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R.I.P. Electronic Cigarette Industry (2004-2016)?

By Sean Williams - May 15, 2016 at 11:41AM

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New regulations unveiled by the Food and Drug Administration threaten to turn the electronic cigarette industry upside down.


Image source: Flickr user Vaping360.com.

The federal government's War on Drugs hasn't exactly been a success, considering that two dozen states have legalized the use of medical marijuana and four states now allow residents to buy marijuana for recreational purposes. But when it comes to the "War on Tobacco," we've witnessed discernable progress.

In the mid-1960s, approximately 42% of adults were smoking cigarettes, and by the late 1990s more than a third of high school students were lighting up. As of 2014, just 16.8% of adults were smoking cigarettes according to the Centers for Disease Control and Prevention, and by 2011 the rate of high school cigarette smoking had been halved to 18%. Considering that tobacco products are known to cause lung cancer, heart disease, and a host of other health problems, this data suggests a step in the right direction. But there are, of course, countless millions of Americans still to be reached who have yet to kick their habit.

A tobacco alternative facing a heap of safety concerns
One way tobacco companies hope to reach these adults is through the use of electronic cigarettes, which the industry has often described as a smoking cessation tool, even if the Food and Drug Administration doesn't recognize it as such. An electronic cigarette heats a flavored liquid containing nicotine into a vapor, which the user then inhales. The seamless design of electronic cigarettes, which were first used in the U.S. in 2004, and their disassociation with the smoke created by traditional tobacco cigarettes, creates a perception that they're a safer product -- a contention that has undergone much scrutiny.

In Dec. 2014, National Jewish Health released a study that examined how electronic cigarette vapor affected users' epithelial cells in their airways, and found that the vapor led to an almost immediate immune response that lasted for up to 48 hours. Or in simpler terms, the vapor would appear to damage the lining of users' airways

And this was far from the only study to contend that electronic cigarettes weren't safe. A study from Harvard T.H, Chan School of Public Health last year analyzed a sample of 51 electronic-cigarette liquids, while specifically looking for the presence of three flavoring chemicals known to have adverse effects on users' lungs. Researchers found at least one of these flavoring components in 92% of the liquids tested, including diacetyl, a chemical known to cause a respiratory disease known as popcorn lung, which can lead to inflammation and scarring of the air sacs of the lungs. 

Studies have even criticized the use of electronic cigarettes as a cessation device. This January, a meta-analysis was published in The Lancet Respiratory Medicine that showed the odds of quitting cigarettes among people using electronic cigarettes were 28% lower than among people who chose not to use electronic cigarettes.

Mind you, these studies also don't touch on the concern that's been raised about adolescents getting their hands on electronic cigarette products. It's been suggested by anti-tobacco advocates that some of the liquid flavorings (i.e., cotton candy, bubble gum) could be taking direct aim at a younger crowd and attempting to get them hooked on nicotine.

Could these regulations spell the end of the electronic cigarette industry?
However, last week the electronic cigarette industry faced its toughest challenge to date, one that has the potential to turn the industry upside down and put smaller players out of business.

Image source: Flickr user Lindsay Fox.

As announced on May 5, 2016, the Food and Drug Administration has decided to expand its definition of tobacco products to include electronic cigarettes, all cigars, hookah tobacco, pipe tobacco, and nicotine gels. Under this expanded regulation, all new devices and products (which means new electronic cigarettes and vaping liquids) would need to be approved by the FDA prior to hitting retailers' shelves. And according to Jeff Stier, an electronic cigarette advocate at the National Center for Public Policy Research via USA Today, each application could cost $1 million or more.

The more damaging component of the FDA's regulations ties into the Tobacco Control Act of 2009, which set Feb. 15, 2007 as the latest date upon which tobacco products could be grandfathered in. What this means is any electronic cigarette or vapor that hit the market after this date -- which covers just about every product on the market today -- would need to go through the regulatory approval process, essentially scaling back about a decade's worth of industry advancement.

Per the ruling, electronic cigarette outlets will have three months to comply with the new rules. By Aug. 8, 2016, the FDA's new guidelines will go into full effect.

Additionally, the new regulations will focus on increasing transparency and keeping adolescents away from products that contain nicotine. Buyers will be required to show ID, health warnings will need to be displayed on cigarette tobacco products, and free samples or vending machines for covered tobacco products will only be permissible in adult-only facilities.

Is it time to say R.I.P. to the electronic cigarette industry?

A move that could favor Big Tobacco
Ironically, the tighter the regulations on tobacco products become, the more it could actually wind up favoring the bigger tobacco companies, Altria (MO 1.15%) and Reynolds American (RAI). There are two reasons in particular they both could see boosts in business as a result of the FDA's ruling.

Image source: Flickr user Claudio Toledo.

First, we're talking about the sheer cost of approval for each electronic device and vaping liquid. If Stier is correct in his estimation of $1 million or more in costs per application, then Altria and Reynolds American, along with perhaps a very small handful of larger vaping businesses, will have the deep pockets to file for applications. What this should do is reduce competition in a big way, allowing Big Tobacco brands to dominate and increasing pricing power as a result of product scarcity.

Secondarily, reduced access to electronic cigarette products could plausibly drive some users back to smoking cigarettes. For Altria and Reynolds American, electronic cigarettes represent just a small fraction of their revenue. The traditional tobacco industry (specifically cigarettes) is their true cash cow. Even a small uptick in cigarette volume can have a big impact on Altria's or Reynolds American's bottom-line.

It's possible Pfizer's (PFE -0.23%) smoking cessation drug Chantix could also see a boost in sales as a result of tighter regulations on electronic cigarettes. Of the nearly 1 in 10 Americans who now uses an electronic cigarette, a choice would need to be made to either move to traditional tobacco products, deal with stringent new regulations within the electronic cigarette market, or perhaps quit for good. This is where Pfizer's Chantix could come into play. For what it's worth, Chantix sales jumped by 63% in the U.S. during the first quarter, and 43% worldwide during Q1, and could be on pace to near $1 billion in sales by this year or 2017.

It's unlikely that electronic cigarette product manufacturers are going to go down without a fight, but the electronic cigarette industry we know could look drastically different just three months from now.

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Stocks Mentioned

Pfizer Inc. Stock Quote
Pfizer Inc.
PFE
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Altria Group, Inc.
MO
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Reynolds American Inc. Stock Quote
Reynolds American Inc.
RAI

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