It's Time to Say Goodbye to the Electronic-Cigarette Industry As We Know It

By Markets Fool.com


Image source: Vaping360.com via Flickr.

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Change is a seeming constant in the business world. But ask electronic-cigarette vape shops if they wanted things to change, and they're likely to tell you "no!"

In May, the U.S. Food and Drug Administration officially classified electronic cigarettes, along with cigars, pipe tobacco, and hookah tobacco, as tobacco-based products. This meant these products would now be subject to the same regulations as smokeless tobacco and roll-your-own tobacco. The FDA guidelines set forth in May gave the industry 90 days to comply with the new regulations. This past Monday, Aug. 8, happened to be the deadline.

These new regulations require that electronic cigarette manufacturers bringing new products to market:

  • Disclose the ingredients being used in nicotine-containing vaping liquid.
  • Place warning labels on packaging.
  • Most importantly, file new product approvals with the FDA before new products hit the market.

According to the newly implemented regulations, devices introduced before the Aug. 8 cutoff date can be marketed for up to three more years, presumably giving the manufacturers an opportunity to file the regulatory paperwork, and allowing the FDA the chance to review what could be an absolute deluge of electronic-cigarette industry paperwork. Not surprisingly, manufacturers took the Aug. 8 cutoff as an opportunity to flood the market with new products, regardless of whether they were ready for store shelves, to gain that extra three-year buffer.

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Image source: Getty Images.

An imminent changing of the guard in the electronic-cigarette industry

Yet even with a number of new products and electronic-cigarette devices hitting vaping shop shelves, there's a clear changing of the guard brewing within the industry. While packaging and ingredient disclosures are a bit of extra work, it's the simple fact that marketing approvals would need to be run by the FDA that could completely turn the electronic-cigarette industry on its head. Each of these regulatory submissions could cost around $1 million, a figure that could lead most electronic-cigarette device makers and liquid producers to close up shop.

On the flipside, increased regulation opens the door for Big Tobacco to clean up what mom-and-pop e-cig shops began. U.S. tobacco giants Altria (NYSE: MO) and Reynolds American (NYSE: RAI) are only getting a low-single-digit percentage of their current revenue from electronic cigarettes, but unlike independent vape shops and small manufacturers, they have the cash balance and operating cash flow to handle a $1 million-per-product-submission fee with the FDA. Altria cleared $5.6 billion in free cash flow in 2015, while Reynolds American typically generates between $1.1 billion and $1.4 billion in annual FCF. With ReportsnReports issuing a 93-page industry report in late June that calls for a 24% compound annual growth rate for the industry through 2020, you can see why Big Tobacco is so eager to step in and dominate the electronic-cigarette industry.

However, even Big Tobacco might be disappointed with the long-term trajectory of the industry, ReportsnReports' forecast aside.


Image source: Getty Images.

Two big hurdles for the electronic-cigarette industry

Over the past couple of years the electronic-cigarette industry has faced two big challenges that it's yet to overcome: namely that it's a safe product, and that it's a smoking-cessation tool.

For example, a study released in late 2014 by National Jewish Health, a nonprofit hospital organization, found that the liquid vapor from electronic cigarettes damaged epithelial cells in users' airways within minutes and left the users more exposed to viral infections. Further, the effects, which were noted by measuring IL-6 protein levels, lasted for up to 48 hours after vaping.

A separate study released last year from researchers at Harvard T.H. Chan School of Public Health analyzed 51 electronic-cigarette liquids for the presence of three chemicals known to have adverse effects on the lungs of users. The findings showed that 92% of the 51 flavored liquids tested had the presence of at least one of these chemicals. Included among the three chemicals tested was diacetyl, which was present in 39 of 51 liquids. Diacetyl has been known to cause a respiratory disease known as popcorn lung, which causes inflammation and scarring of the air sacs of the lung, and can ultimately lead to the need for a lung transplant.

Making matters worse, a study published in The Lancet Respiratory Medicine in January from two researchers at the University of California, San Francisco, found that electronic cigarettes do nothing to aid with smoking cessation. After analyzing 38 studies, which involved control groups, the researchers concluded that the odds of quitting smoking were actually 28% lower for electronic-cigarette users than people who didn't use electronic cigarettes.

Now keep in mind that tobacco's dangers have been well publicized for decades, but that hasn't stopped 40 million American adults from buying tobacco cigarettes. However, there are still many unknowns surrounding electronic-cigarette safety. Perhaps this will be cleared up with the FDA's clampdown on the industry with tighter regulations, but that's no guarantee.


Image source: Getty Images.

Electronic cigarettes may be a fad

What we have is a relatively small snippet of the population using a product that could soon come under the control of Big Tobacco and potentially be priced a lot higher. Remember, without mom-and-pop manufacturers, competition could be greatly diminished in three years' time.

The 2014 National Health Interview Survey from the Centers for Disease Control and prevention found that just 3.7% of all adults were current electronic-cigarette users. While the number of adult users could grow, the emergence of Big Tobacco, and the expected minimization of product on store shelves once the three-year window is up, could have an adverse impact on the electronic-cigarette industry as a whole.

My suspicion, as it's been all along, is that electronic cigarettes will remain a small contributor to Big Tobacco, and the industry itself could struggle to grow under the weight of new regulations.

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Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.

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