Haypp Group AB: Write-Up Preview

Haypp Group AB is a Swedish microcap that offers a potential multi-bagger investment as an online retailer of reduced-risk products.

Investment Thesis Summary

Haypp Group AB (“Haypp”) is a swedish microcap company listed on the NASDAQ First North Growth Market under the ticker, “HAYPP”. At the time of writing, Haypp has a market capitalisation of 2.5 billion SEK or approximately $242 million USD. Shares currently trade at 82.80 SEK or approximately $7.89 USD.

Haypp is an online retailer of reduced-risk products (“RRPs”), which are smoking alternatives. In particular, Haypp’s products include snus, nicotine pouches, vapes, and heat-not-burn-products.

Haypp’s business offers a potential multi-bagger investment opportunity due to the potential for nicotine pouches to supplant a significant proportion of cigarette sales in each of Haypp’s markets. Furthermore, Haypp is the ideal business through which to participate in the nicotine pouch trend because, firstly, there is likely to be intense competition within the nicotine pouch product category; secondly, Haypp’s business will benefit from intense competition rather than be harmed by it because it feeds into and strengthens the business’s competitive advantages; and thirdly, Haypp is a vastly stronger competitor than its primary competitors, convenience stores and grocery stores, due to its excellent economic characteristics and strong competitive advantages.

Nicotine pouches are a novel method of nicotine consumption consisting of a small white pouch made from plant fibers containing nicotine salt. The pouch is placed inside the user’s mouth between the lip and the gum and the nicotine within the pouch is then absorbed into the user’s bloodstream through the mucous membranes in the gums.

People generally consume nicotine for either of three reasons: for the release of dopamine and positive feeling that is triggered by nicotine’s stimulation of the nicotinic acetylcholine receptors in the brain; to benefit from the cognitive enhancements provided by nicotine as an aid to work; or due to addiction and for avoidance of withdrawal symptoms. Nicotine is the compound that makes smoking cigarettes addictive and the propensity for addiction is equally applicable to nicotine pouches.

Nicotine pouches fulfill the basic human want for nicotine consumption in a way that offers significant advantages relative to cigarettes, primarily by significantly reducing harm to the user. The major reduction in harm provided by nicotine pouches is due to the absence of tobacco combustion and the inhalation of smoke, which in the words of the Surgeon General of the United States, is incontrovertibly deadly. Nicotine pouches also provide social benefits in comparison to cigarettes by reducing the cosmetic harm suffered by the user and due to their odorless, convenient, discrete use.

Notwithstanding the relative infancy of the product category, nicotine pouches are being adopted at a blistering and increasing pace and have already achieved a stunning magnitude of unit sales in the United States. For example, the global leading brand, Philip Morris’ “Zyn”, grew its US shipment volumes (measured in “cans” of 15 to 20 individual pouches) from one million units for the 12 month period ending Q1 2017 to 385 million units for the 12 month period ending Q4 2023, equating to a compound annual growth rate over a 7 year period of approximately 134%.

The size of the total addressable market for nicotine pouches is enormous because they have the potential to supplant a significant proportion of cigarette sales. Furthermore, due to their health and social benefits relative to cigarettes and their superior unit economics, there is a very strong economic incentive for tobacco companies to want consumers to switch from cigarettes to nicotine pouches. However, this conception of the TAM for nicotine pouches should be qualified by the observation that some consumers will prefer other forms of RRPs, such as vapes or heat-not-burn products.

For example, there were approximately 160 billion individual cigarettes (or approximately 8 billion packets, assuming 20 cigarettes per packet) sold in the United States in 2022. If nicotine pouches supplant or match a significant proportion of cigarette sales, there could be hundreds of millions to billions of nicotine pouch “cans” sold annually in the United States with a market value in the tens of billions of dollars annually. This logic for assessing the total addressable market for nicotine pouches is equally applicable to Haypp’s other markets, although, again, it should be qualified by the possibility that consumers may prefer other forms of nicotine consumption, including vapes or heat-not-burn products.

In addition to there being a strong economic incentive from the perspective of producers for consumers to switch from cigarettes to nicotine pouches, there are also powerful tailwinds for the adoption of nicotine pouches in the form of governmental and societal support. This is because the availability of smoking alternatives can assist with significantly reducing a nation’s smoking rate, as has been the case in Sweden due to snus and in New Zealand due to vapes; and because reduced smoking rates benefit society by reducing healthcare system costs and by increasing economic output that is otherwise lost due to premature mortality caused by smoking.

Nicotine pouches are relatively undifferentiated products. The primary aspects of the product are flavour and strength. These characteristics are not capable of being meaningfully differentiated between brands, which is evidenced by the fact that multiple brands offer the same flavours and strengths. Furthermore, although branding can be a competitive advantage and distinguishing factor for products, it appears that branding is not a significant factor for nicotine pouches, as evidenced by Zyn’s recent loss of market share due to a shortage of its products.

The undifferentiated nature of the product, the highly attractive unit economics and economic characteristics of the product, and the basic law of economics that high returns on capital attract competition all lead to a single, predictable outcome: intense competition among producers of nicotine pouches.

Enter, Haypp.

Haypp’s business possesses many highly attractive economic characteristics, including a capital-light business model that enables increasing revenues and operating income without proportionate reinvestments of capital; economies of scale; the possibility for margin expansion; high returns on invested capital; high-margin free cash flow conversion due to a lack of significant capital expenditures; high-margin income from its marketing and customer insights business activities; data economies of scale; recurring revenues from repeat customers due to the addictive nature of its products; low customer acquisition costs; and high inventory turnover.

Haypp is better positioned than the major tobacco companies to benefit from the huge secular tailwind of the rising popularity of nicotine pouches because Haypp will benefit from increasing competition. In particular, increasing competition among producers benefits Haypp because it allows the business to offer its customers an even wider assortment of products in comparison to its competitors, thereby further strengthening its competitive position.

Additionally, a wider assortment of products from increasing competition also feeds into and strengthens another of Haypp’s competitive advantages - its two-sided network effects. By providing a greater assortment of products across its websites, Haypp attracts more customers to its websites due to its increasing usefulness and attractiveness. In turn, Haypp’s increasing number of active customers also attracts more suppliers wanting to sell their products to Haypp due to its large and increasing pool of active buyers, thereby creating a positive feedback loop: more customers increase suppliers and more suppliers increase customers.

In addition to benefiting from network effects generally, there are four aspects of Haypp’s business model that enhance its ability to attract suppliers willing to sell their products to Haypp, which thereby reinforces the strength of its network effects. These factors include the favourable characteristics of Haypp’s large, high-value customer base; Haypp’s ability to increase the awareness and trialing of a supplier’s new products through paid marketing tools; Haypp’s ability to provide suppliers with customer insights; and the reduced costs for suppliers of selling products to Haypp, which equates to 15% in comparison to Haypp’s competitors, on average.

In addition to network effects, Haypp’s business also benefits from economies of scale. Haypp achieves economies of scale by maintaining a relatively fixed cost base consisting of its warehouse operating costs. Each of Haypp’s warehouses are able to handle a high volume of unit sales due to the e-commerce friendly nature of its products. Haypp’s increasing revenues are spread over its fixed cost base which results in decreasing costs per unit sale and increasing operating income per unit sale, producing operating leverage as the business scales.

Haypp drives its economies of scale by employing an Amazon-esque, fly-wheel strategy for increasing its revenues. Haypp’s strategy consists of offering low prices by maintaining a relatively low gross-margin, a wide assortment of products consisting of over 1200 SKUs across its websites, and convenient, fast delivery, averaging a delivery time of 2.5 days across all markets.

Haypp offers prices that are 30% lower than convenience stores and 15% lower than grocery stores by maintaining a relatively low gross-margin on its products of approximately 13.5% as at year end 2023. Furthermore, there are three factors that enable Haypp to sustain its low prices in a way that competitors cannot replicate. Firstly, Haypp reduces supplier costs associated with supplying their products by 15% and shares these cost savings with the supplier. Secondly, much like Costco’s membership fees subsidise the business’s ability to offer lower prices, Haypp’s high-margin customer insights and paid marketing income streams subsidise its ability to offer low prices. Thirdly, Haypp benefits from economies of scale and is able to further reduce its cost per unit sale by fully automating its company owned warehouses, which reduces its warehouse costs per order from 5% to 2% on average across all of its markets.

As Haypp’s business achieves scale and begins experiencing operating leverage, Haypp can then either lower its prices even further by reducing its gross margin or reinvest a portion of its gross margin in expanding its product offering, either of which further strengthen the business’s competitive position.

Other competitive strengths of Haypp’s business include the ability to provide superior product information in comparison to physical retailers, especially in countries where plain packaging laws apply, such as Norway; a superior ability to reach new customers due to the difficulty of marketing nicotine products across social media platforms, which Haypp bypasses through search engine optimisation; and Haypp’s ability to collect consumer data due to conducting its sales online and having invested in data management and machine learning.

The economic characteristics of Haypp’s business and its strong, durable competitive advantages make Haypp a vastly stronger competitor in the RRP retailing space than its primary competitors, convenience stores and grocery stores.

In addition to having excellent economic characteristics and strong competitive advantages, Haypp’s business benefits from having an experienced management team, some of whom have come directly from leadership roles at major tobacco companies, who are well-incentivized by insider ownership of the business. In particular, Haypp’s CEO, Gavin O’Dowd, exudes competence and passion for the business.

Haypp’s business currently sells at a price that provides a margin of safety and a free call-option on the business’s future growth. The overall profitability of the business is obscured by losses being made in the “growth markets” segment of the business, which have recently broken even in Q1 of 2024. Backing out those “losses”, which are actually reinvestments in the business’s most important markets, we find that the business’s “core markets” segment (its markets in Sweden and Norway) are profitable and provide downside protection, mitigating the risk of permanent loss of capital while also providing a free-call option on the future growth of the business.

Haypp’s current market capitalisation on a fully diluted basis is approximately 2.5 billion SEK or approximately $242 million USD. Additionally, for the 2023 financial year, Haypp’s core markets segment earned operating income before depreciation and amortisation of tangible and intangible assets of 191.556 million SEK or approximately $18.5 million USD. If Haypp were simply to sustain this level of earnings for the rest of its corporate existence, then, assuming long-term interest rates of 7%, this would imply a value on a discounted cash flows basis of approximately 2.7 billion SEK or $264 million USD.

I estimate that Haypp’s future intrinsic value could be within the following range (USD):

1. Low range: $1,441,640,688.94

2. Medium range: $3,295,178,717.59

3. Medium-high range: $5,601,803,819.90

4. High range: $8,896,982,537.49

Introduction

I’d like to introduce this write-up of Haypp with a quote from Charlie Munger, which I think perfectly encapsulates Haypp’s positioning with respect to the burgeoning societal and economic phenomenon that is nicotine pouches and reduced risk products more generally:

“Then there’s another model from microeconomics which I find very interesting. When technology moves as fast as it does in a civilization like ours, you get a phenomenon which I call competitive destruction. You know, you have the finest buggy whip factory and all of a sudden in comes this little horseless carriage. And before too many years go by, your buggy whip business is dead. You either get into a different business or you’re dead—you’re destroyed. It happens again and again and again.

And when these new businesses come in, there are huge advantages for the early birds. And when you’re an early bird, there’s a model that I call “surfing”—when a surfer gets up and catches the wave and just stays there, he can go a long, long time. But if he gets off the wave, he becomes mired in shallows…”

The mental model of “surfing” that Charlie describes is one that I think perfectly describes Haypp in relation to nicotine pouches. Haypp is an early bird surfing the wave of technological innovation in nicotine consumption vis-a-vis nicotine pouches and RRPs with an enormous secular tailwind at its back in the form of governmental, societal and consumer support for the adoption of nicotine pouches in place of cigarettes.

Furthermore, Haypp has positioned itself to ride the nicotine pouch wave in a manner that is highly advantageous by creating a business with very attractive economic characteristics and strong competitive advantages and by placing competent managers with relevant industry experience at the helm of the company.

Having read the introductory quote and perhaps knowing something about Haypp’s business model, you might pose the question, “aren’t the major tobacco companies also surfing the same wave?” That is true. They are. However, this raises a critical difference between Haypp and the major tobacco companies as a means of participating in the nicotine pouch trend. Due to the economic characteristics of Haypp’s business model, it is positioned to benefit rather than be harmed by the impending onslaught of competition in the nicotine pouch product category. The competition and resultant harm is likely to occur due to a basic law of economics: high returns on invested capital attracts competition which consequently erodes returns on invested capital. In my opinion, that basic law of economics is applicable to nicotine pouches because they are largely undifferentiated products (apart from branding) and because the unit economics of producing and selling nicotine pouches are highly attractive.

Another way in which Charlie’s quote is applicable here is the degree of innovation that has occurred. I really do believe that the comparison of a motor-vehicle to a buggy whip and the degree of superiority that the comparison implies is equally applicable to nicotine pouches and cigarettes, although I don’t expect cigarettes to disappear as quickly as buggy whips. Just as the motor-vehicle was a superior method of transportation in comparison to the buggy whip, the nicotine pouch is a superior method for human nicotine consumption in comparison to cigarettes.

Continuing on with the wave metaphor, I believe that the nicotine pouch wave will be immense in size and of long duration for two reasons. Firstly, the opportunity for nicotine pouches to supplant or match cigarette sales and potentially introduce new nicotine users due to its enhanced safety profile is enormous. However, I would qualify that statement by observing that although governments are likely to be supportive of current smokers switching to RRPs, they are equally likely to want to prevent non-smokers from becoming nicotine users. Secondly, just as the motor-vehicle innovated and addressed the unchanging human need for transportation, the nicotine pouch innovates and fulfils the unchanging human want for nicotine consumption. In my view, nicotine addiction/use is “lindy” and is unlikely to go away, barring some sudden and unforeseen change in human brain chemistry, which also seems unlikely.

The preceding paragraphs make reference to the major elements of my thesis that this write-up will explore. Specifically, this write-up will explore the following topics. Firstly, the nicotine pouch phenomenon, including a brief product description of nicotine pouches, reasons why people use nicotine pouches and nicotine more generally, the advantages of nicotine pouches compared to cigarettes, the current popularity of nicotine pouches in the United States, market trends in the US and Sweden (the most mature market), nicotine pouch unit economics and economic characteristics, and an estimation of the size and value of the total addressable market; secondly, the economic characteristics and competitive advantages of Haypp’s business model; thirdly, an assessment of Haypp’s management; fourthly, valuation and whether the current valuation provides a margin of safety; and finally, a summary of risks posed by an investment in Haypp’s business.

As always, this write-up should not be read or construed as containing financial advice or a recommendation to make a financial investment in Haypp Group AB. The purpose of this write-up is to act as a starting point for your own research. Care has been taken to ensure that the facts presented here are accurate. However, you must conduct your own research to verify the information presented here. All investment decisions are your own. Always do your own due diligence. With that out of the way, I hope you enjoy this write-up. Happy hunting.