Competition is clearly growing in the market for heat-not-burn cigarettes in the United States.
Yet, manufacturers remain in a legal, production and regulatory holding pattern, meaning it could be years before smokers could benefit from some of the potentially reduced-risk tobacco and nicotine alternatives to traditional cigarettes.
Unlike a traditional cigarette that burns tobacco (producing carcinogens in the process), heat-not-burn cigarettes heat tobacco leaves to release nicotine.
On Thursday, Altria Group Inc. announced it would spend an initial $150 million to form a joint venture — Horizon Innovations LLC — with Japan Tobacco to gain access to that company’s Ploom heated cigarette technology, which is already being sold in four countries.
Meanwhile, Philip Morris International Inc. announced Sept. 20 it will pay $2.7 billion to regain on April 30, 2024, from Altria the full commercialization rights to the U.S. market for its IQOS heated cigarette that had limited U.S. distribution before being shelved by an international legal dispute.
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Then there’s British American Tobacco Plc, owner of Reynolds American Inc., which has indicated plans to apply for Food and Drug Administration approval of its glo heated product that has gained a 6.2% market share of all nicotine products in Japan.
Although glo is not available at retail in the U.S., an internet search lists online shipment options into the U.S.
“Nothing that would facilitate the displacement of cigarettes with low-risk alternatives in the U.S. can happen quickly, given the FDA regulatory system,” said David Sweanor, an adjunct law professor at the University of Ottawa and the author of several e-cigarette and health studies.
“The joint venture with Japan Tobacco does not even plan to submit a premarket tobacco application until 2025. Based on past experience, it could then take years to be approved, if indeed the product is approved.”
Cowen & Co. analyst Vivian Azer said that while Altria “seemingly still has the rights to re-commercialize IQOS once PMI has product available domestically, (Thursday’s) move suggests that Altria will be pivoting its efforts to its new partner, Japan Tobacco.”
Altria’s willingness to spend $150 million to hold a 75% stake in Horizon represents a typical strategy of buying access to proven technology rather than developing its own, said Scott Ballin, past chairman of the anti-smoking alliance Coalition of Science or Health.
“Altria has always tended to acquire (or partner) with existing companies rather than spending time on internal expansion,” Ballin said.
“Some have been more successful than others,” Ballin said.
“Given everything else that is going on in the tobacco and nicotine space, this doesn’t come as a surprise.”
The foremost example has been Altria spending $12.8 billion in December 2018 to gain a 35% ownership stake in Juul Labs Inc. at a time when Juul held a 70% market share in the U.S. electronic cigarette sector.
As part of the investment, Altria discontinued production of its electronic cigarette NuMark, which had struggled to gain traction among vapers. Altria agreed to not develop and market its own e-cigarettes products for up to six years as long as Altria was providing services to Juul Labs.
On July 28, Altria disclosed it had written down its investment value in Juul Labs to an estimated fair value of just $450 million. At $450 million, the investment value is just 3.5% of the original Altria expenditure.
On Sept. 30, Altria said in a regulatory filing that it has terminated the non-compete agreement with Juul.
Altria-Japan Tobacco partnership
Both Altria and Japan Tobacco stress their belief that the heated tobacco category “remains largely undeveloped in the U.S.”
“Our extensive U.S. adult smoker research indicates that heated tobacco products can appeal to adult smokers who are seeking satisfying smoke-free products that contain real tobacco.
“We also believe that other adult smokers interested in heated tobacco will prefer a product format that is different from traditional cigarettes, such as a heated tobacco capsule product.”
Both Azer and Barclays analysts Jain Gaurav said an Altria-Japan Tobacco partnership in the U.S. makes sense considering there is very limited competitive overlap and mutually beneficial production and technology gains.
“While Altria generates a substantial portion of profits from the sale of combustible cigarettes in the U.S., the company has all but exited the e-cig market in the U.S., having relinquished its non-compete provisions (and board seats) in Juul, which is facing FDA challenges,” Azer said.
“Meanwhile, Japan Tobacco has minimal exposure to the U.S., namely through the small Logic brand in the e-cigarette category.
“While Japan Tobacco has not pursued an FDA pathway on heat-not-burn in the U.S. for its existing Ploom portfolio of products, it has been actively competing in the global category for several years,” Azer said.
An overlooked aspect of the Altria-Japan Tobacco partnership is Altria gaining access to Japan Tobacco’s global distribution network for its own heated cigarette product, known as HTC1.
Azer said final product design for HTC1 is expected by the end of 2023, with an FDA filing expected by the end of 2024. She said the manufacturers “will test HTC1 in an international market in late 2024/early 2025.”
Gaurav, meanwhile, said Altria gains “access to a heat-not-burn platform in Ploom that seems to be hitting its stride.”
“For Japan Tobacco’s part, it would gain access to the U.S. market, which it has often expressed a desire to enter.
“Such a combination would also give the companies a much larger EBIT (earnings before interest and taxes) pool over which to amortize research and development and smoker conversion cost to next-generation products, as well as the ability to much more effectively compete against BAT and PMI.”
However, Gaurav cautioned that “combining a U.S. and Japanese (team) certainly won’t be the easiest human-resources exercise.”
BAT, Altria challenges
Tobacco analysts note that BAT is playing catch-up to PMI, which has garnered the lion’s share of attention and public-health criticism with its pledge to eventually snuff out traditional cigarette sales.
Tobacco analysts say the FDA typically takes 1½ to 2 years to accept, review and make a decision on a premarket tobacco application, particularly for an industry-changing product such as heated cigarettes.
Altria chief executive Billy Gifford told analysts Thursday that “we continue to believe that more should be done to advance harm reduction in the U.S., and that the FDA should move more deliberately toward creating a marker of authorized smoke-free products to help accelerate smoker transition away from cigarettes.”
Sweanor said that U.S. regulatory policies “that slow the shift away from lethal combustibles are something Altria can publicly lament, but it is hardly an economically damaging scenario.”
Just in the third quarter, Altria reported making more than $2.8 billion from combustible traditional cigarettes, and more than $8.1 billion so far in fiscal 2022.
“The operating company income margin (a measure of profitability) is an astounding 59%,” Sweanor said.
“No other consumer products companies come anywhere close to the sustainable profitability of cigarettes — and this pricing power has been repeatedly facilitated for the cigarette business by its declared enemies” that Sweanor foremost considers as anti-tobacco advocate groups.
PMI challenges
PMI’s main challenge is establishing U.S. production of its IQOS products since Altria doesn’t have FDA authority to make those products.
The FDA approved in June 2020 PMI’s international version of IQOS as modified-risk tobacco products. It was sold as Marlboro HeatSticks in several U.S. markets, including in the Triad.
However, in November, the U.S. Trade Representative affirmed a pivotal legal victory by BAT involving its patent-infringement lawsuit against PMI.
On Sept. 29, 2021, the U.S. International Trade Commission issued a final determination of a violation of the Tariff Act of 1930 by Philip Morris USA Inc. and Altria Client Services LLC as it related to two BAT product patents.
As a result of the ITC ruling, PM USA is barred from importing PMI’s IQOS 2.4, IQOS 3, IQOS 3 Duo heat-not-burn cigarette products. It also was ordered to halt future sales of Marlboro HeatSticks in the U.S.
PMI said in February its plans are to reintroduce IQOS products, potentially under its own brand, in 2023.
“From the very beginning of us going to the FDA, we had in mind that IQOS would one day not only be sold in the U.S., but manufactured there,” PMI chief executive Jacek Olczak told Bloomberg News in February.
“It’s just happening sooner because of the International Trade Commission decision.”
PMI said “our commercial plans include full-scale launches in key cities and regions with rapid progression to a national presence, and we believe that IQOS heat-not-burn products could account for around 10% of total U.S. cigarette and heated tobacco unit volume by 2030,” Olczak said in an Oct. 20 statement.
“We are ready to invest behind IQOS to bring it to market at scale across the U.S., leveraging the proven capabilities of our outstanding commercial engine, which we will deploy domestically during the transition period to April 30, 2024.”
Azer said that Altria is playing defense in some ways with the Ploom joint venture.
“It certainly allows for a competitive response to IQOS, which has the potential to meaningfully disrupt Altria’s principal profit pool of combustible cigarettes,” Azer said.
“PMI is targeting a 10% cigarette share for IQOS in the U.S. by 2030. Given the long-time horizon on FDA approval (which PMI already has for iQos), the companies have a long road ahead to develop a product that can effectively compete against IQOS, which is the clear market share leader in Japan.”
BAT initiative
BAT is in the early stages of a transformation from traditional cigarettes to potentially reduced-risk tobacco and nicotine products.
BAT said in June it had reached 19.4 million consumers of next-generation products worldwide, up from 18.3 million on Dec. 31.
For fiscal 2021, new-category revenue, which has a heavy Reynolds influence, was at $2.79 billion, up 51.8% over fiscal 2020.
New category products are led by R.J. Reynolds Vapor Co.’s Vuse — the top-selling U.S. electronic cigarette along with glo and modern oral products led by top-selling Camel Snus and Velo.
On Sept. 10, BAT released the conclusion of a yearlong research study of 267 people in the United Kingdom that found a prominent reduced-risk role for glo compared with traditional cigarettes.
The final report was published by the Journal of Internal and Emergency Medicine.
It is the latest in a long line of smokefree tobacco and nicotine product reports posted by the Italian research group.
“The full results showed that smokers switching exclusively to glo ... achieved significant and sustained improvements in several indicators of potential harm associated with early disease development compared with smokers who continued to smoke,” according to the study authors.
“This included lung disease, cancer and cardiovascular disease.”
In July, BAT unveiled its latest attempt at closing a substantial market share and innovation gap in the heat-not-burn category with the hyper X2 version of its glo brand in Tokyo. It is not available in the U.S.
How glo hyper X2 performs will be critical for BAT, considering that Japan is the top global market, representing about 85% of heat-not-burn traditional cigarette sales.
The hyper X2 version offers “advanced induction heating technology in a smaller, lighter weight device ... with a separate boost function for faster heating,” the company said.
Kingsley Wheaton, BAT’s chief growth officer, said hyper X2 “marks another key milestone in our transformation as we build the brands of our future.”
“Since launching our first glo product in Japan in 2016, we have built glo into a billion-dollar global brand through our deep consumer insights, science and innovation.”
There are plans for hyper X2 to be rolled out in the other 24 global markets in which glo products are sold.
‘Deep skepticism’
As BAT highlights how its efforts are increasingly in line with public-health goals to reduce U.S. and global traditional cigarette consumption, it continues to face deep skepticism from anti-tobacco and public health advocates.
Most anti-tobacco advocacy groups scrutinize smokeless innovations to determine whether they could serve a public-health benefit — or work as gateway products to cigarettes, particularly for youths.
In January 2020, then-U.S. Surgeon General Dr. Jerome Adams released a 30-year update on smoking-cessation efforts that provided a mixed message on the effectiveness of electronic cigarettes.
E-cigarettes are not currently approved by the Food and Drug Administration as a quit-smoking aid, and are not considered as safe products for any user.
“E-cigarettes, a continually changing and diverse group of products, are used in a variety of ways,” Adams said in the 20-page consumer guide.
“Therefore, it is difficult to make generalizations about efficacy for cessation based on clinical trials involving a particular e-cigarette. More research is needed on whether e-cigarettes are effective for smoking cessation and to better understand the health effects of e-cigarettes.”
Adams also noted the need to “connect with smokers where they are.”
BAT has said it believes the cumulative nature of the report will “show that, over the past decade, the number of people who incorrectly believe vaping is as harmful or more harmful than smoking conventional cigarettes has risen in the UK, Europe and the U.S.”
“This is despite several scientific reviews, published in the same period showing, that vaping products manufactured in accordance with quality standards present less risk to health than cigarettes.”
“The scientific evidence is clear — but consumer misperceptions remain,” BAT said.