BAT bets on vaping as tobacco giants battle with new devices

London - Trailing Philip Morris International in the contest to move smoking alternatives beyond e-cigarettes is just fine with British American Tobacco [JSE:BTI].

According to Kingsley Wheaton, head of BAT’s next-generation products, longer-established electronic smokes hold more promise than the heat-not-burn technology pioneered by its main rival.

The high acceptance of Philip Morris’s iQOS tobacco device in its debut market of Japan won’t be easy to replicate elsewhere, he said in an interview Thursday.

“Are we behind Philip Morris on the tobacco-heating journey? The answer is yes,” Wheaton said. “But we have a different take. Vapor is going to be a bigger category worldwide.”

More than 1 million smokers have switched to Philip Morris’s iQOS since it first went on sale in 2014. Demand has proven strongest so far in Japan, where Philip Morris has had a two-year headstart on BAT.

While analysts at Exane BNP Paribas and Wells Fargo say the Marlboro maker has invented the most promising smoking substitute, BAT contends that heat-not-burn will only become dominant in a few countries, and that Japan alone may represent as much as half of the potential demand.

“Japanese consumers are very tech-savvy and vapor is banned,” Wheaton said. “The consumer is highly socially considerate and really worried about their hygiene impact on others. When you put all that together, you create a real melting pot of reasons why tobacco heating will work in Japan.”

Companies divided

Tobacco companies are divided on where the future of their $770bn industry lies. Philip Morris CEO Andre Calantzopoulos has said his company may one day stop making traditional cigarettes as the market for alternative products takes hold. His non-combustible iQOS devices have taken a 5% share of the Japanese market.

Heated tobacco will be the main driver of growth in next-generation smokes over the next few years and BAT is falling behind in the race to grab market share, according to Jefferies analyst Owen Bennett, who said BAT’s clinical trials to prove its products carry lower health risks than cigarettes won’t be completed until mid-2018.

Philip Morris plans to file its reduced risk claims with the US Food and Drug Administration by the end of the year.

Bennett said BAT may fall further behind when Philip Morris releases the second version of iQOS, which resembles smoking even more as it’s activated by lighting the tip of the device.

These issues could be solved through the acquisition of Reynolds American Inc., a deal which BAT proposed in October to create a “world-class pipeline of vapor and tobacco heating products.” Reynolds has its own heated tobacco product, Revo 2, and has completed clinical trials.

“BAT would go from trailing Philip Morris to potentially leading,” Bennett said.

Reynolds is said to have rejected BAT’s $47bn bid to buy the 58% stake it doesn’t already own, with talks continuing over price.

Vype raptor

For now, Wheaton said the bulk of BAT’s efforts will remain in the vapor market.

In the second half of next year, BAT will start selling a new product called Vype Raptor. The device gets nicotine into the bloodstream faster and more closely mimics the sensation of smoking because the vapor particles are larger, according to BAT.

The company is also opening a store in a fashionable neighborhood of Milan as well as pop-up shops in London to sell Vype-branded vapor products. And it will introduce a $23 brightly-colored plastic device called Pebble that delivers nicotine infused with flavors such as wild berry and smooth vanilla. 

BAT aims to sell vapor products in more than 15 markets by the end of next year, according to next-generation marketing director Frederico Monteiro. It currently has a presence in 10 and plans to be in 30 to 40 markets by 2020.

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