E-Cigs Take the Stage: Summary of Our Conference Call with Ballantyne Brands

Yesterday (6/19) we hosted a call on electronic cigarettes titled “e-Cigs: The Untapped Market for Electronic Cigarettes”, featuring John J. Wiesehan, Jr., CEO of the Charlotte based company, Ballantyne Brands. (Presentation: CLICK HERE ; Podcast: CLICK HERE)

On the call John provided an overview of his company, makers of the Mistic e-cig brand, and offered up some valuable industry insights, which we have included in summary form below.  

We are very bullish on the evolving e-cig category. There has been a rapid pace of innovation, which, along with increased marketing and distribution, is bringing significant awareness to the category. We believe e-cigs offer a compelling alternative to traditional cigarettes and offer a consumer a much different experience than a nicotine patch or gum. The involvement of Big Tobacco (RAI, LO, MO) in the category should continue to lend credibility to e-cigs and accelerate growth; we expect e-cigs to be margin-enhancing to the combined cigarette category for Big Tobacco and 2014 to be a breakout year for them, having tested the waters (through acquisition and mix) through 2013.

The runway for e-cig converters is huge globally:  in America alone, nearly one in five American adults smoke. We expect pending regulation from the FDA to deem e-cigs a tobacco product, and that the regulation could come down harder on online sales, and we expect that the taxation of the product will remain only at the state level. Finally, we believe e-cigs consumption will continue to benefit from its significant price point advantage over traditional cigarettes which will help to grow repeat purchase behavior. 

We think e-cigs is an exciting category with investible potential. For investors looking for a publically traded pure play on e-cigs there is one option, Vapor Corp (VPCO).

On the Category, Industry’s Size, and the Players:


John J. Wiesehan, Jr. is very bullish on the industry. Some analysts have suggested that over the next decade e-cigs could be as big as tobacco is today, a $90 billion industry. He estimates that sales in the U.S. were $150MM in 2011; $500MM in 2012 ($300MM across retail channels and $200MM over the internet); and are projected to be around $1-2B in 2013.

He thinks it is very positive that Big Tobacco has entered the market because it brings credibility (and marketing support) to the category, especially to retailers that will realize the category is not going away due to the backing of Big Tobacco.  He also views regulation from the Federal government (FDA) and regulation on a state-by-state basis as positive for the category.

Despite the involvement of Big Tobacco in the category, John thinks there is plenty of room for non-Big Tobacco players, like a Ballantyne Brands or NJOY.

[Note: Lorillard (LO) acquired e-cig maker Blu Ecigs in April 2012; Altria (MO) will launch its first e-cig under the MarkTen brand in August 2013; and Reynold American (RAI) has the Vuse e-cig].

On Retail Distribution, the Products, and Market Data:


Ballantyne Brands has a national footprint that distributes Mistic e-cigs  across Grocery stores, Drug stores, the Mass Channel, and Convenience stores.  The company notes that disposables sell well at convenience stores, whereas rechargables sell better across their other channels.

The company is focused on product quality, first and foremost the liquid that produces the vapor, insuring that it is consistent and safe.  The liquid is composed of four main ingredients: water, nicotine, propylene glycol (a bonding agent), and tobacco flavoring (traditional or menthol) -- making it an attractive substitute versus the some 4,000 to 7,000 ingredients in a traditional cigarette. None of its products are patented, however, there are some Chinese patents on the hardware that they assemble for the company. [Note: given the existing pace of innovation versus the long time frame for patent approval and desire to protect IP, most e-cig brands have not patented their products].

The company offers two different variations of e-cigs under the Mistic brand, a rechargeable and disposable. For the rechargeable option, customers buy an initial starter kit, which contains 2 cartridges with a MSRP of $14.99, and then buy replacement cartridges as needed (a box of 5 cartridges has a MSRP of $14.99).  John suggests each cartridge is equivalent to approximately two packs of traditional cigarettes.

Replacement cartridges come in traditional and menthol flavors, with 4 levels of nicotine respectively, including a zero percent nicotine level for both flavors. The company does not have any flavors (like coffee, vanilla, pina colada, chocolate, etc.), and markets strictly to tobacco users as an alternative product to traditional tobacco products; in John’s words, “The company is not in the business of recruiting new nicotine users.”

For the disposable e-cig, labeled under the MisticBlack brand (and available in Traditional or Menthol flavors), customers buy a pack of soft tip e-cigs that they dispose of after one use; they have the look, feel and size of traditional cigarettes.  [MisticBlack has a MSRP of $5.99 and will be on the market in July in places such as Wal-Mart.]

The company’s hope is to convert a MisticBlack user to a rechargeable user.  The rechargeable e-cig is in line with the razor, razor-blade model, and is a higher margin business than the disposable for the company and the retailer.  John suggests the gross margin for disposables is in the 40’s (%) for the company and that rechargeable e-cigs are north of that figure, considering the consumer already purchased the battery in a starter kit. 

After the consumer buys the start-up kit John thinks the conversion rate for rechargables will be high (more data supporting this claim is pending), while he thinks converting the disposable user (back to a disposable) will be at a lower rate. 

Mistic brands ranks #3 behind NJOY and BLU in terms of Sales Dollars and Sales Units (according to Nielsen data ended 3/16/13 that does not include internet sales). Importanly, Mistic has been able to holds its share with an average retail price at or above most of its competitors, which John attributes to its high marks on taste and marketing campaigns.

On the FDA, Regulation, and Clinical Studies:


The company believes its products will be treated as a tobacco product in a pending  FDA announcement. On regulations, John admits that it is unclear where the FDA will shake out on e-cigs.   He thinks that regulation is likely to be based on nicotine level, and speculates that a cap could be put in place. Further, the sale of e-cigs could be regulated differently on such factors as internet sales versus retail sales and tobacco flavor vs menthol and other flavors.

John expected an announcement from the FDA back in April. His team now figures that an announcement could be imminent to later this summer.

He notes, today there is no talk of the Federal government issuing an excise tax on e-cigs, but rather expects any taxes will be determined on a state-by-state basis. To date, there are only two states issuing a tax, Minnesota and Oklahoma. In Minnesota, 70% of the cost of goods is taxed, which retailers pass fully onto the consumer. In Oklahoma, e-cigs are taxed at 5% based on liquid content. For Mistic, that translates to a 5 cent tax on a pack of disposables and 25 cent tax on one package of cartridge refills (5 cartridges to one pack). The company is generally comfortable with the Oklahoma tax structure, and it believes that its value proposition over traditional cigarettes will remain a huge tailwind to consumer demand.

To date, there is no clinical study that the FDA recognizes supporting that e-cigs are less harmful than traditional cigarettes.  There are however many independent studies in which the results show that e-cigs are less harmful. He thinks that common sense would indicate that a product with 4 ingredients verses 4,000 that is not burned to consume is a “healthier” alternative, however it’s premature to speculate on how the FDA will rule on e-cigs. The company is pushing hard with its lobbyist in Washington, D.C. that the FDA suggests e-cigs are less harmful than traditional cigarettes.


On Value Proposition and Consumer Appeal:


An average cost of a carton of traditional cigarettes in the U.S. is $60. In comparison, a 5 cartridge replacement pack of Mistic, which is equivalent to a carton of cigarettes, has a MSRP of $14.99. [The company also has a 10pack with a MSRP of $24.99].

John argues that they are not marketing their products to stop smoking, but simply as an alternative to traditional smoking, and nothing else.  However, testimonials do suggests that consumers are using the products to reduce consumption of traditional cigarettes. John believes the consumer’s appeal to an e-cig, versus a nicotine patch or gum, is that that an e-cig satisfies four main desires of smokers: hand to mouth; inhale something and get a kick in the throat; exhale something (a vapor simulates smoke); and the taste of the nicotine (without the burning sensation of a traditional cigarette).

That is to say, with other products like a nicotine patch or gum, the consumer is really not getting a cigarette substitute, just the nicotine.

On Advertising and Restrictions:

The company launched the “Easy Choice” advertising campaign back in April 2013. It is 100% all print, including USA Today and WSJ, targeting 15-20 key metropolitan areas where distribution is strong. The company has chosen to be compliant with the advertising restrictions of tobacco companies, so it does not advertise on television or on billboards. 

It is also focused on age restrictions, and is a member of the WE Card Manufacturing Advisory Council, which forces anyone under the age of 18 at a retail store to be carded.

On International Involvement:


Ballantyne Brands is looking to Europe and Asia for distribution. There are, however, countries in which they are not allowed to sell into, including: China, Canada, Australia, and Brazil. John notes that some parts of Asia are “open”, while some are not.

In Europe, the UK will be a major focus.  A recent decision from the UK’s version of the FDA is to regulate e-cigs as medicines by 2016. The company is broadly comfortable with the regulation because it won’t take its product off the market, ban it, and any implementation of the regulation won’t come until 2016. The company believes that the regulation will fall on the level of nicotine in e-cigs, to make sure it is consistent with traditional cigarettes, which Ballantyne Brands believes it should have no problem complying with. 

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Stay tuned as we continue to do work on the electronic cigarette space.

Matthew Hedrick

Senior Analyst