The e-cigarette industry is in its infancy, but growing quickly; can investors get in on the ground floor? Vincent Shen joins this consumer goods edition of Industry Focus to fill in the Fools on this latest variant on tobacco products.
The big tobacco companies all have their own offerings of course, while plenty of start-ups are also hoping to make their mark. Shen explains how the market will be shaped, in one direction or another, by regulatory decisions expected to come out later this year.
A full transcript follows the video.
Sean O'Reilly: Don't tell our mothers, we're talking about sin stocks again! This is the consumer goods edition of Industry Focus.
Greetings Fools, I am Sean O'Reilly here at Fool headquarters in Alexandria, Virginia, with the one and only Vincent Shen. How are you today sir?
Vincent Shen: I'm doing very well, thank you.
O'Reilly: Does your mom know we're talking about more sin stocks?
Shen: Yes, she does.
O'Reilly: She does? Is she OK with it?
Shen: She approves.
O'Reilly: My mom was not so happy. That's all right!
Last time we talked about specifically big tobacco. This is traditional cigarettes.
Shen: That's correct.
O'Reilly: Today we're talking about e-cigarettes. First and foremost, for our listeners that may or may not know what's going on these days, what is an e-cigarette?
Shen: I think it's important to define it, just because the product mix is changing a little bit. There's a lot of innovation in the industry right now.
Ultimately, at its base level, an e-cigarette is just a device that's filled with some type of liquid nicotine solution, and then there's a battery powered coil which vaporizes that solution and delivers that vaporized nicotine to the user.
O'Reilly: Can it electrocute me?
Shen: There are some issues with ...
O'Reilly: Are you kidding me? I was just making a joke!
Shen: It can happen. There are some safety issues with some of the more advanced devices, but all in all if you're buying one at a convenience store, it's pretty safe.
O'Reilly: Pretty safe, OK.
What's been happening in that industry? How old is it? What do our listeners need to know about it in order to get a feel for what's going on and possibly invest in it?
Shen: Sure. The e-cigarette industry is developing very, very quickly. It pretty much didn't exist ...
O'Reilly: Even a few years ago.
Shen: ... 10 years ago in this country, and it's developed quite a bit. In 2013 revenues were about $1.7 billion, they estimate; jumped up to $2.5 billion last year, and now it's forecasted for about $3.5 billion this year.
Within that, there are a few different kinds of e-cigarettes. You have the standard ones that look like cigarettes, often referred to as "cigalikes." Then you also have some more advanced devices where you can replace a cartridge, you have to replace the battery; they're not disposable.
Then you have really advanced devices where the user can customize every aspect of the experience, from its form factor to the flavor of the nicotine juice that they're using, or how much vapor is being delivered. Those are some of the options out there right now.
O'Reilly: Obviously very small subsets, as we talked about last time. The actual cigarette market with traditional cigarettes is $70-80 billion. You're talking about a couple billion here or there, but growing very, very quickly.
Shen: It is growing quickly.
O'Reilly: The thing that stuck out to me, though, was the dichotomy between the number of people that have tried it at least once in the United States, versus how many people actually regularly buy these things and smoke them.
Shen: Yes, I'm very glad you brought that up. They estimate that there are about 40-plus million smokers still, in the U.S.
O'Reilly: Which is actually ... there are 350 million Americans, so it's actually a decent chunk there.
Shen: Oh, yes. Of those 40-plus million smokers, they think that at least half of them have tried e-cigarettes one time, so there is quite a bit of awareness around e-cigarettes.
But the thing is, when it comes down to the actual revenue numbers and financials, e-cigarettes make up maybe 5% or less of tobacco revenue, and in terms of earnings it's probably even less than that, like 1%.
O'Reilly: Next up we wanted to talk about, who are the players? The biggest percentage of the market goes to blu cigarettes right now?
Shen: Yes.
O'Reilly: Supposedly, depending on the month?
Shen: Yes! The thing is, there are a lot of challenges in terms of determining market share and who the dominant player is in this industry because you have a lot of different distribution channels. Seven in 10 traditional cigarettes are sold in convenience stores, whereas with e-cigarettes you have vape shops that are popping up all over the country ...
O'Reilly: Little kiosks at the mall.
Shen: Exactly. I think, of the 20,000 vape shops there are worldwide, 8,500 of them are just in the U.S.
O'Reilly: Oh, wow.
Shen: It's grown very quickly, like I say, just over the past 10 years. Then you also have online outlets where you can purchase a lot of your different parts that you need, and devices, so it's harder for the industry to track some of the sales and the market share.
But overall the biggest players are, like you mentioned blu -- which is from Lorillard (LO.DL) but, part of the merger with Reynolds American (RAI), is going to go to Imperial Tobacco.
O'Reilly: I was surprised about that.
Shen: Yes.
O'Reilly: As part of the merger -- they've got the market leader in e-cigarettes, which is growing like crazy -- and they're going to sell that portion of their business in order to merge. What's the thinking there?
Shen: The thing is, Reynolds has developed their own e-cigarette, called VUSE, and they consider VUSE to be the superior product. They did testing for VUSE in Colorado and in Utah last year, and they've expanded it nationally now, so it's available in over 100,000 retail locations.
That's their big push so, for Reynolds, they're focusing on VUSE. They're OK letting blu go because they think that ultimately their product is better.
O'Reilly: To say that any particular e-cigarette is a market leader right now doesn't actually ... we're not even at the first day. We're in batting practice here, right?
Shen: It shifts significantly. Altria (MO -1.46%) rolled out with Mark Ten.
O'Reilly: Yes, I read about that. They did the testing in Indiana and ... what was the other state?
Shen: Arizona.
O'Reilly: Arizona, yes. I'm sure there were promotions and free whatevers in there, but supposedly they got like 50% market share, pretty much immediately.
Shen: In their test markets, yes.
O'Reilly: I don't know, the whole situation seems like ... we're not even to the first inning here. This is so, so early.
Shen: Yes. Everything's developing very, very quickly. You have Mark Ten from Altria. You have VUSE from Reynolds. You've got blu. You also have smaller players like NJOY, which is well known because they're backed by some pretty famous investors like Peter Thiel and Sean Parker.
O'Reilly: I was a little surprised that they valued that thing ... it got valued at $1 billion and they got Sean Parker from Facebook (META 1.57%) to invest in it, and all this stuff.
Shen: Yes. The thing is, they've had a few rounds of private equity investments. They've raised almost $150 million. As of the most recent round, they got that $1 billion valuation. They are also available in tens of thousands of retail locations, so they're a significant player and they're not part of that big tobacco group.
Other brands, you have Logic, 21st Century, Krave, VaporX 51, Mistic. It's a very diverse subset of brands there, and options. There's also, as a result of that, quite a bit of consolidation in the industry as well.
O'Reilly: For sure. A lot of the research that I've read about e-cigarettes makes it a point that they're almost disposable; the traditional e-cigarettes you can buy at the gas station or whatever. But now there's the shift, not only away from traditional cigarettes, but toward vaping.
Shen: Yes.
O'Reilly: What's the big difference there, and why is it better?
Shen: For the end user, they're concerned about things like the diversity of the products, how easy it is to use, the economics about it. A lot of people going to e-cigarettes are trying something like blu, or a cigalike. That's disposable. You use it one time, it runs out, and then you have to repurchase.
A lot of people in the industry consider that like an appetizer for e-cigarette users, where they use that but then they learn more about the options available and they will gradually convert to some of their advanced devices, be it with refillable cartridges or some of the really advanced mods and atomizers that are available.
They see a lot of people coming in with cigalikes, and then within six months they've already moved on to something more.
O'Reilly: Wow! Jeez, OK. The NJOY, is that a vapor or a cigalike?
Shen: That's more of a cigalike, but it does have the reusable component with the cartridges and the recharging. It has that small form factor, but there is a little bit more. You could consider it a little bit more advanced than the disposable versions.
O'Reilly: Cool. Okay, you've got all these players, they're all fighting for market share. Rollouts, crazy ... we don't know which horse is going to win.
Shen: Yes.
O'Reilly: What does the government have to say about all this?
Shen: That's the big point of contention, and probably the biggest thing that the industry faces right now. They expect the FDA to come out with their final rulings on e-cigarettes; hopefully this summer, though some people are very skeptical about that.
O'Reilly: I find it hard to believe that the FDA will be more draconian with the regulation of the e-cigarettes than they would be with regular cigarettes.
Shen: The thing is, a lot of people who use e-cigarettes value things like flavors, and that is one of the key things that is being considered as a banned component for e-cigarettes. But that really takes away ...
O'Reilly: Won't the government allow that?
Shen: They wouldn't allow it.
O'Reilly: Oh, wow.
Shen: Also the fact that you can use e-cigarettes in parks or indoors in certain states.
O'Reilly: Right, because most of them put out water vapor, essentially.
Shen: Yes, just vapor that ... though there is testing around what is in that vapor, and if it has harmful effects; the secondhand vapor, basically.
Right now, there are something like 60-plus bills in 21 different state legislatures that are being considered. They'll ban things like flavors, online sales, they'll require permits to sell liquids, they'll prohibit use in public, restrict advertising. A lot of that stuff, they're regulations that the traditional tobacco industry currently has.
O'Reilly: No huge change, then.
Shen: But at the same time, the big issue with that is you have all these smaller players. If the FDA institutes a more rigorous, strict process to get products approved, those processes can take hundreds of thousands, if not millions of dollars, to get through.
O'Reilly: Then it favors the big guys.
Shen: It favors the big companies who have the resources to go through that approval process.
O'Reilly: And have done this dance before.
Shen: Exactly. They have essentially the deep pockets necessary to get their products through, whereas everybody else would just get boxed out.
O'Reilly: It seems like the final winners, when we're looking back 10-20 years from now in the advent of the e-cigarette and vaping and all that, kind of depends on what the government says, first.
Shen: Absolutely. Whatever they decide to do with their regulations will have a big impact on innovation in the industry, options available for users, the experience overall, the quality of the product. It's a big issue to consider. That's absolutely for sure.
O'Reilly: Got it. This is The Motley Fool. We like to help the world invest better. Is there a player that you can bet on safely to take advantage of this consumer trend? What are investors looking at?
Shen: Sure. In the end when you think of tobacco, regardless if it's e-cigarettes or traditional, you have the big tobacco companies. Because the current environment is so uncertain, it's hard to say, "Let's pick some of the smaller e-cigarette players," which a lot of them are essentially penny stocks.
O'Reilly: Yes.
Shen: Whereas, you can pick a Reynolds or an Altria, which is a big company. They have, like I said, the lobbying power, the resources to potentially form the industry around their needs and to their benefits. That's something that, if you're looking for a current investment, is what you would bet on.
But at the same time, if the regulations come through and they allow that innovation to keep going, allow the smaller players to remain in the space and to remain competitive, then the investing environment becomes a lot more interesting.
There are a lot more options and you might, in that case, because the big tobacco companies tend to be slower with the innovation, their products aren't getting the rave reviews that some of the smaller companies get, so you might see them starting to gobble up some of the smaller companies to get that innovation.
You might even see pharmaceutical companies who are seeing their tobacco cessation gum or patches; they might even jump into acquiring some of those smaller companies to get into the action.
O'Reilly: Got it. Very, very good. Pretty much a little too early, but if you want to bet on it, the big players.
Shen: The big players. Ultimately they might be able to get those regulations to go in their favor and allow them to box everybody out and turn the e-cigarette industry into a mirror of what traditional tobacco looks like right now.
O'Reilly: Got it. Very cool. Thank you for your time, Vincent.
Shen: Thank you, appreciate it.
O'Reilly: Yes. Well, you heard it here first, folks. That is it for us. Have a great day and Fool on!
