11 Key Points to Understand the Vaping Industry and Regulatory Trends

1. Concept

E-cigarettes are mainly divided into two types: atomized e-cigarettes and heated non-combustion e-cigarettes.

Atomized e-cigarettes generate aerosol by heating e-liquids containing nicotine, flavorings, and other substances; heated non-combustion e-cigarettes achieve harm reduction by heating thin sheets or tobacco strips.
 
Additionally, traditional tobacco in China has a social attribute beyond just the pleasure of smoking.

2. Market

In 2019, global revenue from atomized e-cigarettes reached $20.2 billion. Based on a domestic base of 350 million smokers, the e-cigarette market has significant potential, with conservative estimates suggesting it could reach 30 billion RMB in China.

Compared to the global market, the penetration rate of e-cigarettes in China is still low. The penetration rate of e-cigarettes in the U.S. reached 31%, while in China it was only 0.6% in 2019 (according to Euromonitor).

In terms of competition, RELX's conservative market share exceeds 40%, with the top five brands accounting for about 70%, indicating a high concentration. Currently, RELX is the leading brand in the domestic atomized e-cigarette market, with a total revenue of 1.55 billion RMB in 2019 and a retail market share of 48%. The leading company in the value chain is Smoore International, the world's largest manufacturer of atomization devices, with FEELM atomization core technology leading the industry and a global market share of 16.5% in 2019.

Last year, the e-cigarette industry grew by 30% due to the pandemic.

3. Main Audience

A paper published by the Chinese Center for Disease Control and Prevention in the prestigious medical journal The Lancet - Public Health, titled "E-cigarette Use Among Chinese Adults: Results from Two Cross-Sectional Surveys in 2015-2016 and 2018-2019," shows that the main e-cigarette users in China are still traditional smokers, characterized by being male, heavy smokers, and those wanting to quit smoking, with very few non-smokers using e-cigarettes.

4. Health Impact

In 2019, the 315 Evening Gala pointed out: "Like traditional cigarettes, the e-liquids used in e-cigarettes contain nicotine, and long-term use can also lead to addiction; the formaldehyde concentration in e-cigarette vapor is dozens or even hundreds of times higher than the highest concentration of formaldehyde in indoor air, and a large amount of propylene glycol and glycerin has been detected in the vapor, which can strongly irritate the human respiratory tract when converted into gas under heating conditions."

5. Regulation (China)

In August 2018, the sale of e-cigarettes to minors was prohibited;

In October 2019, online sales and advertising of e-cigarettes were banned;

In July 2020, a special rectification campaign for e-cigarettes was launched;

In March 2021, the Ministry of Industry and Information Technology publicly solicited opinions on the "Decision on Amending the Implementation Regulations of the Tobacco Monopoly Law of the People's Republic of China (Draft for Comments)."

6. Value Chain

In terms of cost and profit for e-cigarettes, looking at the terminal retail price of pods, RELX's gross profit margin may exceed 50%. The industrial chain of pods is relatively simple; for example, RELX pods can be summarized as Smoore International's factory-made devices + e-liquid + downstream retail.

RELX Selling Price = Smoore International's Factory Device + E-liquid Cost + Retail Markup
 
Currently, the revenue of e-cigarettes mainly comes from competing with traditional tobacco for tax advantages. Cigarette taxes mainly include value-added tax and consumption tax. According to data from the Chinese tax authority, after 2015, cigarette taxes accounted for 56% of retail prices, and in 2018, domestic tobacco consumption tax revenue accounted for 55.8% of national consumption tax revenue, while e-cigarettes are exempt from consumption tax, saving a significant amount in taxes.

7. Industry Chain

The value distribution of the industry chain: the upstream of e-cigarettes includes raw materials and suppliers (value share of 13-17%), the midstream includes manufacturers and tobacco brands (value share of 23%-31%), and the downstream value share is about 51-63%.
 
#p#分页标题#e#8. Why Regulate?

1. Health Issues: Preventing the decrease in smoking age

E-cigarettes may create a "gateway effect" to tobacco addiction—using e-cigarettes can lead non-smokers to develop nicotine dependence and eventually become smokers. Among this group, teenagers are the primary victims.

2. Safety Issues: Crackdown on counterfeit and inferior products

The Chinese Center for Disease Control and Prevention stated: "Currently, there are many brands and types of e-cigarettes on the domestic market, but we do not have standards for these products. Some people mention the danger of certain harmful substances being 'exceeded,' but we currently do not even have 'standards' to exceed. It is urgent to formulate scientific and standardized industry standards."

9. Direction of Regulation and Rectification

1. Referencing regulatory directions from Europe and the U.S.

United States: Policy measures focus on reducing youth smoking rates. The youth smoking rate in the U.S. has gradually increased since 2014, driven by brands like VUSE, BLU, and JUUL. By 2019, over 5 million U.S. youths were using e-cigarettes. Therefore, in addition to PMTA, the U.S. mainly adopts measures such as flavor restrictions, raising the age limit, and taxation to reduce the appeal of e-cigarettes to youths or to increase the barriers and costs for youths to purchase e-cigarettes.

United Kingdom: E-cigarettes are seen as an important tool to reduce smoking rates, and the government's attitude is relatively open. A 2015 study by the UK Department of Health found that e-cigarettes are 95% less harmful than traditional cigarettes. According to the UK Department of Health, there is currently no evidence that e-cigarettes will become a pathway for youth smoking, and 20,000 people in the UK quit smoking each year through e-cigarettes. Based on this, UK policies focus on restrictions on content and marketing, with an overall open attitude.

2. Analysis of optimistic and pessimistic scenarios:

Optimistic scenario: It may be similar to the U.S., where a few industry leaders can obtain production and retail licenses after strict reviews; at the retail end, special licenses for e-cigarettes will be set, and advertising will follow tobacco management models. From an industry development perspective, the long-term trend remains growth;

Pessimistic scenario: It may fully follow traditional tobacco regulations, implementing production and sales monopoly systems, which would reduce opportunities for private enterprises to participate in the industry chain. However, considering employment and exports, this possibility is relatively small.

3. Domestic e-cigarette policies may generally have four directions:

1) Qualification certification;

2) Flavor restrictions;

3) Restrictions on e-liquid content or concentration;

4) Increased taxes on e-liquids/nicotine.

10. Impact of Regulation on E-cigarette Valuation and Competitive Landscape

1. Related companies' profits will be affected by taxes and price limits.

Taxes: Currently, e-cigarettes are taxed like ordinary consumer goods, with a 13% value-added tax. In contrast, tobacco currently has a tax rate of 36%-52%, which is about 3-4 times the current e-cigarette tax.

Price limits: E-cigarettes may have guided prices imposed. Currently, the maximum retail price for cigarettes cannot exceed 1,000 RMB per carton, which is 100 RMB per pack.

2. The production side will be affected.

If e-cigarettes are included in tobacco monopoly management, producers must apply to the tobacco monopoly bureau for production and obtain a "Tobacco Monopoly Production Enterprise License" before they can produce. This will significantly change the landscape of manufacturers.

The sales side will also be affected, as distribution and retail channels will change. Existing distribution and retail channels must obtain tobacco sales licenses to sell. Previously, the e-cigarette industry relied on offline retail channels without needing licenses, allowing for rapid development offline.

3. Short-term and long-term analysis

In the short term, the e-cigarette industry will face significant shocks, and the industry landscape may undergo another reshuffle;

In the long term, the industry will transition from wild growth to health, and regulation will not affect long-term growth. Once regulatory systems are implemented, the operating model of the e-cigarette industry will align more closely with traditional tobacco models, leading to intensified competition among leading companies in offline channels, while the survival space for smaller players will be further squeezed. The implementation of regulatory policies will impact e-cigarette sales, but it may also benefit leading tobacco brands by deepening their ties with leading manufacturers, enhancing future business growth certainty, or increasing industry concentration, as leading companies are better positioned to develop products that meet regulatory requirements.

11. Is the e-cigarette industry a good track to pursue?

1. Referring to the world's largest e-cigarette supplier (Smoore International), leading companies will need high-tech devices during their development process. However, domestic retail brands will need to watch regulatory trends. #p#分页标题#e#

2. In terms of quantity and price, the likelihood of increased taxes is high, which may compress profits gained from prices. If policies can guide e-cigarettes to replace traditional cigarettes, there may be some growth in quantity.

3. Smoore International has a technological advantage; it also has the ability to engage in price wars (if necessary) and strong bargaining power; 80% of its products are sold overseas (the U.S. is the main consumer of e-cigarettes).

4. Overall, the industry currently feels the main issues are regulatory uncertainty, future flow (sales channels) uncertainty, and tax uncertainty. Any policy could deliver a heavy blow.

5. From an investment perspective, one can refer to the gaming industry’s response to regulation. Since the tightening of regulations in 2018 (fewer licenses, restrictions on minors playing games, etc.), although gaming companies have improved their R&D and channel capabilities in the past two years, valuations have continued to decline. Therefore, the capital market is quite sensitive to regulation.