E-Cigarettes Are Smoking Hot

Sales of e-cigarettes are expected to surpass $1 billion later this year and $10 billion within the next decade. The e-cigarette market is red hot, with more than 200 brands available. But with the FDA likely to regulate the sale of e-cigarettes, you may want your e-cigarette exposure through one of the major tobacco companies. Lorillard (NYSE: LO  ) , Reynolds American (NYSE: RAI  ) , and Altria Group (NYSE: MO  ) each offer a brand of e-cigarette and the financial firepower to compete in a market regulated by the FDA.

The rise of e-cigarettes
The first e-cigarette patent was issued in 1963 for a non-nicotine device. The market for e-cigarettes, however, was non-existent prior to a Chinese pharmacist, in 2003, making an e-cigarette with miniature lithium batteries used to vaporize the nicotine. Demand for e-cigarettes then took hold like -- well, an addiction.

The FDA butts in
The FDA first tried to block all sales of e-cigarettes "...claiming that they were unapproved 'drug/device combinations.' [But] Manufacturers successfully challenged the agency's position" in court, as Liz Alderman reported for The New York Times.

Since 2010, global growth of e-cigarette sales has been hit 30% annually. The U.S. is now home to an estimated 4 million vapers, or e-cigarette smokers.

Big tobacco picks up the habit
Lorillard's blu brand of e-cigarette is the current market leader in the still nascent category. Since Lorillard acquired blu in spring 2012, it has expanded e-cigarette distribution from 12,000 to 127,000 retail stores, explained company CEO Murray Kessler.

Net sales more than quadrupled from $14 million a year ago to $63 million this year, and net sales increased 11% sequentially behind a 50% sequential increase in unit volume quarter-to-quarter. Importantly, blu achieved approximately a 49% share of the U.S. electronic cigarette market.

Lorillard is the e-cigarette volume leader worldwide, even though all blu sales are domestic to the U.S.

In summer 2013, Reynolds American launched VUSE. The performance thus far is encouraging, according to company CEO Daniel Delen.

The results are significantly exceeding our expectations. VUSE is getting a great reception from consumers and retailers, and the brand has already taken the market-leading position since VUSE went into Colorado in July. 

And saving the biggest for last -- Altria waited until August 2013 to launch MarkTen. Company CEO Marty Barrington said Altria customers want a more perfect product experience from a big name brand:

...our research shows that adult smokers are aware of only a few brands [of e-cigarettes]. Moreover, the existing products that they have tried often do not meet their desires. 

The company began sales of MarkTen in an Indiana market.

A second go round on regulation
In 2009, Congress delegated regulatory authority for the tobacco industry to the FDA. Congress, however, placed limits on what could be regulated. For example, the FDA may not ban nicotine in cigarettes. Congress also legislated:

Tobacco products that were on the market in the U.S. prior to February 15, 2007, are grandfathered and cannot be banned by the FDA," reported Reason. "That provision also covers "'substantially equivalent' products.

There seems to be general agreement e-cigarettes are not grandfathered, which means they will need to win FDA approval. This leaves the possibility that the FDA could disapprove of e-cigarettes. 

But a ban seems unlikely
Early in 2013, Mitch Zeller became director of the Center for Tobacco Products at the FDA. And from the comments of Lorillard executives, we know "He is an outspoken tobacco control advocate. No secret there."

For much of the 1990's Zeller worked at the FDA, where he became a well known advocate for Congress' assigning tobacco regulation to the FDA.

Nevertheless, Zeller in his new role may not be the death knell feared by e-cigarette and tobacco companies. Such was hinted at by a Lorillard executive at the company's 2013 Investor Day:

It appears that Mr. Zeller supports harm reduction, in part by his approach to and statements on nicotine. He is in every opportunity he has, he talks about reevaluating the role of nicotine with regulations, and what are the effects of nicotine when not delivered by smoke-burning tobacco, in other words. And by saying so, I think he is saying, what is the role of nicotine in harm reduction?

That said, the big three U.S. tobacco companies may be hoping for some level of e-cigarette regulation to complicate matters for smaller rivals.

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