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* Sector not as attractive for private funds as it once was
* NJOY piques interest of Big Tobacco and Pharma-sources
* Gamucci close to fund raising, new product launch-CEO
* BAT says nicotine inhaler licensed as medical product
By Martinne Geller and Jilian Mincer
LONDON/NEW YORK, Sept 12 (Reuters) - As electroniccigarettes flew off shelves on both sides of the Atlantic inrecent years, investors flocked to a business some hope will bethe future for tobacco.
Now sales growth is slowing from a 2011 peak and privatefunds are more cautious about the smokeless devices, making itharder for independent e-cigarette firms to raise capital andhitting their share prices.
The entry of Big Tobacco and a push for tighter regulationhas led outside investors to question the potential of thee-cigarette market, where sales are at a modest $3.5 billionworldwide but still growing faster than for most consumer goods.
"Everybody knows regulation is coming so investors areconcerned about investing in companies that won't be able tomeet those rules," said Craig Weiss, CEO of NJOY, one of themore established e-cigarette makers, which sources say couldpursue an IPO or a takeover by tobacco or healthcare firms.
The World Health Organization last month called for bans onindoor use, advertising and sales to minors of the metal tubesthat heat nicotine-laced liquid into vapor, arguing that thejury was still out on how safe they were.
This would go further than the European Union's rule cominginto force in 2016 to ban advertising and regulate nicotinecontent, and a proposal by the U.S. Food and Drug Administration(FDA) to ban sales to minors.
"For smaller companies, it is challenging - they have toanswer for FDA uncertainty and questions about Big Tobacco,"Weiss said.
Gamucci, one of Britain's earliest e-cigarette makers, hasbeen seeking capital for about 12 months, while rival E-Litesweighed options for a year before agreeing in June to sell outto Big Tobacco's No. 3 player, Japan Tobacco.
With sales of traditional cigarettes declining in manycountries due to health concerns, almost all the major tobaccocompanies have either bought e-cigarette companies or set upin-house development.
This means the independent players must be extra nimble.
Gamucci CEO Tony Scanlan, who worked at a leading tobaccocompany for 17 years before branching out, told Reuters Gamucciis close to securing an injection of about 20 million pounds($32.4 million) and may weigh going public when it gets bigger.
It is planning a new range that is refillable rather thandisposable in line with market trends and is consideringmarketing products as medical devices, as British AmericanTobacco's Nicoventures unit is doing.
Innovation is now key to survival in a business whoseproducts have piqued consumer interest, but not loyalty.
"Last summer ... you were seeing a big build-up of consumertrial, but that trial hasn't come through to regular usage,"said Martin Deboo, an analyst with Jefferies.
He cited research showing that half of all smokers had triede-cigarettes but only 10 percent said they were regular users.
"The first generation 'cig-a-likes', from a smokers' pointof view, have only been a partial solution," Deboo said.
Lorillard, America's No. 3 tobacco firm and No. 1e-cigarette firm, said e-cigarette sales fell 35 percent to $37million in the quarter to June 30, but its retail market sharefell only 1.1 percent, which suggests the entire category shrankdramatically.
"APPLE PIE" TO "ZOMBIE JUICE"
Some vapers complain that with the slim, disposablee-cigarettes, poor vapor quality makes the nicotine hit weakerthan with tobacco, that battery life is too short, and that theyare too pricey, at as much as $15 a day for a very heavy user.
As such, they have been losing share to next-generationmodels that pack a bigger puff at a lower price in a market ofwhich 70 percent is in the United States and Europe.
"You'd be hard-pressed for someone to invest today in thesmaller, independent e-cigarette companies because it's tough toknow whether they'll ever get distribution," said a sourcefinancially involved in the sector.
"Investors are shifting their attention now, trying tofigure out what other areas they should be investing in."
One such area is so-called vaping products, a rainbow ofdo-it-yourself tanks, batteries and e-liquids.
U.S. financial services giant Wells Fargo estimates thatbusiness at $1.1 billion of a $2.5 billion U.S. vapor marketincluding e-cigarettes. Particularly bullish, it says vapingcould surpass smoking in the U.S. in the next decade.
Data gatherer Nielsen, which tracks retail sales but notonline or at specialty "vape shops", says that for the 52 weeksended August 23 e-cigarette and tank revenue in the US grew19 percent. But that was down from 125.5 percent growth forthe same period ending in 2013, 133 percent in 2012 and almost1,103 percent for 2011.
Some predict regulation may slow that down further due tofears vaping may become a gateway to smoking for kids, withe-liquids in thousands of flavors with names ranging from thequaint Apple Pie to the outlandish Zombie Juice.
A recent drop in the value of a group of e-cigarettescompanies trading mostly over-the-counter on the Pink Sheets inthe U.S. highlights the growing caution.
Nine companies had a combined market capitalization of$743.3 million at the close of trading on Wednesday, down nearly60 percent from a March peak of $1.84 billion, though still upon a year ago.
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Graphic http://link.reuters.com/tym82w
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Electronic Cigarettes International Group, by farthe largest, saw its shares close at just $5.50 on Wednesday, down from the high teens in March.
It went public in a reverse merger last year, and has sincedone a string of deals as small players seek consolidation in amarket still home to hundreds of brands.
"The key driver is that by doing this, they're better ableto compete with the tobacco companies," said Mark Winkler ofFleming Family & Partners, who advised British e-cigarette makerSkycig on its sale to Lorillard in October for 30 million pounds($49.58 million) plus future payments.
In May, Michigan-based ECIG filed for a follow-on publicoffering to raise up to $149.5 million and in July announced a$20 million investment from an arm of Egypt's Mansour Group.
Shares in the second-biggest traded firm, 22nd Century Group, have more than halved since its March high of $6.34,even though its shareholders at the time of filings this summerincluded funds managed by the likes of Vanguard, Fidelity andTIAA-CREF.
BIG TOBACCO VS PHARMACEUTICALS?
The major tobacco companies do not face the same pressure,since their investments in the sector are tiny compared with thesize of their traditional businesses and serve as a hedgeagainst declining tobacco sales.
British American, the world's No. 2 tobacco firm, set up aunit in 2011 to develop smokeless alternatives and bought UKbased CN Creative the following year. It sells an e-cigarettecalled Vype in Britain, while Reynolds American, inwhich it holds a large stake, is rolling out an e-cigarettecalled Vuse across America.
U.S. Marlboro maker Altria Group bought Miami-basedGreen Smoke for $110 million in April, and in July Lorillardagreed to sell Skycig and Blu, which it bought for $135 millionin 2012, to Gauloises maker Imperial Tobacco.
Before exploding in the last four years, e-cigarettes weresimple devices largely sold on the Internet, so even thoughthere was venture capital and private equity interest, capitalneeds were relatively modest.
Now that they grace shelves all along the high street, manycompanies must invest in slotting fees, quality control, supplychain and marketing to drive and keep market share. That crimpscash flow, making them less attractive to private equity firmswho need near-term profits to service their debt, said Winkler.
And while some independent companies may still be able tosell out to a bigger company or go public, he said there isconcern that many others may get trampled, leaving investorswith no exit strategy.
"There will be some independents who will be verysuccessful, but I anticipate that many may struggle to achievean exit at the end of the day," Winkler said.
The healthcare industry may be some help.
NJOY, which has had several fund injections from privateequity and venture capital funds and others including SiliconValley heavyweight Sean Parker, has attracted interest from bothmajor tobacco and pharmaceutical firms, according to two sourcesfamiliar with the matter. It was not clear which companies, orwhether any talks took place.
Buying e-cigarette makers may eventually make sense forhealthcare companies since they threaten the nicotinereplacement therapies offered by the likes of Pfizer andGlaxoSmithKline.
BAT's Nicoventures unit, in conjunction with Consort Medical and Kind Consumer, has had a new nicotine inhalercalled Voke licensed in the UK as a medical product, thecompanies said on Friday.
NJOY, which just launched new lines of rechargeable and vapeproducts in flavors like blood orange and butter crunch,declined to comment on any such approaches, but CEO Weiss said,"if the right type of investor approached us, I would have tolisten".(1 US dollar = 0.6203 British pound) (Additional reporting by Vincent Flasseur, Anjuli Davies andFrey Berry in London and Olivia Oran in New York; editing byPhilippa Fletcher)
