Electronic Cigarette Industry: Behind The Smoke And Ashes
As healthy living trends influence the switch from traditional consumable products to ‘wholesome’ alternatives, e-cigarettes are gaining in popularity. Bidness Etc believes the industry holds potential for investors looking at long-term returns
As healthy living becomes a priority for the modern consumer, electronic cigarettes are the latest product to grab public attention as a ‘healthier’ equivalent of a notoriously unhealthy product. Electronic cigarettes – or ‘e-cigarettes’, as they are popularly known – are a type of electronic inhaler and an alternative to traditional tobacco-based cigarettes. Even though their benefits and health risks are still not known fully, e-cigarettes are becoming increasingly popular with smokers who cannot do without the nicotine kick, but who wish to avoid the cancerous side effects of smoking.
The earliest e-cigarettes were introduced and patented by Herbert A. Gilbert in the US in 1963. They were marketed as “a smokeless, non-tobacco cigarette” that replaced burning paper tobacco with heated, moist, flavored air. In 1967, Gilbert was approached by several companies interested in mass manufacturing his patented e-cigarettes. However, a deal failed to materialize, and e-cigarettes disappeared from the public eye till Chinese pharmacist Hon Lik reintroduced them in 2000. Lik’s reinvented e-cigarettes were introduced to the Chinese market sometime during 2002-2005.
Producers and Suppliers:
Today, most e-cigarette brands are produced by more than 370 small manufacturers and suppliers located in China, but a few major non-Chinese producers are also slowly gaining prominence in the industry. These include Logic Technology, NJOY, Vapor Corp (VPCO), Safecig and V2 Cigs. The largest cigarette makers in the US – the Altria Group, Inc. (MO), Reynolds American, Inc. (RAI) and Lorillard Inc. (LO) – have also jumped on the e-cigarette bandwagon since August 2013.
Price of E-cigarettes:
Traditional cigarettes are generally taxed at very high rates to discourage their consumption due to their health risks, but manufacturers are hoping to circumvent those taxes with e-cigarettes. V2 Cigs reports that the cost of a three-pack of disposable e-cigarettes, which is equivalent to six traditional cigarette packs, was less than $25 in 2013. According to the V2 website, the cost of a five-pack of V2 e-cigarette cartridges is currently $12.5, significantly lower than the $36 price tag on a five-pack of conventional cigarettes.
Similarly, the cost of a five-pack of Blu e-cigarettes is about $12-13, depending on the flavor you want to buy. NJOY, one of the largest e-cigarette producers and sellers in the US, sells its NJOY King five-pack of cartridges for just $5.99.
Potential for Growth:
Reynolds estimates that the US e-cigarette industry’s revenues will double to $1 billion by end-2013, and will reach $3 billion within the next five years. Bonnie Herzog, a senior tobacco industry analyst at Wells Fargo & Company, is even more optimistic: she believes industry revenues will grow to around $1.8 billion by the end of 2013, and that e-cigarette sales will top $10 billion by 2017.
Those numbers may mark a turning point for the tobacco industry. Altria, one of the world’s largest tobacco corporations, saw adjusted earnings from cigars and cigarettes rise just 4.2% in 2012, as compared to the 7% increase in earnings from its smokeless products segment. Similarly, Reynolds’ adjusted earnings from cigarettes fell 2.2% in 2012, while earnings from smokeless products rose 10%.
Notwithstanding the exciting growth rates, e-cigarette usage among US adults is still very low. According to a survey conducted by the US government, about 2.7% of all US adults tried e-cigarettes in 2010, compared to only 0.6% in 2009. Furthermore, e-cigarettes contributed only a small portion to the $80-100 billion revenues generated by US tobacco manufacturers in 2011-2012. But these numbers also indicate immense room for growth: if their usage picks up at an annual rate of 15% till 2040, e-cigarettes will account for 60% of total cigarette sales in the US. Furthermore, operating margins for e-cigarettes are expected to climb to 25% in 2019, from the current 20%.
Taking the cue from increased e-cigarette sales from 2009 to 2012, Big Tobacco has started shifting focus to e-cigarettes as its growth driver for the future. E-cigarette production and distribution has increased over the last couple of years as these larger players enter the e-cigarette industry. For example, Lorillard recently expanded distribution of e-cigarettes to more than 80,000 stores after it purchased Blu, a prominent e-cigarette manufacturer, for $135 million.
According to analysts, large tobacco producers will soon start allocating significant marketing budgets to promote e-cigarette consumption, which will boost sales. The rise in consumption of smokeless cigarettes is also attributable to the general perception that they pose lower health risks compared to traditional cigarettes, and are also considered a good first step in kicking the smoking habit.
However, there is at least one hurdle to the growing popularity of e-cigarettes. The use of e-cigarettes has, until now, been permitted in restaurants and public venues in many countries across the world, and in most areas in the US because of the perception that they carry a lower health risk and cause almost no harm to passive smokers. This has encouraged their use by smokers as a hassle-free means to puff on nicotine while they carry on with whatever they are doing. However, this may not last for long.
There are reports that France is planning to ban the use of e-cigarettes in public venues, after a French health agency reported that e-cigarettes may be hazardous to human health. Several cities in the US, Canada and Australia have already banned them in public venues for similar reasons, and several airlines have banned their usage during flights, just like normal cigarettes.
Legal History in the US:
When e-cigarettes were first introduced in the US, the Food and Drug Administration (FDA) classified them as drug delivery devices, and subjected them to regulation under the Food, Drug, and Cosmetic Act (FDCA). The classification was challenged in court, and overruled in January 2010 by Federal District Court Judge Richard J. Leon, who said that “electronic cigarettes should be regulated as tobacco products rather than drug or medical products.” The FDA was also ordered to stop blocking the import of e-cigarettes from China.
In March 2010, the FDA fought for the right to regulate e-cigarettes, based on the argument that it already regulates nicotine replacement therapies such as nicotine gum or patches. The appeals court ruled against the FDA on December 7, 2010, in a 3–0 unanimous decision. The final decision was that the FDA can only regulate e-cigarettes as tobacco products, and thus it cannot block their import.
The court ruled that e-cigarettes and related devices could only be subject to drug legislation if they were marketed for therapeutic use, which was not the case as e-cigarette manufacturers had successfully proven that their products were targeted at smokers and not at those who wanted to quit smoking. On January, 24, 2011, the District of Columbia Circuit appeals court refused to review the decision.
E-Cigarette Component Producers and Suppliers:
Chinese manufacturers have the largest share in the market for e-cigarette components, followed by US and British suppliers.
The liquid used to produce vapor in e-cigarettes, commonly known as e-juice or e-liquid, is a mixture that mostly contains propylene-glycol. Propylene-glycol is manufactured and supplied predominantly by Indian and Chinese producers. Prominent manufacturers include names like Shiva Industries and INEOS Oxide.
There are around 50 known American manufacturers and suppliers of e-liquid, including Altsmoke, VaporFlow and Cignot, Inc and about 10 manufacturers and suppliers of e-liquid in the EU, such as Cybercig and ENjuice. There are also about 10 known Chinese manufacturers and suppliers of e-liquid, such as BestEcig.
The American E-liquid Manufacturing Standards Association (AEMSA) is the first, and only, trade association dedicated to creating and maintaining self-regulating standards for the manufacturing of e-liquids used in electronic cigarettes. AEMSA seeks to establish industry standards and other regulations which will help the e-cigarette industry mature.
The bulk of e-cigarette cartridges are produced in China, but smaller producers in the US, the UK, South Korea, Hong Kong and Taiwan also supply e-cigarette manufacturers. Blu cartridges, flavors and atomizers are made by US suppliers and producers, while Jomo Technology Co., Ltd. is a leading Chinese manufacturer of quality e-cigarette cartridges.
Producers and suppliers of atomizers for e-cigarettes are, once again, mostly Chinese companies. US, South Korean and British companies also produce and supply atomizers, and a few small producers in Canada, Germany, Hong Kong, Philippines and Taiwan are also active in the market.
The total number of worldwide e-cigarette battery suppliers is higher than the total number of suppliers of any other component. As usual, Chinese suppliers take the lead, but a considerable number of battery supplies also originate from the US, the UK and South Korea.
Major tobacco companies have started producing their own brands of e-cigarettes, which will likely be followed by large-scale advertising activity. As companies invest in research and development (R&D) to maintain a competitive edge and circumvent tobacco regulations that impose higher taxes on traditional cigarettes, e-cigarette users will be the ultimate winners. Furthermore, if the use of e-cigarettes in public venues continues to be allowed, more smokers will find reasons to switch to this more convenient method and less harmful way to consume nicotine.
Since there are many component suppliers for manufacturers to choose from, e-cigarette distributors and sellers will want better prices once the industry starts gaining traction. Growing demand will lead to a short-term rise in the price of components, but selling and distribution companies will soon switch to lowest-cost suppliers to maximize gross margins.
As big tobacco companies enter the e-cigarette market, they will buy the smaller players, so the industry will see a lot of mergers and acquisitions taking place.