Bloomberg News

E-Cigarette Pioneers Holding Breath as Big Firms Invade

June 21, 2013

For the past decade, small purveyors of electronic cigarettes have largely had the U.S. market to themselves. Now, with sales projected to double to $1 billion this year, e-cig brands with such names as Logic, Njoy and Vapor are waiting to exhale as giant tobacco companies begin to invade their turf.

In August, Altria Group Inc. (MO:US), the largest cigarette maker in the U.S., will start selling its new MarkTen e-cigs in an undisclosed Indiana market. Second-biggest Reynolds American Inc. plans a national rollout of its Vuse e-cigarette, beginning in Colorado next month. Lorillard Inc. has boosted distribution of its Blu eCigs to more than 80,000 stores since acquiring the brand last year for $135 million.

“We welcome them with open arms as long as they play fair,” said Eli Alelov, chief executive officer of e-cig maker Logic Technology. “We’re hoping they don’t tell their customers, ‘If you want to carry our cigarettes, make sure you have our e-cigs.’ ”

The tobacco companies’ moves come as officials seek to determine if the devices are safer than traditional cigarettes. E-cig users inhale vapor created when a battery-powered tube heats a liquid nicotine solution, giving them a hit without burning or smoke. On June 12, the U.K. government said e-cigs should be regulated as medicines to ensure quality and safety. France plans to ban e-cigs from public venues; several U.S. cities have already.

The U.S. Food and Drug Administration, which regulates tobacco products, has yet to impose rules on e-cigs. Altria CEO Martin Barrington says “harm reduction” would be “good public policy” for the FDA, but the smaller players are more direct in urging the FDA to designate e-cigarettes as less harmful than cigarettes.

‘Dream Product’

“If the FDA wants to improve or remove the risk to public health, this is the FDA’s dream product,” said Vapor CEO Kevin Frija.

As Americans puff fewer cigarettes, manufacturers are raising prices and turning to smokeless products to boost profit growth. Altria’s adjusted earnings from cigarettes and cigars rose 4.2 percent last year, compared with a 7 percent gain for its smokeless business. Reynolds (RAI:US)’ adjusted operating income from cigarettes sank 2.2 percent in 2012 while earnings from snuff advanced 10 percent.

This year the shares of Altria gained 9.2 percent through yesterday, Lorillard 10 percent and Reynolds 12 percent, compared with an 11 percent rise for the Standard & Poor’s 500 Index. Altria rose 1.8 percent to $34.95 at 10:09 a.m. in New York, while Lorillard climbed 1.9 percent to $43.65 and Reynolds gained 1.6 percent to $47.

Faster Growth

Although e-cigs now account for only 1 percent of U.S. cigarette sales, Reynolds projects industry revenue will double to $1 billion this year and reach $3 billion within five years. Bonnie Herzog, a Wells Fargo Securities analyst based in New York, predicts even faster growth, with sales topping $10 billion by 2017.

“The long-term growth trajectory of the category will be robust,” Herzog said in a June 12 report. She and other analysts say FDA regulators may require e-cig makers to disclose ingredient and manufacturing data, imposing research and compliance costs only deep-pocketed players can absorb.

Most e-cigs are made in China, where they were invented a decade ago by pharmacist Hon Lik. As production expands and economies of scale kick in, operating margins will climb to 55 percent in 2019, from about 20 percent now, Herzog estimates. That compares with 43 percent for conventional smokes today. Higher e-cig sales boost profitability because makers won’t have to pay levies set on regular cigarettes under the industry’s 1998 health-care settlement with U.S. states, she said.

Flavor Cartridges

Blu’s starter kit, which includes a wall charger, two batteries and five flavor cartridges, sells for $80. Flavor cartridges run about $12 for a five-pack. Prices will fall through 2014 as big manufacturers try to lure consumers to their new e-cigs, Herzog figures.

E-cig makers are working hard to mimic the smoking experience and deliver the nicotine smokers crave. Blu eCigs feature a glowing blue tip, rechargeable batteries, and a range of flavor cartridges, including Piña Colada and Classic Tobacco. Users of Njoy -- sold in both regular and menthol flavors -- inhale and exhale a vapor that looks and feels much like the real thing.

Reynolds and Altria are trying to set themselves apart from rivals. The Reynolds Vuse is stainless steel, and both companies claim their e-cigs contain technology that improves the user experience.

Scowling Granny

Marketing e-cigs can be tricky, because touting the products as safer than regular smokes could draw the FDA’s ire. Blu has appealed to freedom-loving smokers who want to indulge their habit anywhere. One Blu ad features a scowling granny in a cardigan, saying “Dear Smoking Ban” and brandishing her middle finger.

Already, curbs on e-cigs are popping up. Minors in Indiana won’t be able to buy them starting July 1, joining more than a dozen states with similar restrictions, imposed because some people believe they may lead to smoking real cigarettes. In California, e-cigs would be subject to the same restrictions as cigarettes under a bill passed by the state senate in May.

Starbucks Corp. (SBUX:US) and U.S. airlines don’t allow the devices, and Boston and Seattle are among cities that have added the products to their smoking bans. French Health Minister Marisol Touraine in May announced plans to ban the devices in public places, citing the potential long-term health impact.

Still, Njoy in mid-June said it had raised $75 million from Silicon Valley investors, including Facebook Inc. (FB:US) co-founder Sean Parker, to pour into marketing, research and global expansion. Vapor CEO Frija, who said he’s open to selling a stake to help finance growth, sees e-cigs as a classic disruptive technology.

“A generation from now, people may forget what a machine-rolled cigarette looks like,” he said.

To contact the reporter on this story: Chris Burritt in Greensboro at cburritt@bloomberg.net

To contact the editor responsible for this story: Robin Ajello at rajello@bloomberg.net


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Companies Mentioned

  • MO
    (Altria Group Inc)
    • $43.33 USD
    • -0.10
    • -0.23%
  • RAI
    (Reynolds American Inc)
    • $62.83 USD
    • 1.08
    • 1.72%
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