Will New Regulations on E-Cigs Hurt Big Tobacco?

New regulatory proposals on tobacco questionable on both passage and impact

May 10, 2014 at 10:00AM

The FDA caused quite the stir when it announced its proposal to regulate e-cigarettes last month.

The proposals would require e-cigarette makers to: "Register with the FDA and report product and ingredient listings; Only market new tobacco products after FDA review; Only make direct and implied claims of reduced risk if the FDA confirms that scientific evidence supports the claim and that marketing the product will benefit public health as a whole; and Not distribute free samples."

The rule also included minimum age restrictions, requirements to include health warnings and prohibition of vending machine sales .

Does it matter?
From a public health standpoint, the new regulations are a step forward. However, it's questionable how much this will really affect sales, especially if it will be enough to impact the Big Tobacco triumvirate: Altria (NYSE:MO), Reynolds American (NYSE:RAI), and Lorillard (NYSE:LO). Lorillard, owner of blu eCigs and SKYCIG, was one of the first adopters of e-cigarettes and has almost half of the market share at convenience stores. Reynolds' Vuse and Altria's MarkTen are both expected for national rollout this summer.

Several of the new rules are just codifying existing policy. Requiring the FDA to confirm scientific claims is basically status quo – companies are already unable to market e-cigarettes as a smoking cessation method. Nonetheless, the multiple studies have shown benefit in assistance to quitting, and Addiction's 2011 survey of 3,587 US e-cigarettes users indicate 92% to 96% reported e-cigarette assistance in quitting or reducing smoking. In other words, regardless of the "official" scientific evidence, word of mouth, physician suggestion and anecdotal proof still promote what the companies are unable to officially market.

Similarly, minimum age restrictions were already in place in 33 states and were probably an inevitable trend regardless of federal government involvement. Notably, some states may propose even stricter rules than the FDA's regulations.

As for the required health warnings and prohibition of vending machine sales; as many e-cigarette users may be current cigarette smokers, neither of those propositions are ground-breaking for those accustomed to the rules of traditional cigarettes. Addiction's survey also revealed 70% of e-cigarette users were former smokers. While 84% reported that the perception that e-cigarettes are less toxic than tobacco was a reason for using e-cigarettes, 79% also reported they used e-cigarettes to deal with cravings and 67% reported improvement of withdrawal symptoms. The health warnings may hinder the perception of decreased toxicity, but won't touch the empirical experience of diminished cravings and withdrawal.

One of the bigger changes from status quo is the ban on distribution of free samples. While a higher initial investment in purchasing an e-cigarette could be solved with a free sample, 57% of surveyed users actually reported that e-cigarettes were cheaper for them than cigarette use. This ban may affect the acquisition of new customers, but the FDA is not addressing other marketing restrictions like TV, radio, billboards, or sponsorships which is a huge win for e-cigarette marketers (including tobacco companies).

Flavors, which have previously been cited as potentially targeting adolescents and women, are not banned -- so any targeting by e-cigarette makers can continue.

Bottom line
The FDA made moves to regulate e-cigarettes, but the proposals are not rule of law yet. Science is still equivocal on the health benefits and/or risks and many health care providers already include e-cigarettes in their repertoire of smoking cessation tools despite a lack of conclusive evidence. As such, this is not as clear-cut of a public health battle as that of traditional cigarettes.

Nonetheless, I believe that the e-cigarette industry certainly can only lose in this scenario, and Lorillard is at the biggest risk as its brand blu eCigs has about half of the e-cigarette market. Nonetheless, e-cigarettes represented just $49 million of last quarter's $1.6 billion top line, or about 3%. By no means will tobacco companies welcome more regulations, but also by no means will it be particularly devastating for them even if regulations do come out in full force.  

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4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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