Philip Morris Finds Its Footing In The Electronic Cigarette Industry

by Roger Hannington
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Submitted by Roger Hannington as part of our contributors program.

Philip Morris Finds Its Footing In The Electronic Cigarette Industry

In November last year, Philip Morris International (PM), maker of Marlboro brand cigarette, announced its plans to enter the electronic cigarette market. The company stated that the market for electronic cigarettes would be its “greatest growth opportunity,” and investors waited keenly to see how and when the company would enter the space. Here is the story so far.

What Are Electronic Cigarettes?

The huge amount of media attention that has surrounded electronic cigarettes over the past twelve months means awareness of this growing market is relatively high. For the uninitiated however, here is a brief introduction.

First, a look at electronic cigarettes themselves. Initially sold as a novelty item, electronic cigarettes have grown to become a viable and acceptable alternative to smoking traditional cigarettes. The typical electronic cigarette comprises a plastic tube, a nicotine cartridge that contains liquid nicotine, a battery and a vaporization chamber. When an individual sucks on the device, just as they would a traditional cigarette, the heating coil in the vaporizer turns the liquid nicotine into a nicotine mist that the user inhales. Designs range from those that aim to mimic traditional cigarettes as closely as possible to those that mimic the process of smoking, yet differ aesthetically.

Now a look at the market. In 2008, the electronic cigarette market generated $20M in total sales. By 2013, this had risen to more than $1.7B in annual sales. By 2017, analysts expect sales to reach $10B, and by 2047, Bloomberg expects electronic cigarette sales to outweigh those of their traditional counterpart.

Market Composition

Due in part to its relative infancy, the market for electronic cigarettes is currently fragmented. The big names in the tobacco industry, of which Philip Morris is one, have been somewhat slow with their entry into the space. This left market share on the table for a number of smaller, faster moving companies, each with their own differentiator.

Take, for example, American Heritage International (AHII). American Heritage has built its brand around the all-American concept, self admittedly targeting its product at blue-collar smokers looking for a healthier alternative. In fitting with the blue-collar audience, American Heritage has designed its electronic cigarette to replicate traditional cigarettes as closely as possible. The company’s product has a soft filter and a tobacco-tasting nicotine cartridge. Over the past twelve months, the company has built a distribution portfolio of more than 400 locations in 11 states, which includes big name, Tier 1 convenience store outlets such as 7-Eleven and Chevron.

At the other end of the scale is blu eCigs, which has built its brand around a “distinct look” design. The blu electronic cigarette has no filter, a black outer trim and a blue light at its tip and the company is targeting the product at the more image conscious smoker. In April 2012, tobacco industry incumbent Lorillard (LO) acquired blu eCigs for $135M, becoming the first big tobacco company to enter the industry.

Philip Morris’ Entry

On December 20, 2013, Philip Morris announced it had partnered with parent company Altria Group. (MO) in an effort to capitalize from the rapidly expanding electronic cigarette market. Under the terms of a set of licensing, supply and cooperation agreements, Altria will make available its electronic cigarette products exclusively to Philip Morris for marketing and distribution internationally, while Philip Morris will make available two of its candidate reduced-risk tobacco products exclusively to Altria for commercialization in the US.

The agreements also saw the two companies arrange a cooperative strategy for the scientific assessment, regulatory engagement and authorization related to electronic cigarette products with the FDA, and for a similar framework for electronic cigarettes with relevant regulatory authorities in international markets. Finally, the agreements provide for the sharing of improvements to the existing generation of products.

In short, the two companies will operate in their respective markets in much the same way as they currently do with the Marlboro brand, with Philip Morris selling the traditional cigarettes internationally and Altria selling them domestically. At the date of the announcement, Altria, and in turn Philip Morris, manufactured and distributed the MarkTen branded electronic cigarette, and the MarkTen was undergoing trial retailing in Indiana and Arizona. On February 19, Altria announced its plans to launch the MarkTen brand nationally, starting in the second quarter of 2014. While the national rollout will not benefit Philip Morris directly, it will serve to increase awareness of the brand internationally, and offer the company a foothold from which to market MarkTen electronic cigarettes outside of the US.

Also in February this year, Altria announced the acquisition of Green Smoke’s e-cigarettes business for $110 million. Founded in 2008 and with operations primarily in Israel but also in the UK and the US, Green Smoke had sold e-vapor products since 2009, and its revenues for 2013 were approximately $40 million. The acquisition will serve not only to bolster Altria’s sales, manufacturing and distribution teams in the US, but according to the terms of the November agreement, the Green Smoke products will be available to Philip Morris for marketing and distribution internationally. With a strong international presence already established, the Green Smoke brand could be an important part of the company’s growth strategy moving forward.

Risks

What are the main risks involved with Philip Morris, and the electronic cigarette industry as a whole? The first is adoption. Acceptance to date has been strong, but total tobacco market penetration remains between 1-2%. Investors should remember that analysts’ market forecasts are hypothetical, and the electronic cigarette industry may fall well short of its estimated 2017 $10B capitalization.

Regulation also poses a risk to the industry. At present, there is very little regulation associated with the consumption, purchase and retailing of electronic cigarettes. However, a number of states in the US, and a number of international authorities, are in the process of laying down regulatory framework. High up on the list will be taxation, and increased cost to all parties could have a detrimental effect on industry expansion.

Conclusion

All said, despite the risks outlined above, the electronic cigarette industry looks here to stay. The widely perceived, though not proven, health benefits, coupled with the lower cost of using electronic cigarettes compared to traditional cigarettes, makes it difficult to put forward any other argument. Tobacco industry incumbents such as Philip Morris have been slow to position themselves in the emerging market, affording companies such as American Heritage and blu eCig the opportunity to build a brand and gain market share, but recent activity suggests that this is no longer.

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