Sales data from the US indicate that the value of sales of electronic cigarettes is roughly doubling each year: from $20m in 2008 to $750- $1b in 2013. But this is based on limited monitoring of major sales outlets, mainly reports sales of ‘cigalikes’ captured from electronic sales records, and does not capture online and vape shop sales. Surveys of vaper experiences are mainly biased toward users or second and third generation devices and it is difficult to estimate from these what proportion of the vaping population is using different devices.

New research from Wells Fargo securities shows some light on the size of the electronic cigarette market and the size of the refillable and modified (second and third generation devices) market. The research drew on evidence from independent manufacturers and marketers, most of which had annual sales of less than $30m. Most of the companies surveyed were small - nearly half of the companies that responded had less than 10 employees, 18% had 10-50, 18% had 50-100 employees, and 18% more than 100 employees.

Wells Fargo now puts the estimated total size of the retail market in the US at $2bn – much higher than previous sales estimates, which have focussed on cigalikes. Electronic sales data underestimate total sales by an estimated 60%. About 30% of all sales of e-cigarettes are through convenience stores, 26% online, and 17% through retail vape-shops.

Bonnie Herzog’s team suggest that the growth of second and third generation devices in the US (‘Vapors/Tanks’) is increasing faster than the overall sales of e-cigarettes (she uses the term E-Vapor to describe this category rather than ‘e-cigarettes’), and may be contributing to the slowing in the growth of e-cigarette sales as vapers switch from cigalikes to second and third generation devices.

The report estimates that the US market is split 65% e-cigarettes and 35% second and third generation devices. Part of the drive to second and third generation is a ‘natural progression from cigalikes’. Part is affordability, with average spend of around $16 a week on vaping paraphernalia – 20% less than that spent on rechargeable e-cigarettes and 40% less than a disposable e-cigarettes. Part is due to the ability to personalize devices, better nicotine delivery and product performance. Second and third generation device users were reportedly less likely to dual use e-cigarettes and tobacco cigarettes.

The findings are especially relevant to the EU Tobacco Products Directive, which will ban tanks over 2ml, and through the regulatory requirements will likely limit the range of second and third generation devices and nicotine liquids available. The findings are also challenging for those e-cigarette and tobacco companies that have focussed their product range on cigalikes.

Below we reproduce the summary of the report.

Wells Fargo Securities 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.

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.

This abstract from the Wells Fargo Securities report is reproduced with permission from Bonnie Herzog, Wells Fargo Securities.

Report authors: Bonnie Herzog, Jessica Gerberi, and Adam Scott. Wells Fargo Securities, LLC, Equity Research Department, 24 March 2014