As electronic cigarettes flew off shelves on both sides of the Atlantic in recent years, investors flocked to a business some hope will be the future for tobacco.
Now sales growth is slowing from a 2011 peak and private funds are more cautious about the smokeless devices, making it harder for independent e-cigarette firms to raise capital and hitting their share prices.
The entry of Big Tobacco and a push for tighter regulation has led outside investors to question the potential of the e-cigarette market, where sales are at a modest $3.5 billion worldwide but still growing faster than for most consumer goods.
"Everybody knows regulation is coming so investors are concerned about investing in companies that won't be able to meet those rules," said Craig Weiss, CEO of NJOY, one of the more established e-cigarette makers, which sources say could pursue an IPO or a takeover by tobacco or healthcare firms.
The World Health Organization last month called for bans on indoor use, advertising and sales to minors of the metal tubes that heat nicotine-laced liquid into vapor, arguing that the jury was still out on how safe they were.
This would go further than the European Union's rule coming into force in 2016 to ban advertising and regulate nicotine content, and a proposal by the U.S. Food and Drug Administration (FDA) to ban sales to minors.
"For smaller companies, it is challenging — they have to answer for FDA uncertainty and questions about Big Tobacco," Weiss said.
Gamucci, one of Britain's earliest e-cigarette makers, has been seeking capital for about 12 months, while rival E-Lites weighed options for a year before agreeing in June to sell out to Big Tobacco's No. 3 player, Japan Tobacco.
With sales of traditional cigarettes declining in many countries due to health concerns, almost all the major tobacco companies have either bought e-cigarette companies or set up in-house development.
This means the independent players must be extra nimble.
Gamucci CEO Tony Scanlan, who worked at a leading tobacco company for 17 years before branching out, told Reuters Gamucci is close to securing an injection of about 20 million pounds ($32.4 million) and may weigh going public when it gets bigger.
It is planning a new range that is refillable rather than disposable in line with market trends and is considering marketing products as medical devices, as British American Tobacco's Nicoventures unit is doing.
Innovation is now key to survival in a business whose products have piqued consumer interest, but not loyalty.
"Last summer ... you were seeing a big build-up of consumer trial, but that trial hasn't come through to regular usage," said Martin Deboo, an analyst with Jefferies.
He cited research showing that half of all smokers had tried e-cigarettes but only 10 percent said they were regular users.
"The first generation 'cig-a-likes', from a smokers' point of view, have only been a partial solution," Deboo said.
Lorillard, America's No. 3 tobacco firm and No. 1 e-cigarette firm, said e-cigarette sales fell 35 percent to $37 million in the quarter to June 30, but its retail market share fell only 1.1 percent, which suggests the entire category shrank dramatically.
'APPLE PIE' TO 'ZOMBIE JUICE'
Some vapers complain that with the slim, disposable e-cigarettes, poor vapor quality makes the nicotine hit weaker than with tobacco, that battery life is too short, and that they are too pricey, at as much as $15 a day for a very heavy user.
As such, they have been losing share to next-generation models that pack a bigger puff at a lower price in a market of which 70 percent is in the United States and Europe.
"You'd be hard-pressed for someone to invest today in the smaller, independent e-cigarette companies because it's tough to know whether they'll ever get distribution," said a source financially involved in the sector.
"Investors are shifting their attention now, trying to figure out what other areas they should be investing in."
One such area is so-called vaping products, a rainbow of do-it-yourself tanks, batteries and e-liquids.
U.S. financial services giant Wells Fargo estimates that business at $1.1 billion of a $2.5 billion U.S. vapor market including e-cigarettes. Particularly bullish, it says vaping could surpass smoking in the U.S. in the next decade.
Data gatherer Nielsen, which tracks retail sales but not online or at specialty "vape shops," says that for the 52 weeks ended August 23 e-cigarette and tank revenue in the US grew 19 percent. But that was down from 125.5 percent growth for the same period ending in 2013, 133 percent in 2012 and almost 1,103 percent for 2011.
Some predict regulation may slow that down further due to fears vaping may become a gateway to smoking for kids, with e-liquids in thousands of flavors with names ranging from the quaint Apple Pie to the outlandish Zombie Juice.
A recent drop in the value of a group of e-cigarettes companies trading mostly over-the-counter on the Pink Sheets in the U.S. highlights the growing caution.
Nine companies had a combined market capitalization of $743.3 million at the close of trading on Wednesday, down nearly 60 percent from a March peak of $1.84 billion, though still up on a year ago.
Electronic Cigarettes International Group, by far the largest, saw its shares close at just $5.50 on Wednesday, down from the high teens in March.
It went public in a reverse merger last year, and has since done a string of deals as small players seek consolidation in a market still home to hundreds of brands.
"The key driver is that by doing this, they're better able to compete with the tobacco companies," said Mark Winkler of Fleming Family & Partners, who advised British e-cigarette maker Skycig on its sale to Lorillard in October for 30 million pounds ($49.58 million) plus future payments.
In May, Michigan-based ECIG filed for a follow-on public offering to raise up to $149.5 million and in July announced a $20 million investment from an arm of Egypt's Mansour Group.
Shares in the second-biggest traded firm, 22nd Century Group, have more than halved since its March high of $6.34, even though its shareholders at the time of filings this summer included funds managed by the likes of Vanguard, Fidelity and TIAA-CREF.
BIG TOBACCO VS PHARMACEUTICALS?
The major tobacco companies do not face the same pressure, since their investments in the sector are tiny compared with the size of their traditional businesses and serve as a hedge against declining tobacco sales.
British American, the world's No. 2 tobacco firm, set up a unit in 2011 to develop smokeless alternatives and bought United Kingdom-based CN Creative the following year. It sells an e-cigarette called Vype in Britain, while Reynolds American, in which it holds a large stake, is rolling out an e-cigarette called Vuse across America.
U.S. Marlboro maker Altria Group bought Miami-based Green Smoke for $110 million in April, and in July Lorillard agreed to sell Skycig and Blu, which it bought for $135 million in 2012, to Gauloises maker Imperial Tobacco.
Before exploding in the last four years, e-cigarettes were simple devices largely sold on the Internet, so even though there was venture capital and private equity interest, capital needs were relatively modest.
Now that they grace shelves all along the high street, many companies must invest in slotting fees, quality control, supply chain and marketing to drive and keep market share. That crimps cash flow, making them less attractive to private equity firms who need near-term profits to service their debt, said Winkler.
And while some independent companies may still be able to sell out to a bigger company or go public, he said there is concern that many others may get trampled, leaving investors with no exit strategy.
"There will be some independents who will be very successful, but I anticipate that many may struggle to achieve an exit at the end of the day," Winkler said.
The healthcare industry may be some help.
NJOY, which has had several fund injections from private equity and venture capital funds and others including Silicon Valley heavyweight Sean Parker, has attracted interest from both major tobacco and pharmaceutical firms, according to two sources familiar with the matter. It was not clear which companies, or whether any talks took place.
Buying e-cigarette makers may eventually make sense for healthcare companies since they threaten the nicotine replacement therapies offered by the likes of Pfizer and GlaxoSmithKline.
BAT's Nicoventures unit, in conjunction with Consort Medical and Kind Consumer, has had a new nicotine inhaler called Voke licensed in the United Kingdom as a medical product, the companies said on Friday.
NJOY, which just launched new lines of rechargeable and vape products in flavors like blood orange and butter crunch, declined to comment on any such approaches, but CEO Weiss said, "if the right type of investor approached us, I would have to listen."
© 2021 Thomson/Reuters. All rights reserved.