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In May of electronic cigarettes, who is leaving sadly.

"In recent years, China has been implementing three major tobacco strategies, namely, large market, large enterprises, and leading brands. Policy changes will create local advantageous brands in different provinces, which overall, will be more favorable for the leading brands."

Under the influence of regulatory changes and the impact of the COVID-19 pandemic, our net income in the first quarter of 2022 was 1.7145 billion yuan, a year-on-year decrease of 28.5%.

On May 20, FogCore Technology released its first quarter report for 2022. CFO Lu Chao of FogCore Technology made the above statement in the financial report. Although under the US GAAP, FogCore Technology achieved a return to profit, the significant decline in net income and the decrease in non-GAAP net profit still left investors somewhat disappointed, leading to a 5.56% drop in US stocks that day, with a stock price of only $1.87 per ADS.

However, the two factors mentioned by Lu Chao have a macro-level impact, affecting more than just Yueke. China's electronic cigarette industry is at a crucial transitional point.

Effective May 1, 2022, the State Tobacco Monopoly Administration issued the "Regulations on the Management of Electronic Cigarettes" (hereinafter referred to as the "Regulations"), officially implemented, marking another tightening of regulation in China's electronic cigarette industry, further advancing the industry towards standardization.

Of course, this also signifies significant changes in the landscape of the Chinese electronic cigarette market, including consumer cohorts, manufacturers, retail points, advertising methods, and more.

For top brands, due to the impact of flavor restrictions, there may be a temporary decline in sales, but market share will continue to concentrate among the top brands; top 10 mid-range brands still have opportunities to survive and even expand their market share.As for tail-end brands without distinctive features and technology, they may either perish or lurk in obscurity.

End of the tail.

It's probably very difficult for anyone to accurately answer how many electronic cigarette brands exist in China. Not to mention the hundreds of workshops in areas like Shajing, Fuyong, and Songgang near the 'Vapor Valley' in Shenzhen, which produce over 90% of the world's electronic cigarettes. Just looking at the 'brand pool' of New Consumer Blue Hole, which focuses long-term on the electronic cigarette industry, includes 121 brands.

However, most of these 121 brands may be facing the fate of being eliminated.

First of all, according to Wuxin Technology's disclosure, the decline in revenue is mainly due to the impact of the epidemic on its production and transportation at its factory in Shenzhen. This means that production and transportation of over 90% of electronic cigarettes worldwide may have been affected. Large brands still have sufficient cash reserves to withstand the impact. For example, Wuxin Technology still has 4.38 billion RMB in cash and cash equivalents, so they are basically not worried. However, many small brands may face cash flow breaks and total collapse in this round of impact.

Secondly, the implementation of the 'Measures' means that electronic cigarettes and aerosols are included in the regulatory scope, supervised and managed nationwide by the State Tobacco Monopoly Administration. Afterwards, enterprises engaged in production and operation activities need to apply for corresponding certificates, obtain relevant administrative permits, etc. It seems that engaging in the production and operation of electronic cigarettes is no easier than traditional cigarettes.

How does this affect the brand landscape of electronic cigarettes? Historical experience has shown that the more requirements and the stricter the regulation, the more favorable it is for the industry to concentrate towards the top players.

Liu Dongyuan, Founder of Vitavp WeiTa Technology and Vice Chairman of the China Electronic Commerce Association Electronic Cigarette Committee, commented: 'In recent years, China's tobacco industry has been implementing three major strategies, namely large market, large enterprises, and big brands. Various local monopolies are also focusing on brands. I believe that policy changes will create local advantage brands in different provinces, overall, it will be more favorable for the leading brands. This also aligns with the policy requirements for adjusting and optimizing industry structure and strictly controlling the addition of electronic cigarette production capacity.'

Firstly, under the new regulatory policy, electronic cigarette retail outlets are no longer allowed to establish brand specialty stores, only collective stores, and exclusive operations are prohibited.In this way, small brands that previously did not have the ability to open their own offline stores also have the opportunity to enter the offline market. From this perspective, is it beneficial for the development of small brands?

Formerly employed at a leading electronic cigarette company, Star believes that small brands with strong product capabilities and special features may have opportunities. However, Liu Dongyuan still insists that brands must be centralized, with only the top ten brands having a chance to develop.

"The entire tobacco industry operates on a whitelist system, the possible outcome being that the government provides each province's tobacco administration with a whitelist. Each province then selects N brands from the whitelist to participate in each province," Star explained the future consolidation store mechanism.

When all products are sold together, what influences consumer choice are mainly brand awareness, price, and product user experience. In terms of brand awareness, top brands naturally still have an absolute advantage.Regarding pricing, Star believes that price reductions for market share grab will not occur in the short term.

Likewise, Heewoo also believes that the whitelist system is generally bullish for leading brands: "In brand selection, I believe that factors such as technological strength, product layout, past performance, etc., are all very important, and leading products have deeper accumulations in these aspects."

In addition, whether small brands can obtain the corresponding qualifications is still an unknown. Chen Zhong, chief editor of Blue Hole's new consumer magazine, believes: "After the implementation of the electronic cigarette regulations and the national standard for electronic cigarettes, I estimate that it will be very difficult for small and medium-sized enterprises to meet the national standard, or currently limited by the number of electronic cigarette production permits. Many small and medium-sized, middle to lower-tier brands cannot obtain production licenses because there are some conditions for production licenses, such as capital, various resource advantages, etc., which have relatively high requirements."

Another important factor favoring leading brands is the current level of technology, which largely determines the user experience of the products.

Liu Dongyuan stated: "Leading brands have delved deeper into technology, as they invest tens of millions or even hundreds of millions into research and development each year. Some leading brands have also achieved good results in patent output and the economic benefits of technology. Currently, there seems to be a certain differentiation barrier among companies, and in the future, the main competitive barrier will require more research and development investment and professional talent development."

Yueke won the first specialized, special and new electronic tobacco field in Guangdong, becoming the first national high-tech enterprise in the electronic tobacco field in Peking and selected for the Ministry of Technology's Torch Program. Xiwu has developed exclusive nicotine Y technology specifically for tobacco-flavored products. "In the future, with unified channels, we believe that solid exclusive technology is the strongest competitive advantage," Xiwu said.

Whether it is the current technological barriers or the financial reserves for continuous research and development and talent cultivation in the future, major brands also have advantages. It seems that the head effect in the electronic tobacco industry will become more and more significant, further squeezing out small brands.

If, as predicted by Liu Dongyuan, only the top ten brands are competitive, then many mid-to-tail brands may be nearing the end.

How long will hidden corners exist?

Do top brands eat meat, middle brands grab soup, and tail brands just wait to die? Are there any new opportunities?

Xingxing believes,For small brands, there are probably only two opportunities. The first is to prove that their products are absolutely fine and find a way to enter the domestic market; the second opportunity is to shift focus to overseas markets. "The overseas market is huge. If there are channels to go overseas, it is much better than in the domestic market," Xingxing said. "Some domestic big brands are also going global, but the products going global and local have fundamental differences, such as cotton cores and disposable (over 2000 puffs) electronic cigarettes being popular overseas, whereas domestically it is ceramic cores mainly focusing on pod changes."

"The overseas market is so large. If there are channels to go global, it is much better than in the domestic market," Xingxing said. "Some domestic big brands are also going global, but the products going global and local have fundamental differences, such as cotton cores and disposable (over 2000 puffs) electronic cigarettes being popular overseas, whereas domestically it is ceramic cores mainly focusing on pod changes."

Liu Dongyuan also believes that, at present, the overseas market is more suitable for OEM factories to operate, "However, with some countries supporting the outbound expansion of electronic cigarette brands, in the next few years, Chinese electronic cigarette brand enterprises will definitely rise in certain overseas markets".

Compared with professionals, Xiao Song, who used to part-time sell electronic cigarettes in his circle of friends, told Lujiu Finance that there is no need to worry about their survival.

"Just because you haven't heard of it doesn't mean it's a small brand. Sales channels can be through micro-business, and there are also some physical sales. Even if regulations become stricter, like traditional cigarettes, you see people messing around with both electronic and traditional cigarettes, it's not like what you see (just dead)." Xiao Song said.

Xiao Song also mentioned that there is no need to stock up on e-cigarette pods: "Now there are many counterfeit electronic cigarettes, and miscellaneous brands will not die. Just like imitation Apple earphones, they still survive well because they are cheap."

Indeed, as early as 2019, e-cigarettes were already prohibited from being sold through online channels, but in 2021, Lujiu Finance was still able to order e-cigarettes via WeChat by adding the WeChat of a Taobao merchant selling e-cigarette cases, without verifying whether Lujiu Finance was already an adult.

In May 2022, at the time of writing this article, Lujiu Finance once again ordered smoke cartridges from the physical store added previously, as the merchant was in another location and required shipping. The merchant did not verify the recipient's age before shipping.

It is clear that there are still many "hidden corners" in the electronic cigarette industry, without technology or reputation, and without channels for doing business overseas but still wanting to survive for small brands. Will they all retreat to these dark areas? Lujiu Finance believes this situation definitely exists.

Regulation cannot be achieved in one step, and not all merchants can consciously comply with regulations.However, the current direction is towards legalization and standardization, where hidden corners will become fewer and fewer until they disappear.

The Impact of the "Flavor Ban" on Major Players

The new era of the electronic cigarette industry is truly here, but in the early stages of the new era, due to the "Flavor Ban," where only tobacco-flavored pods can be sold, the entire industry will be impacted in the short term, and major brands will not be spared.

Data from iResearch Consulting shows that in 2021, among Chinese e-cigarette consumers' flavor preferences, 60.9% of respondents prefer rich flavors such as fruits and other foods, while only 27.5% prefer tobacco flavors. The Flavor Ban may temporarily cause e-cigarettes to lose many customers.

However, according to the answers to relevant questions related to the State Tobacco Monopoly Administration's "Regulations on the Management of Electronic Cigarettes" and the national standard for electronic cigarettes released on April 15th, although only tobacco-flavored pods can be produced, over 100 kinds of flavorings from the whitelist can be used to blend with the e-liquid.

Liu Dongyuan explained: "The national standard for electronic cigarettes clearly states that e-cigarettes should not exhibit characteristics or flavors other than tobacco. Our understanding of characteristic flavors should focus on primary fragrance rather than secondary fragrance. For example, taking tobacco as an example, the scent system of tobacco itself is very complex, and it also uses non-tobacco fragrances like plum and cocoa to assist in flavoring, ultimately enhancing the saturation of the flavor, but the main characteristic flavor remains tobacco."

In response to this, Xing Xing, who previously worked at a major e-cigarette company, provided a more specific example: "For flavors like banana and Powerade, if they are on the whitelist, you can make banana tobacco-flavored or Powerade tobacco-flavored pods, but if orange is not on the whitelist, you cannot make orange tobacco-flavored pods."

Soochow Securities research report pointed out that the e-cigarette industry will inevitably face an impact in the short term due to policy adjustments. However, compared to the USA, the impact of the flavor ban on the demand side may be digested within 1-2 years. According to CDC data from the USA, after the flavor ban was introduced in early 2020, e-cigarette total sales in February 2020 were 14.8 million units, a decrease of nearly 33% from 22 million units in August 2019. Subsequently, monthly e-cigarette sales showed a recovery growth trend, and by December 2021, monthly e-cigarette sales in the USA had recovered to 21.4 million units.

Therefore, the electronic cigarette industry may still be a blue ocean for companies with true technology and brand strength.

Will capital continue to foot the bill for addiction?

Data from iResearch Consulting shows that from 2017 to 2021, the compound growth rate of China's domestic e-cigarette market was 37.9%, with an expected year-on-year growth rate of 76.0% in 2022, reaching a market size of 25.52 billion yuan. It is expected that by 2025, the potential market size of China's solid e-cigarettes will be around 53.1 billion yuan to 88.5 billion yuan, while the potential market size of aerosol e-cigarettes will be around 39.6 billion yuan to 79.2 billion yuan.

The growth rate of the Chinese e-cigarette market remains high, and the current penetration rate is still relatively low compared to developed countries such as Europe, America, and Japan, indicating a large growth potential.

The e-cigarette industry is a high-profit margin industry comparable to the internet industry. In 2021, the gross margin of Wuxin Technology was 43.1%, with a 26.4% net profit margin under Non-GAAP. Even with various negative factors, in the first quarter of 2022, Wuxin Technology's gross margin was 38.3%.

High growth, high profit margins, and strong addictiveness mean that the e-cigarette industry has great appeal to capital.In just the past year, at least the parent companies of brands such as Bolide, Vitavp, Xiaoye, eos, Xi Wu, and others have received investments totaling over 1 billion yuan. Bolide has completed three rounds of financing since September 2021; eos had a single funding round in June 2021, with a high of 0.2 billion US dollars.

For Wuxin Technology which is already listed, China Renaissance, Haitong International, and other investment banks still give a 'buy' rating. China Renaissance mentioned in their research reports that due to the implementation of the 'Measures' since May Day this year, Wuxin Technology's revenue forecast for 2022 and the net profit margin forecast under the Non-GAAP basis have been reduced. However, it is expected that by 2023, Wuxin Technology will rebound, surpassing the revenue level of 2021.

The industry concentration has increased, with a temporary performance decline, seemingly giving investors an opportunity to enter the market.

Lu9 Finance consulted investors with nearly 20 years of investment experience, asking about whether the competition among investors will increase in the future due to fewer investment targets, pushing up the valuation level of the electronic cigarette industry. The investor responded, "It is inevitably overvalued."

However, Chen Zhong expressed a different opinion about capital: "Since the establishment of the reference to cigarette management in the electronic cigarette industry, I believe that capital has already ended in the electronic cigarette industry. Investing in electronic cigarettes will not generate exaggerated returns, and societal capital will no longer consider electronic cigarettes as investable projects. In the past year's financing, some were follow-on investments by existing shareholders, some were selling off existing shares. There are no particularly well-known disclosures. Perhaps if brands do not have existing shareholders to follow-on, they will not be able to continue. Therefore, existing shareholders have no choice but to continue following along."

In Chen Zhong's view,For the current top brands, electronic cigarettes seem more like a trade business, becoming a supplier, producing goods and supplying them to various regional tobacco wholesale companies, with no relationship with the retail channel, and their connection with users has become very weak.Chen Zhong is skeptical whether this pure trade relationship can achieve a market size that warrants going public.

Can investors really reject a highly profitable addictive industry? Looking at the trends since the listing of Vvay Technology, electronic cigarettes have not been popular in the secondary market. However, when the bearish factors are exhausted, and Vvay Technology's revenue and net income start to rebound, will market sentiment change? This is still an unknown.

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