22nd Century Group (NYSEMKT:XXII) is a biotech company in possession of over 200 issued patents and 15 pending patents, basically cornering the market for genetic regulation of nicotine levels in tobacco. Revenues come from selling its own brand of cigarettes (Red Sun and the research cigarette Spectrum in the US, Magic in Europe).
Big opportunities potentially lie in Europe, where it is able to market the levels of nicotine on the package. Perhaps an even bigger opportunity lies in the US if it gets approval for marketing as a ** lowered risk cigarette, which could give the company a near monopoly on this, at least initially.
Further opportunities are present in the form of its smoking cessation aid X-22 (it is looking for a joint-venture partner already for quite some time), and in the field of marijuana, where it also has IP through a partial daughter company.
The company's finances are not terribly pretty, whilst revenues are ramping up, losses are still very substantial. Some metrics:
- Revenues from selling its own cigarettes (Red Sun, Magic, and the Spectrum research cigarettes) and contract manufacturing ramped up significantly to $8.5M.
- However, the plant is such that this still produced substantial losses, even if they declined from $15.6M in 2014 to 11.0M this year
- Operating expenses were $11.6M
- Stock based compensation was $3.6M (down from $4.5M in 2014)
Considering the heavy losses, financing deals arrive with some regularity:
- $5.6M in a direct offering in June last year
- $5.14M this month in another direct offering
The company argues it is fully financed until October 2016.
This is its American brand sold in more than 600 stores. It is a high nicotine cigarette. It might seem counterintuitive, especially given the health benefits claimed by its very low nicotine cigarettes, but high nicotine cigarettes could have significant health benefits as well.
This comes from the compensation theory, which states that smokers will smoke more to compensate for lower nicotine levels, but the reverse might very well be true also. That is, smokers might smoke less if they get their daily nicotine fix from a high nicotine cigarette. Here is CEO Sicignano on the Q4CC:
Smokers find a way to achieve about 1 milligram of nicotine no matter the type of cigarette they smoke, unless, the nicotine of a cigarette is so low as to make compensation impossible, which is true with 22nd Century's very low nicotine Spectrum, MAGIC, BRAND A, and X-22 cigarettes.
Red Sun isn't able to market these benefits anyway, at least for now (see below under MRTP designation), so it has to get its appeal from its taste and/or image. Its marketing campaign even includes the use of tattoos (already 200 people have them!), aimed at a segment of smokers that are unapologetic about smoking (basically the American Spirit brand which CEO Cicignano built before).
It's difficult to build a brand basically from scratch, but Sicignano has ample experience and a successful track record at American Spirit and he introduced some novel approaches, like the Trade Partners Program:
Under the program, 22nd Century will give $1 worth of its stock to distributors for every carton of Red Sun cigarettes they sell. Participating retailers will get $3 worth of 22nd Century stock as a rebate for every carton of Red Sun cigarettes they sell during 2015. Sell 100 cartons, get $300 in 22nd Century stock. Sell 1,000 cartons, get $3,000 in stock. If the company succeeds - and the stock goes up - the shares could be worth even more down the road. "This program is a mechanism for retailers to own stock in the brand they're helping to build," Sicignano said.
At least it is differentiating Red Sun:
22nd Century is marketing Red Sun as a super-premium cigarette - one that costs more, but one that also stands out from the mass-market cigarettes, much like craft beers are touted as an alternative to Budweiser and Miller.
It's targeting small retailers, mostly mom-and-pop store owners, trying to convince them to carry Red Sun because it gives them a cigarette brand that you won't find in 7-Eleven or your neighborhood supermarket. And as a super-premium brand, it also will be more profitable for them to sell.
It remains to be seen how this goes, but it's an interesting approach that could yield results.
These are very low nicotine cigarettes marketed in Spain in some 900 shops. The idea was also to expand in other European countries but this was held up by a bottleneck (the inability to get sufficient filters).
This bottleneck arrived at early Spanish feedback that the Magic cigarettes tasted 'too American.' Whilst for obvious reasons, the tobacco couldn't be changed, a different filter could make a difference and it chose a patented filter which also had other benefits in the form of further reducing toxicants.
But while the company is happy with the filters, problems between the American producer of these and some Eastern European suppliers prevent rapid expansion, at least for the moment.
This is a pity, as in Europe these cigarettes can be marketed as low nicotine cigarettes (in fact, they are obliged to convey the nicotine levels on the package)
This is a very low nicotine cigarette created for research purposes, and on January 26 2016, the company announced that it had shipped 4.95M Spectrum cigarettes to the National Institute on Drug Abuse (NIDA). In total, the company has delivered more than 22M Spectrum cigarettes to NIDA.
Does it add up?
While there is significant growth in selling its own brands of cigarettes, as well as in contract manufacturing, and the prospects look good if some of the bottlenecks, like the filter problem hampering European expansion, are resolved, the company had this to say:
It is highly unlikely the growth in these bread and butter businesses alone, will produce the kinds of numbers in the near-term that can substantially increase the value of our company and the market price of our stock.
That's as frank an admission as we've seen from basically any management. The guidance for this year was $12M in sales. Luckily enough, the company has other prospects. However, these prospects depend upon actions taken by third parties over which the company has little sway. Nevertheless, they are potentially very interesting. So let's discuss these.
Perhaps the most immediate upside comes from the possibility of its very low nicotine cigarettes Brand A (containing 95% less nicotine compared to conventional cigarettes) to get the Modified Risk Tobacco Product (MRTP) designation.
The company would then be able to market Brand A as such, a very low nicotine cigarette which has less health risk as it reduces addiction.
An official application was made to the FDA in December last year, and a rather substantial meeting (involving no less than 22 FDA staff members and another 20 by telephone) took place within two weeks, suggesting substantial FDA interest.
This interest was already evident from the ($10M) financing by the FDA and NIDA of a landmark study using 22nd Century's Spectrum research cigarettes that appeared in October 2015 issue of the New England Journal of Medicine.
This double blind, parallel, randomized clinical trials involving 840 smokers, found that smokers of Spectrum very low nicotine cigarettes consumed far fewer cigarettes per day and doubled their quit attempts versus smokers of cigarettes with conventional nicotine content.
There is a new Phase III study underway (August this year) with NIDA and the University of Pittsburgh involving Spectrum cigarettes and 1,250 participants testing two approaches (a gradual approach or shifting immediately to the Spectrum cigarettes with below addiction threshold nicotine levels). Here is what CEO Sicignano had to say about this:
Though we believe we know, which approach will be most effective, at the end of the day no matter which protocol prevails, 22nd Century will be the winner, because our company is the only one in the world capable of manufacturing very low nicotine cigarettes with naturally growing tobacco whose nicotine content is below the addictive threshold.
And the evidence seems to be gathering (Q4 CC):
Doctors Michael Fiore and Timothy Baker also wrote in the October 2015 issue of New England Journal of Medicine that "reducing the nicotine content of combustible tobacco to levels that will not sustain dependence seems to us to be the most promising regulatory policy option for preventing at least 20 million premature deaths". Former FDA commissioner Dr. David Kessler calls cigarettes with non-addictive levels of nicotine, "the ultimate harm reduction strategy". Tying the results of the seven extraordinary independent clinical studies that have used our company's very low nicotine cigarettes, 22nd Century has strategically and opportunistically leveraged tens of millions of dollars of clinical research conducted by outside parties to prepare our own bodies of clinical data for our company's FDA submissions.
22nd Century Group could also have a shot at MRTP status with its Brand B cigarettes, which are akin to the high nicotine Red Sun brand it is already selling. It has a 50% lower tar-to-nicotine ratio than conventional cigarette brands.
By giving smokers the same amount of nicotine with way less tar, it is expected to be less harmful for those smokers that really don't want to quit. The company plans a proof of concept exposure studies in 2016. A successful completion of that will lead to a FDA application for MRTP designation.
Any MRTP designation is entirely at the FDA's discretion, but on the other hand, the FDA also has the power for stuff like maximizing nicotine levels in cigarettes.
X-22 Smoke cessation product
Potentially, there is a really large market opportunity. Consider what a competing product, Pfizer's (NYSE:PFE) CHANTIX is achieving. Here is CEO Henry Sicignano:
Pfizer's CHANTIX there were projections that that drug would be a $1 billion a year product very rapidly. And until the products was given a black box warning, CHANTIX was in fact, I believe logging approximately $200 million a quarter. Now, even with the black box warning, and even with all the - people are becoming more and more aware of all the ill effects of CHANTIX. Even considering those things, CHANTIX does well over $600 billion a year worldwide. So it's our expectation that our X-22 product alone is a $1 billion a year potential product.
X-22 has certain advantages:
- It's a cigarette, people seem to prefer that
- It has no side effects, apart from the harmful effects of cigarette smoke
- It has been proved effective in six clinical trials
In order to bring this product to market, the company is actively looking for a joint-venture partner to fund Phase III clinical trials.
A couple of years ago, British American Tobacco (BAT) acquired a research license for 22nd Century tobacco for $7M and there is the possibility for a further $7M (in $1.5M installments, depending on BAT meeting internal milestones) and/or changing the license into a commercial license. But there were some noises on the CC that BAT was taking its time..
Given the stated target of New Zealand to basically eliminate smoking by 2025, there is a high interest in what 22nd Century can do here, mostly as the result of a clinical trial with Spectrum cigarettes two years ago.
There is an initiative to either lower the tax rate on low nicotine cigarettes or eliminate it altogether on the company's very low nicotine cigarettes. Stay tuned.
The company also has important IP via its 25% stake (and worldwide license deal and exclusive rights in the US) in Anandia Labs. This is a company which is able to vary genetically the levels of the active ingredients (cannabinoids) in hemp. This is still mostly in the research phase, although the goal is to develop strains with commercializable advantages (like having hemp with little or no THC to avoid the ban on growing it, or with high levels of THC for the medicinal marijuana market).
While even the company itself argues that the present sales trajectory isn't sufficient to get to near time profitability, and things go slower than hoped, the IP position and longer-term monetization opportunities are interesting, real and potentially large.
And while sales of its Magic and Red Sun cigarettes might not be profitable today due to the large unused capacity, sales are growing and there is plenty of opportunity for further growth. If the filter bottleneck is resolved, Magic can be sold in other European countries, and although certainly not imminent, but an MRPT status could really boost the company in the home market.
We don't expect an imminent ramp-up in the shares, but for the longer term they remain interesting.
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