2015
`
`Oct 2015
`
`Jan 2016
`
`Apr 2016
`
`Jul 2016
`
`Closing Price
`
`Target Price
`
`www.cowen.com
`
`9
`
`JLI Ex. 2040, Page 9 of 12
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`

`

`Cowen and Company
`Equity Research
`
`September 22, 2016
`
`I:(1):$47.00
`07/10/14
`80
`
`(1):$53.00
`10/06/14
`
`(1):NA
`01/22/15
`
`Altria Group Equity Research Rating History as of 09/21/2016
`powered by: BlueMatrix
`(2):$67.00
`03/29/16
`
`(1):$59.00
`01/30/15
`
`(1):$62.00
`07/29/15
`
`(2):$65.00
`10/30/15
`
`70
`
`60
`
`50
`
`40
`
`30
`Oct 2013
`
`Jan 2014
`
`Apr 2014
`
`Jul 2014
`
`Oct 2014
`
`Jan 2015
`
`Apr 2015
`
`Jul 2015
`
`Oct 2015
`
`Jan 2016
`
`Apr 2016
`
`Jul 2016
`
`Closing Price
`
`Target Price
`
`Reynolds American Equity Research Rating History as of 09/21/2016
`powered by: BlueMatrix
`(1):$95.00
`(1):$47.00
`07/28/15
`09/08/15
`
`(2):$67.00
`11/18/14
`
`(2):$72.00
`02/10/15
`
`(2):$75.00
`04/17/15
`
`(1):$86.00
`05/27/15
`
`(1):$55.00
`10/14/15
`
`(1):$56.00
`02/11/16
`
`(1):$57.00
`04/26/16
`
`(2):$63.00
`10/21/14
`
`I:(2):$62.00
`07/10/14
`100
`90
`80
`70
`60
`50
`40
`30
`20
`Oct 2013
`
`Jan 2014
`
`Apr 2014
`
`Jul 2014
`
`Oct 2014
`
`Jan 2015
`
`Apr 2015
`
`Jul 2015
`
`Oct 2015
`
`Jan 2016
`
`Apr 2016
`
`Jul 2016
`
`Closing Price
`
`Target Price
`
`Imperial Brands Equity Research Rating History as of 09/21/2016
`powered by: BlueMatrix
`
`(1):$4,100.00
`11/03/15
`
`(1):$4,120.00
`05/05/16
`
`(1):$4,390.00
`06/29/16
`
`(1):$3,492.00
`09/02/15
`
`I:(1):$3,370.00
`08/25/15
`4,600
`4,400
`4,200
`4,000
`3,800
`3,600
`3,400
`3,200
`Oct 2013
`
`Jan 2014
`
`Apr 2014
`
`Jul 2014
`
`Oct 2014
`
`Jan 2015
`
`Apr 2015
`
`Jul 2015
`
`Oct 2015
`
`Jan 2016
`
`Apr 2016
`
`Jul 2016
`
`Closing Price
`
`Target Price
`
`10
`
`www.cowen.com
`
`JLI Ex. 2040, Page 10 of 12
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`

`

`Cowen and Company
`Equity Research
`
`September 22, 2016
`
`I:(2):$4,050.00
`08/25/15
`5,000
`
`(2):$4,007.00
`09/02/15
`
`(2):$4,250.00
`11/05/15
`
`Japan Tobacco Equity Research Rating History as of 09/21/2016
`powered by: BlueMatrix
`(2):$4,800.00
`(2):$4,350.00
`05/02/16
`08/02/16
`
`(2):$4,540.00
`02/08/16
`
`(2):$4,410.00
`12/22/15
`
`4,500
`
`4,000
`
`3,500
`
`3,000
`
`2,500
`Oct 2013
`
`Jan 2014
`
`Apr 2014
`
`Jul 2014
`
`Oct 2014
`
`Jan 2015
`
`Apr 2015
`
`Jul 2015
`
`Oct 2015
`
`Jan 2016
`
`Apr 2016
`
`Jul 2016
`
`Closing Price
`
`Target Price
`
`Legend for Price Chart:
`I = Initiation | 1 = Outperform | 2 = Market Perform | 3 = Underperform | UR = Price Target Under Review | T = Terminated Coverage | $xx = Price Target | NA = Not Available |
`S=Suspended
`
`www.cowen.com
`
`11
`
`JLI Ex. 2040, Page 11 of 12
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`

`

`Cowen and Company
`Equity Research
`
`September 22, 2016
`
`Points Of Contact
`
`Analyst Profiles
`
`Vivien Azer
`New York
`646.562.1351
`vivien.azer@cowen.com
`
`Aaron Grey, CFA
`New York
`646.562.1421
`aaron.grey@cowen.com
`
`Vivien Azer is a senior analyst covering
`beverages and tobacco. She joined
`Cowen in 2014.
`
`Aaron Grey is an associate covering
`tobacco. He joined Cowen in 2014 and is
`a graduate of Villanova University.
`
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`
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`12
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`www.cowen.com
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`JLI Ex. 2040, Page 12 of 12
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