Via Financial Times

One of this year’s top-performing hedge fund managers made a large chunk of his returns from a surprising source: an e-cigarette company whose value has soared despite the clampdown on vaping that has rocked the industry.

Jason Mudrick’s Mudrick Capital Management is on course for an annual gain of more than 20 per cent, net of fees, while many of his peers in distressed investing are nursing losses after a number of ill-fated bets.

The reason is an outsize stake in Njoy, the second-largest independent e-cigarette company behind Juul, which is Mudrick’s best-performing position even after the hedge fund trimmed the value of the holding this month. 

Mudrick’s more than $2bn-in-assets flagship fund was up 28.8 per cent in the year to the end of November, according to data compiled by HSBC. The average hedge fund was up 11.4 per cent in the same period, according to HFR’s Global Hedge Fund index. Mudrick declined to comment.

E-cigarettes have endured a global regulatory backlash this year in response to concerns that young people are getting hooked, and after hundreds of cases of lung damage and at least 30 deaths in the US that medical experts have linked to vaping. 

Juul has also found itself in the regulatory crosshairs for allegedly marketing to teenagers. 

The tobacco group Altria, which invested $12.8bn in Juul last year in return for a 35 per cent stake, wrote down the value of that investment by more than one-third two months ago, citing vaping bans in certain US cities, states and some international markets as a threat to future profits. 

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Numerous vaping devices and pods can be found at drug stores and gas stations. Devices like the NJoy resemble a USB flash drive.Vaping Njoy Pods
Njoy has seen spectacular growth over the past year, with sales up more than 1,100 per cent year-on-year, according to a Cowen analysis of Nielsen data © USA TODAY NETWORK

Investment group Tiger Global Management took an even sharper, 50 per cent markdown on its own stake in Juul at the end of September, one person briefed on the matter said.

In a letter to investors, which did not disclose the new valuation, Tiger Global said Juul faced “increasing uncertainty on the regulatory front”. The group declined to comment on the decision.

Mudrick took control of Njoy in the first quarter of 2017 after the company had fallen into bankruptcy, becoming its majority owner. As the group recapitalised, the hedge fund has been able to sell part of its stake and mark up the reminder to higher and higher valuations. 

Njoy has seen spectacular growth over the past year, with sales up more than 1,100 per cent year-on-year, according to a Cowen analysis of Nielsen data. The company commands 14.5 per cent of spending on e-cigarettes in the US, according to the analysis.

But the company has also taken a hit due to regulatory uncertainty. Earlier this year, it planned to raise capital at a valuation of up to $5bn but talks with investors fell through after US President Donald Trump threatened to ban flavoured vaping products, people familiar with the talks said. 

Instead, earlier this month, the Scottsdale, Arizona-based company raised $112m in so-called pay-in-kind debt with a 10 per cent interest rate and five-year maturity. Under the agreement, investors can convert the debt into equity at a valuation of $2.5bn —— half the valuation Njoy had hoped to achieve but higher than the $2bn mark it secured at a May funding round. 

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Mudrick marked down its Njoy investment by close to 20 per cent this month in advance of a year-end report by its auditor, according to a person familiar with the report, knocking the value of the flagship fund by 7 per cent. Other positions have reduced Mudrick’s overall loss for December to closer to 5 per cent.

The valuation cut was due to lower sales projections for next year as a result of Njoy’s lower fundraising, the person said.

Additional reporting by Joe Rennison