Here's Why Big Tobacco Will Squash Smaller Peers to Dominate the E-Cig Sector

Lorillard, Reynolds, and Altria have size and experience on their side.

Jun 17, 2014 at 9:43AM

When Lorillard (NYSE:LO) acquired electronic cigarette start-up Blu, the start-up had combined sales of only $50 million and the product was only available within 12,000 retail outlets.

But Lorillard quickly threw its weight behind Blu and the company now dominates the US' domestic e-cig market. Indeed, Blu's annual sales now exceed $200 million and the product is available in just under 150,000 retail outlets. Blu e-cigs have a leading market share of approximately 50 %.

A great example
Blu's growth story shows how big tobacco is throwing its weight behind owned e-cig subsidiaries and squashing smaller peers.

For further example, Altria (NYSE:MO) and Reynolds (NYSE:RAI) are both rolling out their e-cig offerings nationally during the next few months. The two companies have been able to take their time to understand the needs of customers by launching in single markets and spending millions on development, an approach that would be difficult for smaller peers to replicate.

Reynolds' e-cig offering is the VUSE digital vapor cigarette, which it has rolled out in Colorado, and VUSE has quickly become consumers' e-cig product of choice. The company is undertaking a national roll-out right now. Taking into account the fact that VUSE quickly became the leading e-cig by sales within Colorado, Lorillard should be concerned.

In addition, Altria's e-cig offering, MarkTen, achieved brand leadership of 48% within its trial market over a period of just seven weeks.

For Reynolds and Altria, national roll-outs should be no trouble at all. The two companies already have expansive distribution networks and supplier relationships. So these two tobacco giants have very little work to do in order to get their products stocked nationally.

Regulatory advantage
Big tobacco also has another advantage over its smaller peers, age and experience. The recent regulations introduced by the FDA to reassure e-cig users may seem daunting for smaller producers, but for big tobacco these rules should be easy to navigate.

During April the FDA issued proposed rules banning the sale of e-cigs to anyone under 18 and requiring all companies to list their ingredients. The rules also require that e-cigs be branded as "tobacco products," an extensive and expensive process.

Big tobacco is in a much better position to implement the rules as the companies have plenty of experience in dealing with regulators and battling anti-tobacco lawsuits. Big tobacco also has the upper hand in assuring quality control, as the industry comes under stepped-up scrutiny following reports of accidental poisoning caused by some ingredients.

Comments from RBC Capital Markets analyst Nik Modi really sum the argument up:

The big three tobacco guys will be the big three e-cigarette companies because of their resources, relationship with distributors and ability to comply with the FDA faster than competitors,

Foolish summary
So overall, it would appear that for big tobacco at least, e-cigs are here to stay. Indeed, big tobacco has experience in dealing with regulators and the companies should be able to overcome any hurdles the FDA throws at them.

On the other hand, smaller, independent e-cig companies will have trouble complying with these rules. Furthermore, with an almost endless supply of cash big tobacco will be able to out-market the smaller producers, develop marketing campaigns, and design products that cater to consumer needs.

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Rupert Hargreaves owns shares of Altria Group. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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