If children are the future, e-cigarettes could be the next great frontier for tobacco investors. At the same time, recent data could force health officials to rewrite a playbook that has helped lower smoking rates for 50 years.
That is because e-cigarette usage rates tripled among American middle and high school students from 2013 to 2014, according to The New York Times, and the product is now more popular with the demographic than traditional cigarettes. Thirteen percent of high school students nationwide use the vaporized cigarette substitute, according to recently released data from the Centers for Disease Control and Prevention. The surge marked the first time in years that tobacco product usage had potentially increased among teens. Some teenagers say they are vaping, the term for using e-cigarettes, as a way to quit smoking, while others had never taken a puff before and are simply jumping on a trend seen as cool and edgy.
The development has accompanied an accelerated decline in the use of cigarettes among teens, but health officials see that as a small victory in light of the growing prominence of vaping. Thomas Frieden, the director of the CDC, called the trend "a really bad thing," and other health experts noted that nicotine has been found to harm the developing brain, even if the e-cigs do not carry tar, tobacco, and other ingredients in traditional cigarettes known to cause health problems.
Teenagers, of course, represent the most desirable customers to many companies, and, though tobacco companies would never admit it, teen use is one of the greatest determinants of a lifelong smoker. Teenagers are just beginning to make their first independent decisions as a consumer, and they have 60 years of consumption ahead of them, making them such valuable targets for brands.
Adolescents also have different brain chemistry from adults, making them more vulnerable to addiction and habit formation in general. Therefore, not only are teenagers the most valuable targets for tobacco companies, they are also the easiest ones.
Tobacco companies have long understood the value of the youth customer and the importance of marketing to them. Internal documents from Philip Morris have acknowledged that "The ability to attract new smokers and develop them into a young adult franchise is key to brand development," and that "Today's teenager is tomorrow's potential regular customer and the overwhelming majority of smokers first begin to smoke while in their teens."
For teens, the appeal of e-cigarettes seems to be both their perceived advantages over smoking, such as fewer health risks and a lack of offensive odor, and the wide variety of flavors and devices that allows users to customize the habit to their own tastes. Though often illegal for minors, purchasing is made easy with the Internet. Teen vapers can choose from a range of sweet, candy-like flavors that would likely make the Marlboro Man cringe -- flavors such as berry menthol or one called Unicorn Puke, said to resemble a mix of Skittles.
The success of Unicorn Puke, made by Lost Art Liquids, a small Los Angeles-based company, highlights the Wild West-like nature of the e-cigarette industry today, which is full of dozens of similar startups, making a wide variety of flavored liquids and devices.
Unsurprisingly, big tobacco companies have already snatched up some of the most promising e-cigarette startups. In 2012, Lorillard acquired blu eCigs for $135 million and turned it into the No. 1 e-cigarette brand in the U.S.
When Lorillard and Reynolds American announced their merger last year, Lorillard arranged to sell blu to Imperial Tobacco in a $7.1 billion package deal with other traditional cigarette brands including Kool and Winston. With blu no longer part of the brand portfolio, the combined company (pending FTC approval) will instead focus on Reynolds' Vuse brand, which executives believe "offers superior technology."
As the success of upstarts such as Lost Art Liquids shows, the industry is still highly fragmented, and the future of e-cigarettes may lie with small startups rather than Big Tobacco. An estimated 60% of vapor sales occur through untracked channels, and the vast majority of competitors are still small niche brands.
Still, the next few years should bring further consolidation to the industry, particularly as teens seem to represent a burgeoning market, and coming Food and Drug Administration regulations are also likely to create barriers to new entrants and promote consolidation. With their deep pockets, that should make Big Tobacco companies the winner here over the long run. While it is unclear at this point which stocks are best positioned, the e-cigarette market represents a rare growth opportunity for tobacco investors who are already happily reaping healthy dividend payouts.