March 24, 2014
Equity Research
Tobacco Talk: Vapors/Tanks Driving Next Wave Of
E-Vapor Growth
• Burgeoning Vapors/Tanks Category Not to be Underestimated –
Growing 2x Faster Than Overall E-Vapor Category – We recently
conducted a “Tobacco Talk” survey of independent e-vapor manufacturers around
the world, driven by our desire to better understand the vapor/tanks sub-segment
of the broader e-vapor category, which includes “traditional” or “cig-alike” e-cigs
as well as vapors/tanks (also referred to as “open systems”). Our view that
vapor/tank growth is accelerating and taking share from e-cigs, making
vapors/tanks an increasing threat was substantiated by our survey as respondents
expect vapors/tanks to grow at 2x the rate of the e-vapor category in 2014 with
attractive margins that rival combustible cigs. Therefore, if the robust
growth of the vapor/tank category continues and is not hindered by
FDA regulation, we expect big tobacco has no choice but to enter this
category either organically or via acquisition. However, at this early stage,
we see a few challenges for big tobacco if this plays out including: (1) distribution
of vapors/tanks is primarily online and in vape shops, channels over which big
tobacco has limited control (this would also be a challenge for c-store retailers);
(2) limited branding and commoditization of vapors/tanks; and (3) potential
compression of revenue pool given lower spend per consumer on vapors/tanks.
Tobacco
• Vapor/Tanks Undeniably A Key Growth Driver of Broader E-Vapor
Category–Likely Exceeding $2B At Retail Today - According to our survey,
the retail e-vapor market is $2.2B – more than 20% of our respondents estimated
a market size over $3B. Though recent Nielsen data captures only $750MM in
annual e-vapor sales, our survey gives credence to our assertion the true market
size is likely much larger. The discrepancy is due to ~60% of e-vapor sales
through untracked channels such as online and “vape shops” (an estimated 5,000
in the U.S). On one hand this should ease concerns around e-cig category growth
deceleration but on the other hand highlights the pressures blu e-cigs and the ecig category are facing from vapors/tanks. Bottom line - we believe e-cig
sales growth deceleration reflects volume moving to vapors/tanks.
• Vape ‘Em if You Got ‘Em – Characterizing the New “Vaping Culture” –
Vapor/tank users are overwhelmingly more committed to vaping vs. e-cig
consumers and are much less likely to “dual use” – or vape in addition to smoking
combustible cigs. Due to vapor/tanks’ razor/blade on steroids pricing model, the
avg vapor/tank consumer spends ~$16/week on vaping paraphernalia – 20% less
than a rechargeable e-cig user’s and 40% less than a disposable e-cig user’s
weekly spend. Though the vapor/tank users’ high loyalty is undeniably driving
growth, we’re concerned there could be limited ability to drive brand image with
vapors/tanks and e-juice compared to combustible cigs due to these products’
being more commoditized. Bottom line, given lower spend per consumer
for vapors/tanks and greater potential for these products to become
commoditized, we’re concerned the l.t. revenue pool for the e-vapor
category could contract assuming mix shift to vapors/tanks continues.
• Regulation Remains a Question Mark – We continue to wait for the FDA to
publish its proposed regulations for the e-vapor category, which we believe could
be more stringent on vapors/tanks relative to e-cigs. Given the estimated 5,000
(and growing) U.S. vape shops and hundreds of online purveyors of e-vapor
products, we wonder how (if at all) the FDA will consider the potential impact on
jobs if online sales and/or vape shops were banned or severely restricted.
Please see page 15 for rating definitions, important disclosures
and required analyst certifications
All estimates/forecasts are as of 03/24/14 unless otherwise stated.
Wells Fargo Securities, LLC does and seeks to do business with companies
covered in its research reports. As a result, investors should be aware that
the firm may have a conflict of interest that could affect the objectivity of the
report and investors should consider this report as only a single factor in
making their investment decision.
Bonnie Herzog, Senior Analyst
( 21 2 ) 2 1 4 -5 0 5 1 /
bo n n i e. h e rzo g @ w el ls f a rgo . c o m
Jessica Gerberi, CFA, Associate Analyst
( 21 2 ) 2 1 4 -5 0 2 9 /
j e s si c a . g e r b e r i @ w el l s fa rgo . co m
Adam Scott, Associate Analyst
( 21 2 ) 2 1 4 -8 0 6 4 /
ad a m. s co t t@ we ll s f ar go . co m
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Tobacco
Key Takeaways from “Tobacco
Manufacturer and Marketer Survey
Talk”
Independent
E-Vapor
We recently reached out to several independent e-cig/e-vapor companies to gather and consolidate information on the e-vapor
category, specifically the burgeoning vapor/tank sub-segment of the broader e-vapor category. We surveyed independent
manufacturers and marketers of e-vapor products. The majority of the respondents have annual sales of $30MM or less with
operating margins of 20-30%. Nearly half of the companies that responded have less than 10 employees, 18% have 10-50
employees, 18% have 50-100 employees, and 18% have more than 100 employees. In terms of online sales, 29% of respondents
have no online sales while 29% have more than 50% of their sales online. Nearly 80% of the companies that responded have less
than 5 brands and less than 50 different flavors with the majority offering between 10-100 SKUs. Points of retail distribution
were widely dispersed, as 30% of the companies that responded having greater than 1,000 points of distribution. Please see
pages 14-15 for more detailed information on the companies that completed our survey. Below are some of the key
takeaways from this survey including direct quotes from a number of independent company owners, founders
and senior executives.
• Retail Market for E-Vapor Products Likely Exceeds $2B in the U.S. Today – Greater Than Our Original
Estimates – “I believe scan data is way lower than actual sales.”
• E-Vapor Retail Sales Mix Evolving - 65% Weighted Towards E-cigarettes vs. 35% Vapors/Tanks
• Vape Shops Increasingly Popular Places to Buy E-Vapor Products – Slight Movement Away From CStores and Online
• Vapors/Tanks Sub-Segment Growth Expected to Continue to Accelerate in 2014–In Contrast to Broader
E-Vapor Category Where Growth Remains Robust but Expected to Decelerate in 2014
• Average Vapor/Tank Consumer's Weekly Spend About 30% Less Than E-Cig Consumer’s Weekly Spend –
This is Likely Contributing to the Lower Revenue (Decelerating Growth) of the Overall E-Vapor Category
• Vapors/Tanks Overwhelmingly Taking E-Cig Share According to 90% of Respondents – Transition to
Vapors Is the “Natural Progression” After E-Cigs – “The big boys who sell just e-cigs are already
becoming dinosaurs.”
• Vapor/Tank Consumers 84% More Committed Then E-Cig Consumers to Their Vaping Lifestyle – Driven
by Greater Affordability, Ability to Personalize, Better Nicotine Delivery and Product Performance –
“Passionate vapers don't use cigalikes, simple as that.”
• Greater Consumer Satisfaction, “Vaping Lifestyle” Factor and Better Affordability Key Drivers Behind
Vapor/Tank Consumers Being Less Likely To Dual Use Vapors/Tanks vs. E-Cig Consumers – We Believe
These Factors Will Continue to Accelerate Growth of Vapors/Tanks - “Nicotine delivery is more efficient
for vapors/tanks with more heat and more reliable products which have better battery life and more
durability which makes people less likely to relapse to smoking.”
• Vapors/Tanks Resonating with Millennials – And Other Generations – Interestingly, we believe Millennials
(essentially adult vapers under 30 – or “AVU” 30) have been early adopters of vapors/tanks due to: (1) ability to
customize the vaping experience by virtue of creating your own flavor profiles; (2) Superior vaping experience that better
mimics combustible cigs (greater vapor volume and better nicotine delivery to the bloodstream); (3) high comfort level
with electronic devices/carrying chargers, and adapting to
fast-changing technology; (4) high comfort level with
online purchasing; (5) greater affordability relative to e-cigs or combustible cigs; (6) variable uses of vapor/tank devices;
and (7) their view that smoking combustible cigs is “passé” and not wanting to be associated with cigarettes or be
considered “smokers”.
• The Growth of Vapors/Tanks Will Likely Continue to Put Pressure on Both Combustible and
E-Cig
Manufacturers Such That They Will Need to Join – “The writing is on the wall for combustible cigarettes,
if the FDA can act to support the positive potential that they bring.”
• FDA Regulation Will Likely Impose Age, Marketing Restrictions and Set E-Liquid Manufacturing
Standards for Public Safety; Respondents Hopeful FDA Will View E-Vapor Market As Harm Reduction
Opportunity – “I'm hopeful that the FDA will act responsibly, and I'm encouraged by the investment they
2
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Tobacco Talk: Vapors/Tanks Driving Next Wave Of E-Vapor Growth
have made into an ongoing e-cigarette research program, and the engagement with vapor product
industry bodies.”
• New Innovation Ranges From Improved Vaping Experience, Bringing Automated, U.S.-Based
Manufacturing to E-Vapor Product Production To Total Redesign of E-Cig Architecture As We Know It –
“We are constantly evaluating new technology and evaluating every changing consumer wants and
needs. Innovation will be a constant and continuous process within this industry.”
• General Industry and Consumer Trends
•
More and More E-Cig Consumers Switching To Vapors/Tanks From E-Cigs Due to
Increased Satisfaction with Vapor/Tank Products
• Technology Still Has Lots of Room for Improvement
• Industry Will Likely Consolidate Over Time
• Regulation is Needed but Will Hopefully Not Stifle Innovation
Retail Market for E-Vapor Products Likely Exceeds $2B in the U.S.
Today – Greater Than Our Original Estimates – “I believe scan data is
way lower than actual sales.” – About 30% of our respondents estimated the size of the retail
market for e-vapor products in the U.S. to be between $1.75B and $2.0B. Another 21% felt the market has
surpassed the $3.0B mark with one respondent observing that the “scan data is actually much lower than the
actual sales data”.
Total Size of U.S. Retail Market for E-vapor Products
35%
31.6%
30%
25%
21.1%
20%
15.8%
15%
10.5%
10.5%
10%
5.3%
5.3%
5%
0.0%
0.0%
0.0%
0.0%
0%
Comments
“From conversations I've had with liquid vendors, some of the best shops are doing about $30-40K in just liquid purchases. I would put average shop
volume at 1.2MM/yr. and about 1,000 stores on and offline in the USA.”
“Whilst we don't have a great deal of retail sales, we are seeing customer trial at a retail level and then continuing to purchase online. In particular,
customers are looking for a variety of strengths and flavors.”
“There are approx. 5,000 e-cig stores and according to insurance agents, they average 500K each in annual revenue. That's $2.5B by themselves plus
retail plus online....”
“I have a (mostly) updated directory of retail locations and it's approaching 3,000 U.S. and growing every single month. The benchmark we use to
determine a marginal store vs. a successful one is $30,000 monthly revenue. Add in the huge number of online locations, plus what the institutional market
covers, and we're over $3B.”
“I believe scan data is way lower than actual sales. Just by looking at our own scan numbers compared to our actual sales.”
“Conversion rate is amazing, and bailout ratio is non-existent.”
Source: Wells Fargo Securities, LLC
3
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Tobacco
E-Vapor Retail Sales Mix Evolving - 65% Weighted Towards E-cigarettes vs. 35%
Vapors/Tanks
U.S. Retail Sales Mix - E-cigs vs. Vapors/Tanks
70%
65.0%
60%
50%
40%
33.0%
30%
20%
10%
2.0%
0%
E-Cigs and Accessories
Vaporizers and Accessories
Other
Source: Wells Fargo Securities, LLC
Vape Shops Increasingly Popular Places to Buy E-Vapor Products – Slight
Movement Away From C-Stores and Online
U.S. Channel Mix of Total E-vapor Sales TODAY
U.S. Channel Mix of Total E-vapor Sales 6 MONTHS AGO
35%
35%
30.5%
29.9%
30%
30%
25.7%
26.9%
25%
25%
20%
20%
16.6%
13.0%
15%
14.8%
15%
11.9%
10%
10%
12.9%
11.2%
5.8%
4.9%
5%
5%
0%
0%
Retail - CStores
Online
Retail - Vape Retail Retail - Retail - Other
Shops
Grocery,
Tobacco
Drug, Mass & Outlets
Club
Online
Retail - C- Retail - Vape Retail Retail - Retail - Other
Stores
Shops
Grocery, Tobacco
Drug, Mass & Outlets
Club
Source: Wells Fargo Securities, LLC
Vapors/Tanks Sub-Segment Growth Expected to Continue to Accelerate in 2014–In
Contrast to Broader E-Vapor Category Where Growth Remains Robust but
Expected to Decelerate in 2014
4
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Tobacco Talk: Vapors/Tanks Driving Next Wave Of E-Vapor Growth
Growth (in %) of U.S. Retail Sales – Total E-Vapor Category
200%
Growth (in %) of U.S. Retail Sales – Vapors/Tanks Category
350%
187.1%
180%
160%
282.7%
300%
150.1%
298.4%
147.1%
250%
140%
120%
200%
195.1%
100%
150%
80%
60%
100%
40%
50%
20%
0%
0%
2012
2013
2014E
2012
2013
2014E
Source: Wells Fargo Securities, LLC estimates
Average Vapor/Tank Consumer's Weekly Spend About 30% Less Than E-Cig
Consumer’s Weekly Spend – This is Likely Contributing to the Lower Revenue
(Decelerating Growth) of the Overall E-Vapor Category
Consumer's Average Weekly Spend At Retail (Including Online) – Vapor/Tank Consumer vs. E-Cig Consumer
$30
$26.44
$25
$20.29
$20
$16.45
$15
$10
$5
$0
Vapor/ tank consumer
Disposable e-cig consumer
Rechargeable e-cig consumer
Source: Wells Fargo Securities, LLC
Vapors/Tanks Overwhelmingly Taking E-Cig Share According to 90% of
Respondents – Transition to Vapors Is the “Natural Progression” After E-Cigs –
“The big boys who sell just e-cigs are already becoming dinosaurs.”
5
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Tobacco
Are Vapors/Tanks Taking Share From E-Cigs?
100%
89.5%
90%
80%
70%
60%
50%
40%
30%
20%
10.5%
10%
0%
Yes
No
Comments
“More consumers every day try advanced level products and realize the difference in effectiveness from cig-a-like style e-cigs. Vapor products grow so
quickly due to word of mouth advertising and with more consumers using advanced level products after failing with cig-a-likes, more of them are
recommending these advanced style products over cig-a-likes.”
“Having just attended ECRM (Efficient Collaborative Retail Management) and the Tobacco Expo in Las Vegas, we've run into a lot of retailers looking for
vaping solutions who currently only sell e-cigs as their customers are graduating to other products and not returning to the store to buy e-cigs. The big
boys who sell just e-cigs are already becoming dinosaurs.”
“Yes, but not a ton (more as time goes by, barring regulation). Industry is growing, so hard to tell exactly how much. But it makes sense for any repeat,
long-term user of e-cigs to switch to tanks if for no other reason than cost (but flavor, nicotine absorption, etc. are better with tanks).”
“Early adopters are evolving.”
“Natural progression for users, as tanks provides better value in costs, better quality of experience, and better quality of juice/flavor/hit.”
“Sure, the uprising sales of bottle liquid tells that and also the number of e-liquid factories in USA tells that, plus, it fits the nature of American that allows
people to dominate their vaping habit.”
“Back yard vapor shops who manufacture their own e-juice, will put all other "Reduced Risk” tobacco products out of business unless FDA regulates
them.”
“Choice and convenience!”
“The addition of vapors to the E-Cig category closes the consumer loop. The disposables are the entry, the cartridge business is the user, and the
vapors are the experts or veteran cartridge users who desire more control over their total vaping experience.”
“Many e-cigs are not satisfying- they just don't work well and the taste is often poor (especially Chinese e-liquid with the bitter aftertaste).”
“As statistics and efficacy will prove, the tank systems are better at delivering nicotine to the blood stream. Also the tanks are able to handle a mix of
vegetable glycerin & propylene glycol that allows for more clouds of vapor. Where the cig-a-like versions are necessary to attract skeptical smokers, the
tank system becomes the preferred delivery device for the heavier users.”
“And they will continue to do that until it levels off. Currently the Vape Space is controlled and run by Millennials and they are reaping the benefits of
being at the right place at the right time and supporting the trending of this Space. The OVERALL number of vapors will grow, but the percentages of
Millennials will drop and be replaced by Gen X and Baby Boomers.”
“E-Liquids and E-Products are taking share from E-Cigarettes. I believe the variety of products and the ability to escalate the products in the category
have much to do with that growth.”
“Vapors/tanks are less expensive, much more customizable and most are not in a form factor that resembles a traditional tobacco product- causing less
confusion and consternation about where and when they can be used.”
“Absolutely they are taking share. We have seen our rechargeable cig-a-like sales get cannibalized - especially over the last 12 months. We ask every
inactive customer why they have discontinued the purchase of cartridges and 70% of those asked responded that they had switched to vapor/tank
systems.”
Source: Wells Fargo Securities, LLC
6
Tobacco Talk: Vapors/Tanks Driving Next Wave Of E-Vapor Growth
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Vapor/Tank Consumers 84% More Committed Than E-Cig Consumers to Their
Vaping Lifestyle – Driven by Greater Affordability, Ability to Personalize, Better
Nicotine Delivery and Product Performance – “Passionate vapers don't use
cigalikes, simple as that.” – Many respondents opined that despite the higher initial investment and somewhat
steep learning curve, consumers tend to stick to vaping because of the various obvious advantages over e-cigarettes sophistication of product offerings, enhanced flavor profiles, and more diverse uses of these products, the “coolness” quotient
and lastly, the lower cost of vaping.
Are Vapor/Tank Consumers More/Less/Equally Committed To Vaping vs. E-Cig Consumers?
90%
84.2%
80%
70%
60%
50%
40%
30%
20%
10.5%
10%
5.3%
0%
More Committed
Less Committed
Equally Committed
Comments
“Vaping is much more personal, and by being able to mix, the creative and freedom options are unlimited. You can create your own style.”
“If consumers are willing to take the time for the open system and spend the initial amount of money on the unit, they are more committed.”
“Vapers are much more committed. We have a very loyal following of folks who continue to upgrade within our innovative product line.”
“Passionate vapers don't use cigalikes, simple as that.”
“Willingness to give up the holding the e-cig between the fingers and trade the habits of smoking for a new one (for example pushing a button to activate
instead of just drawing and having automatic activation) usually mean someone is more committed to making the switch.”
“Due to economics.”
“Initially, I viewed this more of a niche market, much like the 'make your own beer' crowd. However, we're starting to see a sophistication of product
offerings, enhanced flavor profiles, and more diverse uses of these products (THC).”
“In my experience all are equally committed but each user style favors product features over the other. Cig-a-likes enjoy the size/weight and feel of the
device as most closely associated with their previous or continuing habit of smoking. Whereas the tank users are looking for a more dramatic and deep
hit.”
“Varies by person. Some people don't like filling liquids - for them regular e-cigs serve the purpose, especially if they just want the flavor that is available
them. Normally, after trying a vapor/tank product and after understanding how the tank is filled, they like it better. Cost is also a big reason as it is
cheaper with vapor/tank system in the long run.”
“They are vapors and hobbyists.”
“E-cigs are convenience items and available "on demand". They allow people to replace analogs with a cheaper & healthier alternative. Period. They
have not created that "go to" appeal yet and are more functionary than anything else. There is no "e-cig" lifestyle or persona, but there is a Vape
Lifestyle.”
“Initial investment is high and most make this investment after trying other forms of the product and deciding that the investment and the attributes of the
product outweigh purchase and use of the other products.”
“There's a learning curve which requires commitment and few start out with such products. Typical trend is disposable, rechargeable, filling your own
cartomizers, and lastly tanks.”
“Seems like there's far less dual use with vapors.”
“Most consumers start with e-cigs and move to tanks. It's more work but the commitment is greater.”
“As consumer follows logical path from disposables to vaping, they become more personally satisfied with the change and results.”
“The experience is more like traditional cigarettes in terms of fulfillment. The vapors/tanks create more vapors which provides for more fulfilling throat
7
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Tobacco
impact. In addition, the consumer has the ability to tailor the taste profile to his/her own tastes by the ability to mix multiple flavor Liquids.”
Source: Wells Fargo Securities, LLC
Greater Consumer Satisfaction, “Vaping Lifestyle” Factor and Better Affordability
Key Drivers Behind Vapor/Tank Consumers Being Less Likely To Dual Use
Vapors/Tanks vs. E-Cig Consumers – We Believe These Factors Will Continue to
Accelerate Growth of Vapors/Tanks - “Nicotine delivery is more efficient for
vapors/tanks with more heat and more reliable products which have better battery
life and more durability which makes people less likely to relapse to smoking.”
Likelihood of Vapor/Tank Users to “Dual Use” with Cigarettes Compared to E-Cig Users
80%
68.4%
70%
60%
50%
40%
30%
21.1%
20%
10.5%
10%
0%
More Likely to Dual Use
Less Likely to Dual Use
Equally Likely to Dual Use
Comments
“Tank is a habit change.”
“Once they graduate from e-cigs, vapers look at e-cigs as an inferior product.”
“Vapor/Tank users are much more likely to have made the full switch to vaping.”
“Nicotine delivery is more efficient with more heat and more reliable products which have better battery life and more durability which makes people less
likely to relapse to smoking.”
“Stats tell that, even the regular smokers will make it dual use, that model will continue until you cannot buy a pack of real cigs.”
“The traditional cigarette and the E-Cig seem to be a relationship of convenience. I can't smoke indoors; therefore, I'll smoke electronically. The vapor
seems to be more of a committed consumer trying to hone their craft and create the flavor they find most desirable.”
“Until the user is committed to switching they will continue dual use. For those that have not learned how to monitor or self-medicate themselves with
their nicotine intake they will continue to use the combustible cigarette to increase their nicotine up take.”
“The vapor/tank segment is trying new things but likes to smoke in general. Vape/tank system provides another system to them. E-cigs are normally
being used by people who are looking to quit smoking.”
“Vapers are committed to vaping and very few go back to analogs. Again, they become part of the "tribe" mentality and it now becomes un-cool to smoke
cigarettes. They MAY cross over into conventional e-cigs, but generally e-cigs are more solo expressions of a desire to quit smoking for various reasons
I can share in greater detail based on research.”
“Vapor/tank consumers are committed to a vaping of style vs. a temporary alternative.”
“It's more satisfying which leads to less dual use.”
“Just so much cheaper to use the tanks and you actually get a nicotine hit much, much closer to a real cigarette.”
“Some will use disposables as back up, but not much after conversion.”
“Since more vapors equal or exceeds the satisfaction fulfillment of a traditional cigarette, consumers don't require the tradition cigarettes deliverables to
achieve the same satisfaction levels. Additionally, the ability to change the taste and nicotine profiles by mixing E Liquid flavors appeals to many
consumers and aids in fulfilling their satisfaction levels. This allows consumers to leave the traditional combustible tobacco products.”
Source: Wells Fargo Securities, LLC
8
Tobacco Talk: Vapors/Tanks Driving Next Wave Of E-Vapor Growth
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Vapors/Tanks Offer Better Nicotine Delivery, Better Economics and
Versatility Making Them More Attractive Than E-Cigs For Consumers
Why Are Consumers Drawn to Vapors/Tanks Rather than E-Cigs? – Comments
“Bigger drag and variable nicotine.”
“Flavors, battery strengths, delivery methods, quality. Mainstream leaders such as blu and NJOY are inferior products compared to other vaping
solutions or other e-cig solutions out there. People who want to quit smoking turn to blu and NJOY and others but don't stay with these products as they
don't taste like a traditional cigarette. As a result they go back to smoking traditional cigs or look for better products.”
“Scientific evidence to suggest that bigger devices are better at getting nicotine into the vapers’ bloodstream, thus increasing their chance of switching.
Customization - the ability to perfectly engineer the experience the vaper is looking for, flavor, throat hit, type of device, amount of vapor, are all
important variables that can be customized. Common perception among vapers is that 'cigalikes' are overpriced and offer a poor experience, the only
positive being a gateway out of smoking. And that people who stop smoking permanently don't do it with these devices. Our research suggests that after
3 months, a vaper no longer wants a device that looks and tastes like a cigarette, as they now consider themselves to have quit smoking. Maybe this
isn't for the mainstream, but it isn't the big companies trying to make vaping cool, it is the bottom up subculture who found a way to stop smoking and
come in from the cold.”
“It can either hit like a cigarette or look like one… but with current technology we cannot have both. Most long term smokers would prefer the sensation
of smoking over the look of it.”
“Bigger, thicker vapor. Customization. USA made juice. Flavor, flavor, flavor.”
“The experience is more like traditional cigarettes in terms of fulfillment. The vapors/tanks create more vapor which provides for a more fulfilling throat
impact. In addition, the consumer has the ability to tailor the taste profile to his/her own tastes by the ability to mix multiple flavor liquids.”
“As again, because Americans like a home depot style of e-cig and flavor. Besides, vapor tank system are a stronger sensation than the smaller e-cig,
nicotine kick is better surely, strong taste-orientated, Americans love it.”
“Smoking is passé, not cool. Vaping is not really smoking, and it’s hip.”
“Cost of tank vaporizing and e-liquid is more affordable than the cost of disposable e-cigarettes.”
“Many people we have asked that have moved to tank systems have told us they would like to have the convenience of cig-a-like products if they had
more variety in strength, flavor and personalization.”
“Customization, freedom to blend/create desired flavor profiles, and the potential for greater nicotine intake. Additionally, by design, the vaping product
creates a bigger 'draw'. That inhalation feels far more comparable to a traditional cigarette.”
“More flavors, more satisfying, and cheaper in the long run.”
“Better nicotine delivery and larger amounts of vapor. Their size is a draw back and so is the manual switch required.”
“A lot of thick vapor; Choice of different flavors and ability to mix flavors to try new ones; Generally low chances of finding a bad cartridge in a
rechargeable.”
“More choice in flavor and customer service to explain the options.”
“More variety, better tastes, the "cool" factor, the social factor, the "image", the (perceived) glitz and glamour, cheaper than analog cigs and e-cigs, they
are and can be played with an infinite amount, targeting marketing, the "rebel" factor.”
“Variety of flavors, varying nicotine levels, and more choices.”
“There are a few reasons: (1) It's a better user experience for the consumer - providing a more satisfying experience;(2) it is more economical; and (3)
e-liquids offer more flavor options than cartridges and disposables. It's the natural evolution.”
“Only a small percentage of total users are drawn to this new form of Vaping. Traditional smokers have been and always will adopt the use of
rechargeable and disposable units as the standard form factor.”
Source: Wells Fargo Securities, LLC
The Growth of Vapors/Tanks Will Likely Continue to Put Pressure on Both
Combustible and E-Cig Manufacturers Such That They May Need to Join – “The
writing is on the wall for combustible cigarettes, if the FDA can act to support the
positive potential that they bring.” – A common thought that emerged from the respondents was that in
the face of growing popularity of vaping devices, e-cigarettes will likely soon need to rationalize their prices and/or bring forth
better product offerings in terms of choice of flavors, versatility and personalization. Respondents unanimously believed that
combustibles had a bleak outlook and that Vapor is becoming “category of its own,” on the strength of the degree of satisfaction
they provide and due to lack of definitive, binding regulations at present.
Given the Growth of Vapor/Tanks, What are the Implications for Combustible and E-Cig Manufacturers? – Comments
“The writing is on the wall for combustible cigarettes, if the FDA can act to support the positive potential that they bring. As far as I know one big tobacco
company (BAT) is now experimenting selling liquids and this will have to be the path they go down in western markets to maintain share. The problem
for Tobacco Companies is that the retail model is obviously completely different - cheaper and less frequent purchases which impact the whole c-store
sector and so on... Added to this is there is increasing evidence to suggest that e-cigarettes are less addictive than tobacco. So there are huge questions
9
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Tobacco
around whether brand loyalty can even exist in the same way as it does for traditional tobacco, and in turn the lifetime value of a customer.
“Tobacco companies better start working on extracting nicotine from tobacco and selling it to labs that make e-liquid or start making their own e-liquids.”
“The general cost will be lower, and if they solve the efficiency of nicotine delivery as well as the satisfaction rate, this will be a big threat to them, but
there are still a lot of bad products in the market, not likely, in a quality aspect, a lot of people will hate bad product, malfunction and misuse rate of the evapor could be 10 times higher, a lot of issues with leaking. Also, a messy issue.”
“Eventually they will become the late manufacturing adopters.”
“Not very good if e-vapor continues to expand due to unchecked regulation.”
“The challenge will be to produce products that provide the versatility, choice and personalization of tank systems without the mess and potential
regulatory issues relating to refilling and leaking.”
“FDA regulations on content and composition will be the biggest hurdle to vapors becoming the next big thing. It is the 'Wild West' in terms of lack of
regulation. Big Tobacco has an obvious, significant vested interest in their long-term viability. We'll continue to see declining traditional cigarette sales
and more acquisitions by big tobacco (Lorillard-blu, National-V2, etc...).”
“Less sales! E-cigs need to become better, more reliable and available in multiple flavors.”
“Vapor will, and is becoming its own category. However standard cig-a-like version e-cigs will still hold the predominant position for competition to the
combustible cigarette. Until multiple distribution points accept the process of educating the consumer for the tank system they will continue to see the
competitive marketing of the comparable products (cig-a-likes).”
“Definitely, combustible cigarettes usage will slow down as more and more people use vape/tanks or e-cigs. However, if the vape/tank system becomes
bigger, e-cig manufacturers will have to either lower their prices a little or come up with products that have better/more features. Reduction in weight of
e-cigs could create differentiation for people as well.”
“They will get in the game faster and devote more marketing dollars and consolidation.”
“Declining market share, this will stabilize.”
“1. Loss of customers for traditional products. 2. Narrowing margins for e-cig manufacturers. 3. Growing success for "juice" formulators and
manufacturers.”
“They will need to evolve and I believe they will.”
“I do not think vapors/tanks will be the next big thing.”
“Don't know how big it will get but it will force a shift towards tanks across the board. Only thing that can prevent this is regulation, or societal
unacceptability (a la Google Glasses).”
“I think there will be consumers for all of it assuming the FDA guides the industry from an informed position. There's a lot of anti-smoking emotion driving
the legislative dialog today.”
“As long as the FDA doesn't ban flavors and liquids, the tank segment will continue to grow and become bigger. E-cig suppliers will need to improve the
quality of current products.”
“Obviously combustibles will continue to decline; with their only advantage possibly being cost, which continually drives down pricing and a natural end.
E Cig biz will continue to be main stream, and may take multiple channels of distribution. Our model of up-scale bricks and mortar is working very well
and being well received.”
“Combustible cigarette consumption will continue to decline at an accelerating rate. Existing cigarette manufacturers will continue to increase the breadth
and depth of distribution of this segment.”
Source: Wells Fargo Securities, LLC
FDA Regulation Will Likely Impose Age, Marketing Restrictions and Set E-Liquid
Manufacturing Standards for Public Safety; Respondents Hopeful FDA Will View
E-Vapor Market As Harm Reduction Opportunity – “I'm hopeful that the FDA will
act responsibly, and I'm encouraged by the investment they have made into an
ongoing e-cigarette research program, and the engagement with vapor product
industry bodies.” – The majority of our respondents would like to see the FDA set some standards of quality for
e-vapor products with regards to packaging (to avoid leakage & possible misuse), nicotine content, and amount of raw liquid
permitted to be sold at one time. The survey also revealed that most respondents anticipate FDA to impose age restrictions and
marketing restrictions on vapors/tanks, similar to other traditional tobacco products, in the interest of public safety.
How Do You Think the FDA Might Regulate Vapors/Tanks? – Comments
“They will only allow vape shops where they can control consumption or only allow a closed system.”
“Will attempt to regulate by insisting upon additional standards to make sure the customer cannot expose themselves to too much nicotine.”
“Vaping is seen as edgy and not mainstream. Yet, if the FDA is a rational actor (and I'm not assuming they are) they will see vaping products as harm
reduction much like e-cigs.”
“I'm hopeful that the FDA will act responsibly, and I'm encouraged by the investment they have made into an ongoing e-cigarette research program, and
the engagement with vapor product industry bodies such as AEMSA and SFATA. The standards, (which global trade bodies are working together on
developing currently) are what is desperately needed and the FDA needs to treat all of it with the same set of regulations. You can have both good and
bad products in either category and the same level of regulation and attention is needed to develop both sectors towards absolute safety. Poor facilities
and working practices are the biggest area that need regulation in my opinion, this is for both categories.”
10
Tobacco Talk: Vapors/Tanks Driving Next Wave Of E-Vapor Growth
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
“They will try to lump it in with tobacco, but hopefully harm reduction advocates will be able to stop this for the greater good of public health. Regulating
vapor products as tobacco would set the industry back severely and would significantly change all my estimates above on industry growth rate.”
“It should be different. FDA should set a standard of quality, because this product is out of control with its shape, power, function, main thing: quality.
Leakage will hurt consumer, nicotine on skin is fatal if surface of exposure is big enough.”
“Eventually vapors/tanks will be taxed. There is also a grass roots impact of the 5,000 plus Vape shops opening on corners across every state in the US.
- They employ many people. Vape shops are becoming like coffee shops, and people are willing to pay for education and information, even if it is at a
premium price versus traditional retailers.”
“They could classify them as a Medical Delivery System and that would be their demise.”
“There will probably be product standards, sales restrictions (age etc.) and something around the packaging that protects from leaking and misuse
(accidental of otherwise).”
“The liquid will ultimately be taxed and the contents regulated for public safety. All that is needed is one bad batch of liquid from a less-than-upstanding
'Vape Shop' to harm a few people. At that point, the FDA will have no recourse but respond swiftly.”
“They may ban e-liquids in containers of 2 ml or more. May require closed tank systems so customers aren't acting as their own chemists.”
“My personal feeling, is that they will try every angle to ban this product. From that point it will be up to the industry to fight them every step of the way.
Only then will we be able to operate and invest without the issue of the FDA. I believe the FDA has limited the investment in the electronic cigarette. That
being said I could see a settling for a set of standards for the e-liquid manufacture. Not sure how that will work with imported e-liquid. But I do not see
them having the ability to regulate hardware. Especially if someone wants to manufacture liquid without nicotine they would have to prove jurisdiction.
Currently the House of Reps believes the current Tobacco act does not give the FDA the right to regulate the product so we will see.”
“They are going to limit flavors, require age of 18.”
“They will be considered tobacco products and the manufacturing of juice will be regulated and taxed.”
“I hope they regulate the manufacturing process of E-Liquids. It should be made in the USA under some sort of FDA requirements. It should also be
batch tested to make sure the nicotine level is accurate and measurable. Any manufacturer of E-Liquids should carry at least a $10 million product
liability insurance policy.”
“Long-term I am not sure. Short term I expect that the FDA will follow the lead of the EU and allow them with some regulation limiting the nicotine
density of the "juice."”
“In a perfect world, they will focus regulations on areas that make sense like manufacturing standards and age restrictions.”
“Regulation of flavors, nicotine content, and amount of raw liquid permitted to be sold at one time. Amount of nicotine permitted in raw liquid will all be
regulated and this segment will not gain a substantial market share. Sealed units built by certified companies with regulatory controls over the e-Liquid
are the only way to protect consumers.”
“It's anyone's guess.
“I don't try and guess what the government will do.”
“No one knows what the FDA will do. I'm worried that the liquid and flavor business is in danger. One way around is possibly having liquids with zero
nicotine. Theoretically these should not be impacted by the FDA.”
“Who knows, hopefully they will put some quality controls into production of juice, eliminate the sketchy imports, and put confidence in consumers that
their juice is of minimum standards that will make it safer. Age restriction is obvious reaction, hopefully age restriction will mitigate need to attack
flavorings as all adults enjoy flavorings, especially women. Online sales may be on the block, which will drive demand for more local channels of
distribution in both C-stores and brick & mortars.”
“They most likely will impose sales and marketing restrictions similar to traditional tobacco products. These will include age restrictions, advertising
constraints and restrictions on the levels of nicotine. While they would like to place restrictions on flavors and internet sales, that could prove to be a
more difficult process. Due to the rapid and continual evolution of the industry, Substantial Equivalence requirements will be a nightmare for FDA and the
Industry.”
Source: Wells Fargo Securities, LLC
New Innovation Ranges From Improved Vaping Experience, Bringing
Automated, U.S.-Based Manufacturing to E-Vapor Product Production
To Total Redesign of E-Cig Architecture As We Know It – “We are
constantly evaluating new technology and evaluating every changing
consumer wants and needs. Innovation will be a constant and
continuous process within this industry.”
What New Product/Technology Innovation Are You Bringing to Market and In What Timeframe? – Comments
“Yes we are working on new technologies in vaporizer and e-liquid to further improve the vaping experience and expect to introduce new innovations into
market within a year.”
“Yes a Puff Counter.”
“I have worked with a number of overseas manufacturers on improving on designs of existing products. New products are released every DAY in this
industry. Consumers will create the products they demand to get the satisfaction they are looking for.”
“Yes, as e-cig maker we mainly want to improve the material and also mainly, in the future, concept-wise, to make something like NESPRESSO - Liquid
11
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Tobacco
seal, and inject into device.”
“Yes. May 1st. Stay tuned.”
“We expect in 2014 to introduce Nicotine Gum and Nicotine Lozenges as Nicotine Replacement Therapy Products (NRT). We are also working on
Cancer research with the LD1 Gene.”
“Yes! We have substantial patent filings around the space between e-cigs and tanks. Watch this space in the next 6 months!”
“Yes- improved e-cig experience- longer lasting battery- better vaporization. Also bringing automation to the US.”
“We introduced our rechargeable kit at EFCRM last month and have received great reviews. To sum up the advantages of our new Premium E-cig Kit”:
1. Protective, patent pending carrying case and supplies are always with the vaper and fits in a pocket or purse.
2. Collectible carrying case can hold 2 cartridges, an extra battery, a USB charger and a fully assembled e-cig. Customers will always have a back up ecig and charger.
3. You can leave one e-cig battery at home, work, etc. to charge while bringing your carrying case with you. You do not need to charge the entire case.
4. Our flavors are USA E-liquid and are proven to be delicious and smooth. Our flavors are taste tested by real smokers and we have been continually
told we have nailed it with both our Tobacco and Menthol flavors.
5. Our collectible tins will promote repurchasing of the kits and the extra battery and USB charger create profitable add on opportunities to the sale.
6. Our 5 pack of cartridges are a great value and will keep customers coming back for more.
“Yes we are, several actually, some by Q2.”
“Yes. A unit that will measure, monitor and meter dosages of nicotine on a per puff basis. The intention is to seek FDA approval as a nicotine
replacement therapy smoking/nicotine cessation product and timing to market will be determined by the FDA's Center for Drug Evaluation and Research
("CDER") and not the FDA's Center for Tobacco Products ("CTP").”
“YES, can’t say, but the form factor you see today is not the form factor you will see in 12 months.”
“No, unless you count new flavors. Improvements will come in reliability; but hard to see any real improvements in mechanism (it's a glorified miniature
fog machine; not a computer).”
“Yes and on multiple levels. Consistency and customization.”
“Yes. We are working on a grounds-up redesign of the architecture of the e-cig. We are including smart technologies, user control and more accurate
dosing control. Dosing control is the most challenging part. The new architecture will enable us to manufacture and fill the e-cig in the USA. The
prototype should be ready by the end of March early April.”
“Yes. Hardware will continue to innovate; juice packaging will also continue to evolve.”
“We are constantly evaluating new technology and evaluating every changing consumer wants and needs. Innovation will be a constant and continuous
process within this industry.”
Source: Wells Fargo Securities, LLC
General Industry and Consumer Trends
•
•
•
•
More and More E-Cig Consumers Switching To Vapors/Tanks From E-Cigs Due to
Increased Satisfaction with Vapor/Tank Products
Technology Still Has Lots of Room for Improvement
Industry Will Likely Consolidate Over Time
Regulation is Needed but Will Hopefully Not Stifle Innovation
Comments
1. E-cig good, nice, but littering will kill the product one day.
2. VAPOR device, good, nice, but nicotine overexposure could become excuse of putting it into extinction one day.
3. There is no superb and long life product yet.
4. Automation is building up to fit made in USA/EUROPE production, but, if there no perfect product, no one will get anywhere.
5. Not to mention Imperial Tobacco's lawsuit will create a mess outside USA.
Bottom line – someone should invent a product that addresses all of the points above.
“Consumer is very confused. Economics of tank vaporizers is taking a toll on the e-cigarette market.”
“We have been in this field for 5 years now and are frustrated with the way that "Big Tobacco", having largely tried to dismiss the category historically.
They should be building a sector by educating consumers and public health. Instead, they run the risk of damaging the sector for all concerned.
Fotem/Imperial is a classic example. This type of in-fighting does not help the sector or public health (even though we are not named).”
“BLU, in particular, made a wise strategic move in the roll out of their Starter Kits. Unlike NJOY, who decided on a flawed, all-in strategy with
disposables, BLU realized the E-Cig consumer is a young, but maturing consumer. The next natural progression was to incorporate kits into their full
retail play. Market indicators suggest their consumers are migrating nicely towards it and its substantial retail ring.”
“Too many companies are making e-liquid in their kitchens/bathrooms. E-liquid companies don't understand batch testing, nitrosamines, etc.”
“We hear every day from our customers how much they feel healthier after they switched to e-cigs. We recently collected some data and found that
about 15% of our customers quit smoking completely after they started using our products for few months. Many customers have switched from higher
levels to 0mg strength nicotine and just enjoy vaping but with no nicotine at all. Most of our customers have shown great satisfaction after they switched
to e-cigs.”
“We feel that the basic rechargeable kits have the most potential and that the cartridge system has the most potential because of convenience and price.
There is also the opportunity to have many flavors in the cartridge system if the FDA allows it.”
12
Tobacco Talk: Vapors/Tanks Driving Next Wave Of E-Vapor Growth
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
“I think that the industry is significantly underestimating the impact of the IP litigation initiated by Ruyan/Dragonite and now continued by Imperial/Fontem
Ventures who purchased the IP from Ruyan/Dragonite in late 2013 for US $75 million. The portfolio is large, robust and still developing and the fact that
it is in the hands of a traditional tobacco company should be of concern to e-cigarette companies and the e-cigarette industry as a whole.”
“Smoking has looked the same way for centuries, while everything else around us has evolved. Big tobacco has stifled the evolution of smoking
technology for obvious reasons. Today, consumers no longer feel like e-cigs need to look and feel like a real cigarette. We have broken through that
early need and consumers today are embracing a new better way to smoke/vape.”
“This industry is in desperate need of consolidation amongst the smaller players.”
“Its vapes today but who knows tomorrow.”
“In my opinion the most disturbing issue I see with e-vapor business is the lack of conversion. We give a lot of free product to friends that are smokers.
Most, if not all, use our product for a while. They will stop smoking or cut down. Eventually (6 months or less) they all go back to smoking analog cigs
and stop using e-cigs. They may use e-cigs when in public or around none smokers. Until our products can solve this issue, the industry will not be as
large as predicted.”
“The casual consumer is trending more to the vapor/tank sub segment of the industry. Increased satisfaction with this type of product has overcome the
initial discomfort with the size of the hardware. The ability of the consumer to satisfy their own taste profiles and not simply rely on the offerings of a
manufacturer appeals to the consumer as their sophistication level increases. Unless FDA regulation halts the innovation and evolution of this industry, it
will only continue to grow. Traditional tobacco consumption will continue to decline. Obviously another unknown factor will be the effects to taxation but I
believe that the option of a cleaner alternative will continue to grow in interest to the consuming public.”
“We definitely see more and more smokers switching from real cigs to ecigs, and more and more cig-like users moving to vapor/eliquid products.
Vapor/eliquid users have a much higher success rate of quitting tobacco cigs.”
Source: Wells Fargo Securities, LLC
13
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Tobacco
Profile of Survey Respondents’ Companies
Annual Revenue/Sales in Dollars
50%
Total Operating Profit in Dollars
60%
46.2%
45%
50%
50%
50%
38.5%
40%
35%
40%
33%
30%
25%
30%
20%
20%
15%
10%
7.7%
7.7%
90 million
200 million
17%
10%
5%
0%
0%
<5 million
10-30 million
< 1 million
Gross Profit Margins (in %)
1-10 million
10-20 million
Net Loss
Operating Profit Margins (in %)
33.3%
35%
45%
40%
40%
30%
35%
30%
25%
30%
22.2%
22.2%
22.2%
40-60%
Net Loss
20%
25%
20%
20%
15%
15%
10%
10%
10%
5%
5%
0%
0%
30-40%
40-50%
50-60%
<10%
>60%
Number of Employees
50%
20-30%
% of Revenue Sold Online
30%
45.5%
28.6%
28.6%
45%
25%
40%
21.4%
35%
20%
30%
14.3%
15%
25%
18.2%
20%
18.2%
18.2%
10%
15%
10%
7.1%
5%
5%
0%
0%
<10
14
10-50
50-100
>100
0.0%
0%-10%
10%-50%
50%-99%
100.0%
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Tobacco Talk: Vapors/Tanks Driving Next Wave Of E-Vapor Growth
Number of Retail Distribution Points
25%
23%
23%
Number of Different Brands
90%
23%
80%
20%
76.9%
70%
15%
15%
15%
60%
50%
40%
10%
30%
20%
5%
10%
0%
7.7%
7.7%
7.7%
5-10
10-20
>1000
0%
<10
20-100
100-500
1000-10000
<5
>10000
Number of Different SKU's
50%
Number of Different Flavors
40%
46.7%
35.7%
45%
35.7%
35%
40%
30%
33.3%
35%
25%
30%
20%
15%
21.4%
20%
25%
15%
13.3%
10%
10%
7.1%
6.7%
5%
5%
0%
0%
<10
10-100
100-500
>10000
<10
10-50
50-100
>100
Source for all charts: Wells Fargo Securities, LLC
Required Disclosures
Additional Information Available Upon Request
I certify that:
1) All views expressed in this research report accurately reflect my personal views about any and all of the subject securities or
issuers discussed; and
2) No part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed
by me in this research report.
15
Tobacco
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions.
Wells Fargo Securities, LLC’s research analysts receive compensation that is based upon and impacted by the overall profitability
and revenue of the firm, which includes, but is not limited to investment banking revenue.
STOCK RATING
1=Outperform: The stock appears attractively valued, and we believe the stock's total return will exceed that of the market over the
next 12 months. BUY
2=Market Perform: The stock appears appropriately valued, and we believe the stock's total return will be in line with the market
over the next 12 months. HOLD
3=Underperform: The stock appears overvalued, and we believe the stock's total return will be below the market over the next 12
months. SELL
SECTOR RATING
O=Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months.
M=Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months.
U=Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months.
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analyst expects significant volatility. All IPO stocks are automatically rated volatile within the first 24 months of trading.
As of: March 24, 2014
48% of companies covered by Wells Fargo Securities, LLC
Equity Research are rated Outperform.
Wells Fargo Securities, LLC has provided investment banking
services for 47% of its Equity Research Outperform-rated
companies.
49% of companies covered by Wells Fargo Securities, LLC
Equity Research are rated Market Perform.
Wells Fargo Securities, LLC has provided investment banking
services for 35% of its Equity Research Market Perform-rated
companies.
3% of companies covered by Wells Fargo Securities, LLC
Equity Research are rated Underperform.
Wells Fargo Securities, LLC has provided investment banking
services for 12% of its Equity Research Underperform-rated
companies.
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16
Tobacco Talk: Vapors/Tanks Driving Next Wave Of E-Vapor Growth
WELLS FARGO SECURITIES, LLC
EQUITY RESEARCH DEPARTMENT
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17