E-cigarettes could stub out tobacco bonds sooner than thought

Tue Jun 24, 2014 4:35am EDT
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By Robin Respaut

NEW YORK (Reuters) - The rapid growth of electronic cigarette sales poses a rising but under-appreciated risk to holders of as much as $96 billion of bonds tied to payments tobacco companies make to U.S. states from a sweeping legal settlement in 1998.

Tobacco bonds were already forecast by many analysts to begin defaulting within the next 10 years. That's because Americans have given up smoking at a faster rate than estimated when most of the bonds were sold in the previous decade.

Cigarette consumption has dropped an annual average 3.4 percent since 2000 while many bonds were structured to withstand consumption declines of only 2 to 3 percent.

But as smokers swap traditional cigarettes for tobacco-free e-cigarettes and other vaping products, the smoking rate is declining even faster and analysts now predict some bonds could go into default before the end of this decade.

"If the decline goes to 6 or 7 percent, it will be very quick," said Tom Metzold, portfolio manager at Eaton Vance Investment Managers. "I think that the first ones are probably five years away," he said in reference to defaults.

While still a small part of the cigarette market, sales of e-cigarettes and vaporizers have already grown to be worth more than $2.2 billion from next to nothing four years ago. By some estimates, they will capture more than half the smoking market within a decade, and tobacco companies are already jockeying for leading positions as that change unfolds.

"We believe consumption of e-vapor will eclipse consumption of combustible cigs over the next decade as technology improves," wrote Bonnie Herzog, analyst at Wells Fargo, who has tracked the tobacco industry for years, in a recent report.

Last month, Reuters reported that Reynolds American Inc. and Lorillard Inc., the second and third U.S. cigarette makers, were exploring a merger. Lorillard's leading blu e-cigarette brand, which has roughly 50 percent of the U.S. market, is seen as one of the appeals of the deal to Reynolds.   Continued...

A man walks past an advertisement for e-cigarettes in New York April 24, 2014. REUTERS/Lucas Jackson