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    Tobacco Analyst Breaks Down Possible Deeming Effects

    E-cigarette industry could see further consolidation.

    NEW YORK — Most of the tobacco industry agreed with the Food and Drug Administration's (FDA) plan to regulate electronic cigarettes and vaping products. However, very few are happy with the final deeming rule and its provisions. And just what impact the regulations have may depend on where you stand on the manufacturing scale.

    "It is a misnomer to refer to what the FDA is doing as 'regulation,'" said Gregory Conley, president of the American Vaping Association. "This isn't regulation; it's prohibition for all but Big Tobacco and perhaps a couple of companies with big Wall Street investments."

    Analyst Bonnie Herzog noted that "while the final deeming e-cigarette regulation brings much-needed structure and oversight to the e-cig/vapor category, there is little doubt the cost and complexity of compliance overwhelmingly favor big tobacco (the goose) at the expense of smaller, less well-funded players (the gander)."

    Herzog, managing director of tobacco, beverage and convenience store research at Wells Fargo Securities LLC, added Altria Group Inc. and Reynolds American Inc. (RAI) were prepared for the changes, with RAI launching several new VUSE formats before the Aug. 8 effective date and Altria reaching an agreement with the FDA over the descriptor ban on its Black & Mild cigar brand.

    She added Richmond, Va.-based Altria and Winston-Salem, N.C.-based RAI are actively engaged with the FDA on a number of critical issues that could have longstanding effects on innovation, the promotion of healthy competition, and ultimately consumer choice. 

    "Both Altria and RAI appear well prepared to comply with the FDA's deeming regulations, if not benefit from potential category consolidation. That said, the companies are rightfully taking the longer view as they actively work with the FDA to ensure a rich environment for innovation and healthy competition," Herzog explained.

    In addition to multiple lawsuits and legislative action pending, Herzog believes the top two tobacco companies lend "considerable weight" to current stakeholder discussions with the FDA to rethink some of the more strident areas of the regulation. 

    "We were pleased to hear both companies reporting the FDA is 'open to listening,' 'not immune,' and 'more straightforward' than it would appear," Herzog said. "As such, we are increasingly optimistic that the ultimate outcome won't be as deleterious to the category or as burdensome as we originally feared."

    As for further implications of the deeming rule and its provisions, Herzog expects to see a continued shift in consumption of e-cigarettes and vapor products back to combustible cigarettes as e-cigarette choices become more limited. She added this is "a net 'win' for big tobacco."

    In addition, Wells Fargo Securities expects the e-cigarette and vapor industry will see further consolidation, and, as a result, manufacturers' pricing power and retail leverage will increase with Atria and RAI best positioned given their scale and capabilities. 

    However, Herzog noted the main concern is the effect the deeming rule will have on innovation, which could slow industry growth by disincentivizing consumer conversion from combustible cigarettes to e-cigarettes.

    "This ultimately has a net negative impact on public health, which is clearly in direct opposition to the FDA's goal," Herzog said. "However, we have reason to be more optimistic given actions being taken by both Altria and RAI to soften the current limitations of the deeming regulations on innovation."

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