Executive Summary: Vapor Corp (NASDAQ:VPCO) is at the forefront of an emerging business in the sales of electronic cigarettes and product derivatives and is the only fully reporting, public traded e-cigarette company in the United States. The company is flush with cash, has turned from losing money to booking gains, has expanded into major retailers product offerings. With the ever growing number of traditional tobacco smokers switching to these healthier alternatives, a future buyout is likely should they take market share from major tobacco companies. A large 15% pullback has offered a lucrative entry point following a wise reverse split decision by management giving investors the moderate risk, high reward play.
In this article I will discuss some of the business highlights of Vapor Corp., a leading supplier of electronic cigarettes (e-cigs) with a diverse product portfolio that includes the most recognized brands by both retailers and consumers in the industry. I will briefly discuss recent quarterly performance, a promising conference presentation and then the impact of the just announced reverse split of shares. Thus far, VPCO is the only fully reporting, publicly traded e-cig company in the U.S. Vapor's leading brands include Krave, Fifty-One, Green Puffer, Americig and Vapor-X, among others. To my knowledge, VPCO is the only company to successfully employ a multiple brand business model for the sale of e-cigs. Its products are available online, on television, and at retail locations across all levels/channels of retail throughout the United States. The company tends to hire former celebrities who used to smoke to advertise their products.
The company reported Q3 2013 results on Oct. 21. These are the important takeaways and metrics to look for in the upcoming quarterly report. First how are sales? In the quarter net sales exceeded $6.4 million, an increase of approximately $2.6 million, or approximately 66.3% from the comparable year ago quarter. One slight concern was that the cost of goods sold increased 56% to nearly $4 million as compared to approximately $2.5 million for the comparable year ago quarter. The mostly positive results were primarily attributable to increased sales volume, product mix and lower average cost per unit through higher volume purchases from suppliers. I was impressed with margin expansion. Gross margins increased to 38.9% from 35.1% in the comparable 2012 quarter. Further operating income turned positive for the quarter. Operating income was $393,282 compared to an operating loss of $1,252,086 for the same quarter in the prior year. This led to net income for the quarter of $280,827 compared to a net loss of $819,010 for the comparable 2012 quarter.
Getting Advertising Costs Down Then a Well Timed Increase in Advertisement
So we see that sales in the quarter were up but the company must have spent money to make money right? WRONG! In my research for this article I was really impressed that sales were up so sharply while at the same time, advertising expenses decreased approximately 50.3% to approximately $0.4 million for the quarter ended September 30, 2013 compared to approximately $0.8 million in the comparable 2012 quarter. The company decreased internet advertising, print advertising campaigns, and new television direct marketing campaign for the Alternacig brand and continued various other advertising campaigns. However the company anticipates that advertising expense will increase in the fourth quarter of 2013 as it re-launches the television direct marketing campaign for their Alternacig brand and as the company re-launches its flagship KRAVE brand. This increase is well timed to promote the new product.
Recent Promising Presentation
VPCO President Jeffery Holman recently presented at the annual LD Microconference on December 3rd. This conference is for small and micro-cap companies to present their business models to prospective investors and analysts. Some highlights to be made aware of were that VPCO's Vapur is the most popular e-cig brand in Canada with a 70% market share. VPCO has a number white label brands sold to locals by Indian reservations using VPCO products, offering a new way to reach additional customers. Impressively, the company has achieved 10% market penetration with products at over 60,000 locations nationwide. However, on a global scale, there is a lot of room for growth. In fact, about 90% of the retail market is still available for expansion. It was also announced that products would be offered at Family Dollar (NYSE:FDO) in addition to other national chains. In fact, on December 20 VPCO announced the sales with FDO. Krave King tobacco and menthol flavored products are now available at all 6,600 FDO stores nationwide where tobacco is sold. Krave King will be the first electronic cigarette sold at FDO and will sell for $5.99 per pack. The impact of this move for VPCO cannot be understated.
Recent Capital Raise
The recent capital raise has dramatically improved the company financially and its potential for growth in the future. VPCO is flush with over 9 million dollars in cash on hand to support its balance sheet and to support growth and expansion. The capital is already being deployed. The capital raise has created significant insider ownership as the holders of the VPCO's approximately $1.7 million of outstanding senior convertible notes, some of whom are officers and directors of the company, converted in full all of these senior convertible notes into approximately 3.9 million shares of VPCO common stock. As a result, management has its own money at stake.
What is Going on Today
Today shares are being slammed. Down 15% to $1.42 as I write. Why? Well the company, in an effort to seek NASDAQ listing and attract institutional investment dollars has announced a 1 for 5 reverse split.
When The Reverse Split Will Occur And What Will Happen to Your Holdings
Investors aren't pleased with this split. They may feel it is dilutive or somehow a punishment. Then again, the stock has surged up from $0.20 and has pulled back from the $2.00 mark. I want to explain a bit about what happens during a reverse split and highlight the implications for VPCO shareholders. I will also weigh in on what investors should do with VPCO ahead of the split. First, it is important to note that no other company, tobacco competitor or index fund will be affected by this split. The reverse split will be conducted at a ratio of 1 for 5 and will apply to shareholders of record at the close of the markets on December 26, 2013; shares will begin trading at the adjusted price December 27, 2013. The ticker symbol for the fund will change to VPCOD for 20 business days, after which it will revert back to VPCO. A new CUSIP number will be issued. The reverse split will increase the price per share of the fund with a proportionate decrease in the number of shares outstanding. In a 1 for 5 reverse split, every five pre-split shares held by a shareholder will result in the receipt of one post-split share, which will be priced five times higher than the value of the pre-split share. The following example best illustrates what to expect:
Example 1: If you hold 10,000 shares of VPCO priced at $2.00 each, then after the reverse split you will hold 2,000 shares valued at $10.00 each. As you can see, the reverse split does not change the value of a shareholder's investment, it still remains $20,000.
VPCO Fractional Shares?
One of the common issues with reverse splits is the potential creation of fractional shares. Shareholders who have quantities of shares that are not a whole number with an exact multiple of the reverse split ratio will be left with what is known as a fractional share. A fractional share will be created and affect any shareholder who does not hold a number of shares that is a multiple of four. After the reverse split occurs, fractional shares are generally redeemed for cash and sent to your broker of record, generally within two to three weeks post-split. However, VPCO is taking a different approach. If fractional shares are created, then VPCO will round the fractions up to a full share and issue a whole number. Thus, investors win on this deal (even if it only means a couple of dollars).
There Aren't VPCO Options
You should be aware that holders of options contracts are usually impacted but VPCO does not have options given its listing and small cap nature.
Takeaways From The Split
I like this reverse split. Often they are done when a company's stock has been decimated and the company wants to remain listed on an exchange. In this case, the stock has done very well this year and I think is a great low to moderate risk, high reward play. In fact, buying pre-split (if you believe the company will continue to execute), can be advantageous because even though your investment value doesn't change, a higher price does tend to attract more volume and more money. To bring the product to an investment price that VPCO believes is more attractive, it is conducting this reverse split. No fractional shares will be created; the company will round up your fraction and issue a whole share. My sentiment is to buy common stock ahead of the split. I think it has the potential to the number of potential investors and future equity analyst coverage. Shareholders should benefit through less volatility in the share price, lower transaction costs and greater liquidity.
Risks To The Company
Although VPCO is on the forefront of a whole emerging market into E-cigs, it is not without risks. It faces stiff competition from Blu which is made by Lorillard (NYSE:LO), and is still not in the top ten of recent Nielsen ratings for online sales. However, sales of e-cigs are projected to grow to around $1.8 billion. VPCO has a lot of room to improve, and I see this as a positive development. During the most recent period, blu boasted a 45.6% dollar share (up 40.1% from this time last year) and a 37.2% unit share in the c-store channel. The Nielsen data is also beginning to provide clarity on the top three -- if not the top five -- e-cig players in the c-store channel. In terms of dollar share, NJOY remained in second with 21.6% share, Logic in third at 17.8%, with 21st Century and Nicotek rounding out the top five While blu was the clear leader for unit share as well, Logic moved into second place with a 19.8% share; NJOY (18.8%) was in third, followed by CB Distributors (7.1%) and Nicotek (4.7%). Thus VPCO has a lot of work to do. That said, they can only move upward. The company is young and in a stiff market. The next few quarters of data will be critical to the company.
Further the political risks are substantial. Right now there are almost no e-cig regulations and this will change for political or fiscal gain by municipalities. New York State and more specifically, New York City are likely candidates for the first to implement new regulations. New York City is already on the "ban them" bandwagon. It could impede sales for all competitors.
Management of VPCO has done well thus far and especially this year. That said, they do not have any top tobacco execs or experienced tobacco sales staff on the management team. This is a touch concerning, despite recent performance.
VPCO is a little guy in this space right now. However, if the e-cig market gets big enough to matter, the tobacco companies will move in and start aggressive takeovers. Altria (NYSE:MO) is looking into getting further into the space given the recent positive trends in e-cig sales. If this pattern continues and the market for e-cigs grows VPCO won't be able to compete. It is likely they would be bought out for a hefty premium and absorbed into a larger tobacco company's existing structure.
In conclusion, VPCO has had a great year. Often a reverse split is done to stocks that have been obliterated. This is not the case with VPCO. Shares currently are trading at $1.42. I personally believe the stock is a buying opportunity for long-term investors looking for exposure to the growing e-cigarette market. It offers a greater risk/reward play than purchasing a larger LO or MO. Although the latter offer stability and dividends, VPCO offers a substantial opportunity for investors. Sales are higher, the deals are stronger, the macro environment is positive and the pending reverse split could attract institutional dollars. A move to the NASDAQ would be a huge plus for the company trying to gain exposure, and will offer shareholders less volatility versus its OTC listing and low share price. Should the e-cig market continue its growth, larger tobacco retailers will have no choice but to start picking off smaller companies with existing product lines and lucrative deals. VPCO would be a great target. My sentiment, buy under $1.50 and ahead of the split.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in VPCO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.