Small E Cig Vendor vs Big Tobacco Company

On Tuesday morning, Reynolds American RAI -6.87% agreed to buy rival Lorillard LO -10.49% in a $27.4 billion deal ($68.88 per share in cash and stock) that will create a credible second-place challenger to cigarette giant Altria. The deal ends Lorillard’s independent reign as the oldest continuously operating US tobacco company and brings together some iconic cigarette brands, like Camel, Newport, Pall Mall, and American Spirit.

"While difficult to predict, we think it is possible that consumption of e cigarettes could outpace traditional cigarettes over the next decade, especially given the rapid pace of innovation and consumers' demand for reduced harm products," said Bonnie Herzog, managing director, beverage, tobacco and consumer research at Wells Fargo Securities LLC. "As e-cigarettes continue to evolve and offer an experience that is increasingly similar to smoking a traditional cigarette, we think consumer acceptance and conversion will accelerate."

This is happening already. Most notably, Lorillard Inc. -- the tobacco company behind the Newport brand -- acquired blu cigs for $135 million this spring. "Considering both Lorillard and Reynolds American Inc. have dipped their toes in the e-cig waters, the next move is the Altria Group Inc.'s and we expect it to be big," she added.

In addition, she noted a parallel between e-cigarettes and the energy drink category. "We think e-cigs are to tobacco what energy drinks are to the beverage industry. Therefore, we think big tobacco needs to wake up and recognize the potential opportunity of the e-cigarette category and not make the mistakes of the large beverage companies that overlooked the potential of the energy drink category when it was in its nascent stage," Herzog explained.

On the retail end, Herzog explained that retailer feedback from Wells Fargo Securities' "Tobacco Talk" surveys has been positive around e cigarettes, primarily due to their healthy margins -- particularly given ongoing margin...