How big tobacco could fill the void if vaping goes up in smoke

Health concerns and scrutiny could deliver a major setback to the e-cigarette industry. Would whatever comes next be any better for consumers’ well-being?
October 22, 2019, 10:30 AM UTC

In the early 2000s, Hon Lik’s father, a heavy smoker, was diagnosed with lung cancer. Hon, a pharmacist by training living in Shenyang, China, had a tobacco dependency of his own. That fact, along with the sobering news, spurred him to invent the device that became the precursor of most of today’s e-cigarettes. 

Hon believed that “aerosolizing” nicotine, infusing it in a vapor rather than delivering it through smoke from tobacco, could help addicts sustain their habit without risking their life from exposure to tar and toxic chemicals. Hon’s product made its debut in 2003. His father died shortly afterward, but within a few years, e-cigarettes proliferated worldwide—their rapid adoption driven by the belief that they were safer than traditional cigarettes. 

Sixteen years later, e-cigarettes and “vaping” devices represent a $9 billion business in the U.S. alone. But belief in their safety has been replaced by doubt—and manufacturers are under attack from all sides. First came scandals around the devices’ marketing claims, including allegations that e-cig makers were pitching them to children. Then came something far more grave: a recent epidemic of mysterious flu- and pneumonia-like lung illnesses, predominantly in the U.S., that appear to be connected to vaping. 

Since the beginning of summer, nearly 1,300 of these cases (and 29 confirmed deaths, as of press time) have emerged. The victims include lifelong smokers of retirement age and children too young to vote: On Oct. 8, New York Governor Andrew Cuomo announced that a 17-year-old Bronx teen had become the youngest person nationally to die of such an ailment. 

While many of the serious recent cases have been linked to the use of illicit marijuana or nicotine pods, the crisis has put the entire industry on its haunches. The Trump administration recently proposed a total ban on flavored e-cigarette pods; dozens of state attorneys general are suing e-cig manufacturers over marketing and consumer safety concerns; and regulators in huge markets like China and India are cracking down on vaping. 

To a casual observer, the e-cigarette industry’s stumbles may seem like a lucky break for old-school Big Tobacco. But to a large extent, the e-cigarette industry is Big Tobacco. With combustible cigarette use in steady decline in the U.S. and other markets, traditional tobacco companies have latched on to the opportunity to sell sexier, high-tech products that carry an aura of being, if not objectively healthy, at least healthier than a pack of Lucky Strikes. 

Subscribe to Fortune’s Brainstorm Health Daily newsletter, where we monitor advances in healthcare and biopharma.

Through partnerships, investments, and acquisitions, the tobacco giants have fielded their own nicotine ponies in the vaping race. Imperial Brands, which sells Salem and Kool cigarettes, also sells the Blu e-cig brand. British American Tobacco subsidiary Reynolds American (Newport and Camel) sells Vuse, the second-most-popular e-cigarette on the market, according to Nielsen data, with about 13% of convenience store sales. 

And then there’s the sector’s, well, crown Juul. That San Francisco startup dominates the e-cig industry. As a private company, it doesn’t report sales figures, but Wells Fargo analyst Bonnie Herzog estimates Juul accounts for around 70% of the U.S. vaping market. It’s also in business with the country’s biggest tobacco company. In December 2018, Altria—the firm that markets Marlboro—took a 35% stake for $12.8 billion, awarding Juul a $38 billion valuation.

That valuation has come crashing down in the wake of the regulatory, legal, and public blowback. Shares of Altria are down, too, by more than 25% from their spring peak and more than 10% since Sept. 1. And their conjoined woes point to the dilemma facing the whole smokeless-cigarette sector: If snowballing controversies chase customers away from vaping, who and what fill the void for Big Tobacco?

Hon Lik’s aerosolized-nicotine technology has taken on countless new permutations over the years. The earliest products were, essentially, disposable cylinders that closely resembled conventional cigarettes; then came devices that resembled pens, armed with rechargeable batteries; finally came the USB-drive-like products that Juul has made ubiquitous. These devices are modifiable, with parts that can be replaced and interchanged. That’s why Juul’s most common device can also be used to vape black-market THC cartridges. 

Those permutations make the size of the opportunity hard to pin down. “This market is hard to measure because of things like online sales, sales through unmeasured channels, including vape shops,” Piper Jaffray analyst Michael Lavery tells Fortune.  Wells Fargo’s Herzog estimates that nicotine e-cigarettes will reach $9 billion in U.S. sales this year. Marijuana vaping cartridges and pens are expected to ring in $2.5 billion in 2019 sales, according to cannabis tracking firm BDS Analytics. And that’s just the legal ones; taking the illicit THC market into account could double the figure.

What’s certain is that the market is growing fast. Between 2012 and 2016 (the most recent figures available), average monthly e-cigarette sales spiked 132%, growing to 1,547 units per 100,000 people in 2016, according to the Centers for Disease Control. By the end of 2017, Juul alone was selling 3.2 million devices each month, says the CDC. 

The Juul juggernaut not only attracted Altria’s investment but also helped prompt merger talks between Altria and Philip Morris International (PMI)—the company that Altria spun off in 2008. Those talks fell apart as the e-cig controversy swelled. Juul seems to be in retrenchment mode; it directed Fortune to a statement in which it committed to “responsible leadership” and combating “unacceptable levels of youth usage.” But Altria and PMI, which still collaborate on all kinds of tobacco products, may have a secret weapon tucked into their vests. It’s called “heat not burn” technology—and it could buoy the industry if vaping becomes untenable. 

For a man whose job is selling smokeless tobacco devices, Jacek Olczak makes buying smokeless tobacco devices sound like a huge hassle.

Olczak is the chief operating officer of PMI, and the device he’s pitching is the IQOS (“EYE-cose”), a heat-not-burn device. Such devices deliver nicotine using a pellet made up of finely ground and reconstituted tobacco. (PMI calls its version a HeatStick.) After users place a stick into the stylus device, a small internal blade heats the tobacco to a temperature hot enough to release a nicotine-laden vapor but not hot enough to set the tobacco on fire. As with a vaping device, there’s no combustion, so there’s no ash or smoke. 

The IQOS, which looks like what would result if Apple’s Jony Ive designed a ballpoint pen, made its U.S. debut in early October at a minimalist IQOS-branded store in an upscale mall in Atlanta. But obtaining one, as Olczak describes it, is no casual affair. You can order it online, Olczak says, but you have to pick it up at a store. You’ll have to prove you’re 21. You’ll also have to testify that you’re an active smoker trying to quit. You could lie about that, but PMI says customers will be asked about how long they’ve smoked, how often, and which brands they purchase—to test their bona fides. 

NEW FLAVOR: An IQOS store in Athens, Greece. The first U.S. IQOS store opened in Atlanta on Oct. 4.

“I started smoking when I was about 22,” says Olczak, a native of Poland. “I want to target adult smokers.” He also wants to build a smokeless customer base. PMI hopes to derive about 40% of net revenue from smoke-free products by 2025, up from 13.8% last year. And responsible adult use is key to the IQOS pitch: The idea is to serve up nicotine in a package that’s less prone to abuse, or to ultra-intensive use, than vaping devices have turned out to be.

Outside the U.S., the IQOS has found an audience. The device, made its debut at the end of 2014. As of last year, PMI says, there were 9.6 million users in 44 countries, with Russia and Japan among its biggest markets. The FDA cleared the device for sale in the U.S. last spring, and Altria is handling marketing and distribution in the U.S. Unlike vape rivals that have been available in candy-like flavors, the IQOS is regulated like a cigarette, and thus can sell no flavors other than regular tobacco and two menthol variants. (Mint is sold in some markets outside the U.S.) And Olczak insists most of its users are adults. “Underage use of IQOS is 0.2%, maybe 0.3%,” he says. 

It can take several minutes to recharge an IQOS device between uses—which can make the smoking experience less like lighting a cigarette and more like boiling water for tea. But cumbersome as the process seems, it has its loyalists. “Outside the U.S., people switch from cigarettes to IQOS 60% to 70% to 80% of the time,” says Lavery, the Piper Jaffray analyst. PMI says it shipped 11.5 billion HeatSticks in its fiscal first quarter this year. PMI doesn’t break out revenue, but the product could prove to be a lucrative seller—one not yet tainted by the public-health concerns over e-cigarettes.

Heat-not-burn devices raise pods of tobacco to a low heat, causing the tobacco itself to emit a nicotine vapor, but without setting the tobacco on fire as traditional cigarettes do. The heat-not-burn IQOS device (shown here) recently debuted in the U.S.

Wall Street certainly sees an opportunity. In a recent analyst note, Wells Fargo argued that the retrenchment in the e-cigarette market should incentivize Altria to aggressively double down on heat-not-burn sales.

For now, PMI and Altria aren’t being specific about their growth goals. Atlanta is the test market, Altria says, with devices and HeatSticks rolling out through pop-up sales teams and in 500 “retail trade partner stores,” mostly convenience stores. Smokers can buy a starter pack—an IQOS and a carton of 200 sticks—for $80. Olczak is careful not to overpromise on the health front. “I’m not saying IQOS is a zero-risk product,” he says. “What I’m saying is, it’s better than what’s available right now.” And even that claim, it turns out, isn’t one that PMI is legally allowed to make in the U.S. Whether it will someday do so is in the hands of the FDA.

The FDA’s oversight of e-cigarette products has been a roller coaster of regulatory catch-up and murky legal maneuvers. The agency first attempted to regulate them as drug devices, in 2009, but manufacturers successfully blocked that effort. The passage of the Family Smoking Prevention and Tobacco Control Act, which President Barack Obama signed in June 2009, gave the FDA the power to regulate tobacco products for the first time, but years of wrangling among lawmakers and lobbyists delayed any new e-cig rules. It was May of 2016 before the Obama administration instituted the first regulations, including a ban on sales to minors and a requirement that manufacturers disclose ingredient lists. 

More significant, those new rules pushed e-cigarettes closer to full regulation, requiring manufacturers to prove that their products did more good than harm in order to keep them on the market. In 2017, new FDA commissioner Scott Gottlieb, an advocate of e-cigarettes as an alternative to combustible ones, delayed those requirements, giving manufacturers until August 2022 to submit so-called marketing applications. But a cohort of doctors, public-health advocacy groups, and anti-tobacco organizations sued to block that extension, arguing that tighter oversight was needed now, not later.

The $9 billion U.S. e-cigarette business is dominated by vaping devices, which heat cartridges of aerosolized nicotine into a vapor that users inhale.

This July, a federal judge ruled for the plaintiffs. Companies must now submit public-health reviews by May 2020. After that, regulators could take another year to determine if the devices are kosher for consumers, but the industry will face a ticking clock: If manufacturers can’t prove that their products don’t make the public any worse off, they could face more strict control of sales, or even an outright ban.

Representatives for Gottlieb, who stepped down this April, did not respond to Fortune’s requests for comment. The FDA directed Fortune to an agency statement from July wherein acting commissioner Ned Sharpless said, “FDA stands ready to accelerate the review of e-cigarettes and other new tobacco products.”

PMI and Altria may be rooting for a review. They’ve been trying to get the FDA to classify the IQOS and other products as definitively less harmful than combustible cigarettes—a potential marketing bonanza. This process involves something called the “Modified Risk Tobacco Product” protocol, and it’s a bar that current e-cigarettes haven’t cleared. But some investors think the IQOS could qualify. “We believe the science supports the application for a modified risk claim,” says Lavery.

Despite the recent controversies, there’s a strong possibility that vaping-style e-cigarettes will stay on the market for years—perhaps alongside heat-not-burn. If the current spate of illnesses is eventually tied exclusively to illicit THC and nicotine products, mainstream e-cig makers may escape further restrictions. Modest adaptations could increase their odds: For instance, manufacturers may be able to create new models that make it harder to modify and interchange pods.

But some critics say the fundamental hazards of both e-cigs and heat-not-burn products run deeper. One thing both systems share is the use of propylene glycol and vegetable glycerins as “humectants” that keep other ingredients moist. Both vape pods and the heat sticks in an IQOS contain these compounds, and users inevitably inhale them. 

Research has linked glycols—a key e-cigarette ingredient—to lung damage in mice.

Glycols and glycerins are recognized as safe in food, but early research suggests that inhalation is a different story. One study by Baylor College of Medicine researchers, published in September, examined the impact of e-cigarette vapor in mice. It found that exposing mice to vapors that contained propylene glycol and vegetable glycerin led to lung damage and the buildup of certain lipids, or fats, in the lungs that could disrupt their function. Some scientists have speculated that lipid buildup is playing a role in the current vaping-illness epidemic, although there are many other factors in play. If further studies strengthen a link between these substances and lung damage, it won’t bode well for heat-not-burn. “IQOS has much, much higher levels of glycols than a regular cigarette,” says Stanton Glantz, a professor at the University of California, San Francisco.

In a statement, PMI says that the IQOS “emits significantly lower number and levels” of the harmful compounds and none of the ­carbon-based solid particles found in traditional cigarettes. “No tobacco- or nicotine-containing product is risk-free,” the company notes.

Put another way: The new smokeless cigarettes may not be good for you, but they could be worse. That may be Big Tobacco’s winning argument, even as today’s controversies test it. The industry has survived such tests before. After all, combustible cigarettes are undeniably bad for you—and in case you haven’t noticed, you can still buy them if you want them. 

CLARIFICATION: This article has been updated to more accurately explain the markets in which mint- and menthol-flavored versions of IQOS HeatSticks can be sold.

A version of this article appears in the November 2019 issue of Fortune with the headline “Up in Smoke?”

More must-read stories from Fortune:

—The 2019 Fortune Future 50: See which companies made the list
How the Fortune Future 50 identifies companies with long-term growth potential
Businesses are balancing tomorrow’s opportunity and today’s capacity
—Spotify saved the music industry. Now what?
—Inside James Dyson’s costly decision to kill his electric car
Follow Fortune on Flipboard to stay up-to-date on the latest news and analysis.