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Summary

  • It's not clear if Big Tobacco sees e-cigs as a potential profit center, putting all their marketing muscle behind the devices, or as a threat and crush the industry.
  • Government and health agencies do not accept e-cigs as risk-free and stop-smoking aids. They are vulnerable to regulation, even banishment, and there are patent lawsuits pending.
  • Investing in Big Tobacco stocks is not investing in e-cigs, but there are several independent companies making a lot of noise, and one preparing for an IPO.

What is a mere 70mm (2 3/4in) in length and weighs 1.2 grams? The top six manufacturers sell more than $330b a year of them. They are sold retail in drug stores, supermarkets, and discount stores. Rich and poor, literati, musicians, lawyers, teachers, coal miners, warlords, and the homeless share them. Entertainers in movies promote them. 007 carried personalized ones. Oscar Wilde described it as "the perfect pleasure," the cigarette.

A health-conscious society is turning to technology to wean smokers from the "cancer sticks" and "coffin nails." Electronic cigarettes (e-cigs) are promoted as a healthier alternative to tobacco, and as stop-smoking aids. They are battery-powered devices simulating tobacco smoke, flavor, and nicotine rush. A heating element atomizer vaporizes a liquid solution powering e-cigs, depending on varying patents. The World Health Organization (WHO) terms them ENDS for electronic nicotine delivery systems. E-cigs are "the most common prototype" for delivering nicotine.

Investors ought be cautious, and not enticed by the noise and hype. Seeking Alpha has posted nearly a dozen articles recently about e-cigs, complemented by a plethora of articles in the mainstream media. Despite a billion dollars in annual sales, is this industry on firm footing? Some fundamental analysis is in order for investor consideration.

First, e-cigarette sales generate a tiny fraction of tobacco sales. Big tobacco companies are irascible, giving no quarter to products getting in the way of cigarette and cigar sales. It will buy out or crush competition through its dominating control of distribution and government lobbying.

For example, in spite of a very small share of the e-cig market, Green Smoke, Inc. was bought by a subsidiary of Altria two-and-one-half times sales. The Wall Street Journal suggests Altria wants a faster entry into the e-cig market, an established Internet marketing component, and a product with a better reputation for quality than competitors enjoy. Altria is also looking for ways to offset 4% volume declines in its main business. In time, investors will learn if Big Tobacco will seriously market and promote e-cigs with the same vigor and vitality as cigarettes, or will big tobacco capture the market, then give it short shrift, minimizing harm to their core business?

Second, investors cannot be fooled by the propaganda that e-cigs are a "healthier" alternative, and therefore, will have wide appeal over time. There is no rigorous scientific evidence conclusively affirming that e-cigs are health risk-free, or aid in cessation of tobacco smoking. Health, medical, and anti-smoking groups are campaigning against the sale and distribution of ENDS.

WHO is campaigning against ENDS for containing ingredients causing irritants when inhaled, and toxic chemicals aside from nicotine. Further, there is the risk of nicotine poisoning, "a risk for addiction to nonsmokers," and ENDS "can be particularly hazardous to the health and safety of… children, young people, pregnant women, nursing mothers, people with heart conditions, and the elderly." WHO goes on to describe ENDS as fostering "an illusive 'safety'… enticing to consumers."

Some producers are capitalizing on e-cigs as a mix of hip fashion and fad, exploiting the recreational use and relaxation reputations of smoking. Anti-smoking advocates charge the packaging often resembles a cigarette box; flavorings and marketing promotions are to cuittle minors, making e-cigs a gateway device to the use of nicotine and tobacco products.

The industry faces tough regulations coming from the US Food and Drug Administration and European regulatory agencies. The Israel Knesset is close to outlawing their sale, as are New York City and other municipalities. It is rumored the FDA warned the manufacturers not to claim e-cigs as a cure for addicted smokers.

Most articles encourage investors to buy Big Tobacco stocks if they want to pursue the e-cigs industry. There remain a few independent, publicly traded companies for those not high-risk averse. I doubt these are long-term hold prospects, but gambling opportunities capitalizing on buyouts.

Vapor Corp. (NASDAQ:VPCO) trades now under $7 per share. It traded as low as $1.75 and as high as $10. It has a market cap of $110m. Its portfolio includes brand names familiar to those in the industry sold in more than 60,000 locations mostly through Family Dollar stores. (Caution, most tobacco products are sold through convenience stores, gas stations, and supermarkets; further growth may be slower-paced.) Vapor files reports of its financial data.

Total revenue grew from $16m in December 2011 to $26m through December 2013, and Net Income grew from $713,000 to $801,000. Its revenues are pretty skimpy compared to Lorillard's (NYSE:LO) Blu eCigs that enjoy sales over $230m. Vapor reports having a lot of cash and equivalents, and assets six times greater than liabilities, but what does it offer a buyout suitor?

Victory Electronic Cigarettes Corp. (OTCQB:ECIG) stock sells for about $10 per share, up from $1.01 in the last 52 weeks. The company has a market cap of $734m. Revenues are about $3m, and cash is $2m. It is launching a $20m marketing campaign promoting its brand in Europe, expanding on its popularity there. Victory sells through major outlets in Europe, and with a strong reputation, might do well concentrating on that market.

mCig, Inc. (OTCQB:MCIG) is a start-up combining the fads of the legal marijuana business and e-cigs. mCig got a boost when CNBC featured the company in April 2014. "It's something of a hybrid between e-cig and a joint, in that you can put 'dry herb' in it and heat it to the edge of combustion." Vaporizing marijuana is for recreational and medicinal purposes. The stock trades well under $1, and does not report filing financial information. It recently received clearance to sell in the EU, and reports breaking a one-day sales record of $45,800.

The company has a new $2 device emitting water-based direct inhalation vapors delivering vitamins, supplements, and organic flavors. Its compounds from plants "provide significant health benefits" that relax, refresh, and energize. None of its claims have been evaluated by the USFDA. Management does not want it classified as an e-cig, despite similar design elements, because it is nicotine-free. "The VitaCig, Inc. Spin-Off, Dividend, and IPO remains on schedule. The company will be filing the S1 Prospectus with the SEC by April 20th, 2014." The company makes conflicting statements, like the disclaimer that this product is not intended to diagnose, treat, cure, or prevent any disease. Meanwhile, management describes theirs as a "technology company that is harnessing mobile vaporization technology for medical delivery purposes" in the same paragraph describing their new $2 product.

Small e-cig business owners share the fear of one chief executive officer who told Chris Burrett of Bloomberg, "We're hoping they don't tell their customers, 'If you want to carry our cigarettes, make sure you have our e-cigs.'" That kind of authority can have a deleterious effect on venture capital and shareholder investment necessary for implementing market growth programs.

Another reason for caution is product quality control. All the brands are made in China, many using generic Chinese juices for flavoring. Some users report e-cigs taste stale rather quickly, and flavorings may have an aftertaste. There is one incidence of an e-cig "exploding," knocking out two of a customer's teeth. On a positive note, e-cigs are not heavily taxed like tobacco products, sell for less than a package of cigarettes, and so far, the manufacturers are not subject to lawsuits for health hazards.

Tenacious lawyers are fighting on another front to protect their turf. Imperial Tobacco Group Plc filed an intellectual property infringements lawsuit against Lorillard subsidiary NJOY, Vapor, and others. Patent fights are expensive. Big tobacco knows how to beat down small guys with not-so-deep pockets.

The safest investments in this industry are still with the big tobacco companies. Following Dr. Seuss' advice, the safest way to smoke is to fill your pipe with dirt, and plant strawberry seeds in it; instead of lighting the pipe, water it with an eyedropper.

Editor's Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Source: Where There's Smoke, There May Not Be Fire: E-Cigs