The introduction of e-cigarettes (e-cigs) has acutely disrupted the tobacco product/nicotine marketplace. As of 2013, Citi estimates that just under half of the 42 million smokers in the US have tried an e-cig. And, while e-cigs currently account for only 1% of overall US cigarette industry volumes, global e-cig sales have rapidly increased to $1 billion annually in 2012 ($500 million in US sales). More importantly, there is a staggeringly large pool of smokers that have not yet been introduced to the nascent product. The World Health Organization reckons that of the one billion smokers globally, 80% live in low and middle-income countries, most of which are markets that have not yet been penetrated by e-cigs.
Given the breakneck rate at which smokers are assessing the new product, it is no surprise that major tobacco companies are committing capital to R&D to develop next generation e-cig products. We’ve also witnessed several notable acquisitions, such as Lorillard acquiring blu in 2012 and Altria acquiring Green Smoke this year. This disruptive product is also causing the markets to take note and a debate is emerging around the financial ramifications for the tobacco industry.
Some investors are focused on recent trends that indicate both dollar and volume sales growth are decelerating (off a very small base) in the e-cig category, and conclude e-cigs are unlikely to materially impact earnings in the short to intermediate-term. Others, such as Wells Fargo, believe e-cig consumption has the potential to surpass combustible cigarette consumption in the next decade if innovation is not hindered by regulation. Wells Fargo also believes the industry may evolve into a razor/razorblade model, where less margin is made upfront on e-cig sales but more is made on the refill cartridges.
Healthcare investors, too, are paying close attention to this market as e-cigs may cut into the pharmaceutical company led nicotine replace therapy (NRT) market. A GlaxoSmithKline marketing manager said “[Nicotine] patches have been suffering seriously since the summer of 2013, just when e-cigarette shops started to multiply in France.” The latest data, in fact, shows that NRT sales dropped by 6.6% in 2013 in France, which put the total market turnover at under EUR100 million for the first time since 2010.1
It is still early days for the e-cig market, but the overriding message seems to be: there is a large demand for clean forms of nicotine. In our minds, e-cig adoption will largely be dependent on the regulatory environment.
Despite high levels of e-cig awareness, experimentation and regular use, experts are divided as to whether e-cigs will advance or threaten public health. Some feel that e-cigs represent the best hope to move smokers addicted to nicotine from inhaling deadly smoke from combusted tobacco products (cigarettes) to potentially less harmful methods of delivering nicotine. And, as this happens, future deaths and disease caused by tobacco could be dramatically cut (about 450,000 Americans die from tobacco every year). In contrast, others believe there are possible unintended consequences from the introduction of e-cigs that may result in an overall adverse effect on public health. The diversity of views reflects the paucity of data, different perceptions of risk, and divergent views on whether companies making reduced harm products can be trusted.
There is general consensus that the major public health value of e-cigs is to help smokers transition from combusted tobacco products to cleaner sources of nicotine, much as is the purpose of NRT, with the possible long term goal of phasing combustibles off the market. In our opinion, possible unintended consequences from the use of e-cigs – youth initiation to nicotine, dual use, delayed cessation, relapse and re-normalization of smoking – all seem to be manageable through regulations developed to tackle tobacco products. However, these actions will not address a perception of risk that pervades the policy, general public and even health professional worlds and ascribes as much risk to non-tobacco products as to traditional tobacco products.
One way of addressing this distorted perception is for companies committed to developing, marketing and selling non combustibles to develop an industry code of conduct that addresses the major unintended consequences in a proactive way and supports independent regular reporting of their implementation of the code. The benefits of such an industry code would be twofold: 1) the industry can respond more quickly than governments can act and 2) it would quickly separate those companies viewing their products as having major positive impacts on health from those using them as means to continue business as usual.
It is not often that such a potentially disruptive technology comes to bear. Regulators and e-cig companies have equally important roles in ensuring risks are met with sensible regulation and transparent reporting. Likewise, investors should monitor how these stakeholders respond. If executed properly, the industry has the potential to develop into a healthy nexus between profits and better health.
Derek Yach is the SVP & Executive Director of Vitality Institute, Chairman of the Board at Cornerstone Capital Inc. and former World Health Organization Executive Director and SVP Global Health & Agriculture Policy at PepsiCo.