When I look for a Big Stock, I want to see a company that has a competitive advantage in a major investing wave. This wave can be created by disruptive technology, extensive intellectual property, or a government mandate...or fortunately in this case, all three.
22nd Century Group Inc. (NYSEMKT:XXII), with a market capitalization of approximately $30M, has proprietary technology, products and IP that is set to disrupt an $80B industry in the U. S. alone, and the $700B plus global market.
Over several years with multiple R&D partners, XXII has patented all of the key genes in the tobacco plant responsible for nicotine production. This technology allows for the level of nicotine in the tobacco plant to be dramatically decreased or increased. The resulting tobacco is grown and processed exactly like conventional tobacco. Non-GM (genetically modified) tobacco has also been produced with this patented technology. At present, 22nd Century is the only company in the world capable of manufacturing tobacco cigarettes with less than one-half of one milligram of nicotine. Marlboro® Camel® and Newport® have about 15 milligrams of nicotine. (The major brands contain in excess of 20 times more nicotine.)
This technology and XXII, have the potential to be worth billions.
XXII has 105 issued patents in 78 countries where 75% of the world's smokers live. They also have 38 pending patent applications. The company's technology produces a monopoly on both the world's lowest nicotine tobacco and the world's highest nicotine tobacco, while preserving all other tobacco leaf characteristics which are important to a cigarette's taste.
Proven technology and patents that disrupt a $700B plus industry...it doesn't get much "Big"ger than that. This isn't just a concept either, XXII has already produced and grown its proprietary tobacco for 4 years and has sold cigarettes containing varying levels of nicotine -- from very low to high. In 2013, the company plans to launch its RED SUN® super-premium cigarettes nationally.
22nd Century products address unmet needs of smokers: for those that want to quit, an innovative smoking cessation aid, and for those who decide to continue to smoke, cigarettes that can reduce the level of exposure to nicotine, "tar" and other chemicals in cigarettes. (Source: Dr. Elemer Piros, May 2011)
The company has 5 revenue models. (market in red)
1. Two "modified risk" cigarette candidates for F.D.A. clearance: BRAND A, a very low nicotine (VLN) cigarette and BRAND B, a very low tar-to-nicotine product (Modified Risk Products)... $80B U. S. and $700B globally
2. A prescription smoking cessation aid in development (X-22)...$1.5B U. S. and $4B globally
3. Super premium cigarettes (Red Sun® and Magic®) …just 1% of the premium U.S. market is valued more than $1B - Lorillard (NYSE: LO) only sells cigarettes in the U.S.; has 14% market share and $15B market cap
4. Huge licensing opportunities (105 patents in 78 countries and 38 patent applications) to both Big Pharma (prescription X-22) and Big Tobacco (technology and tobaccos for modified risk tobacco products...Multibillion dollar opportunity
5. A 5-year U.S. government contract with NIDA, a department of the National Institutes of Health (NIH) to sell its SPECTRUM® research cigarettes that contain various nicotine levels (from very low to high).
New regulations could make XXII a monopoly
In 2009, the Tobacco Control Act granted the F.D.A. regulatory control of ALL tobacco products, and established procedures for less harmful products to be marketed as Modified Risk Tobacco Products. In June 2010, the F.D.A. banned the labeling or marketing of "light", "ultra light" and "low tar" cigarettes. In March of this year, the F.D.A. issued Modified Risk Tobacco Product Applications Draft Guidance. The very next month, XXII announced that applications would be filed for two types of proprietary modified risk cigarettes in accordance with the F.D.A.'s March 30, 2012 Draft Guidance.
A Bank of America/Merrill Lynch analyst published a report on Modified Risk Tobacco Products (MRTPs) highlighting the impact that it will have on the $748B annual worldwide tobacco industry. Louis Camilleri, the CEO of Philip Morris International called this:
"the very real potential to not only be a game changer, but also be the key to unlock several hitherto virgin territories, most notably the huge Chinese market".
It is expected that the China National Tobacco Corporation (CNTC), the Chinese tobacco monopoly that is one of the most profitable companies in the world, to eventually be sold to a Big Tobacco transnational. Yes in China, the world's largest cigarette market, XXII owns exclusive rights to 6 issued patents and 4 patent applications.
Due to smoking behavior, XXII's BRAND A and BRAND B cigarettes reduce exposure to whole tobacco smoke, not just limited smoke toxins! This is a key reason the company expects their cigarette brands will be the first to be authorized by the F.D.A. as Modified Risk Products. Why do they feel that confident? XXII already has a 5-year contract with the government to supply modified nicotine cigarettes. The U. S. Government is buying the company's SPECTRUM® cigarettes for independent research purposes.
Harvard Professor of Public Health and former member of the F.D.A. Tobacco Products Scientific Advisory Committee (known as TPSAC), Dr. Gregory Connolly, is also publicly calling for the F.D.A. to mandate a massive reduction of nicotine levels in cigarettes to approximately 0.3 milligrams per cigarette.
XXII is the only company in the world that can, and has, produced tobacco cigarettes with this tiny amount of nicotine. They also have protected this process with their extensive intellectual property portfolio.
A $300M PROJECT
According to internal documents which are now available on the internet, Philip Morris USA invested approximately $300M on a project to extract nicotine from tobacco using supercritical carbon dioxide extraction technology; the same process used to make decaffeinated coffee. If the biggest U.S. tobacco company spent $300M just trying to extract nicotine, can you imagine what kind of valuation XXII should have? 22nd Century Group has already successfully demonstrated the ability (as well as products) to increase and decrease nicotine at the tobacco plant level - a much more efficient basis that leaves taste and aroma characteristics of the resulting products intact!
As Philip Morris discovered, extracting nicotine from tobacco destroyed the integrity of the tobacco leaf and resulted in cigarettes that tasted horrible. Furthermore, this process could not match the nicotine levels achieved in XXII's superior process.
If the F.D.A. mandates drastically lowering nicotine levels in all commercial cigarettes, or if XXII is authorized to market its cigarettes as "Modified Risk," the company would have MASSIVE licensing opportunities both domestically and internationally. The F.D.A. regulates tobacco marketing in the U.S., but many other countries (without such regulation) have expressed interest in offering these cigarettes. That demand has attracted the interest of several big tobacco companies, as clearly evidenced by Philip Morris' $300M previous efforts.
Until the F.D.A. approves XXII's products as Modified Risk, there is still a $650B plus market in the world that is eager for this company's technology and unique tobacco products. There are many countries looking for a less harmful cigarette that doesn't require government approval as in the U. S.
While we are never big fans of waiting for any government regulatory approval to determine the success of a company, we think the market is so big for this disruptive technology in other countries without government regulations as in the U. S., that it offers an enormous opportunity beforehand, and even more so if/when the F.D.A. does approve of BRAND A and BRAND B as Modified Risk Products.
A story in The New York Times, http://www.nytimes.com/2011/10/29/health/research/cigarettes-are-being-used-in-studies-to-help-smokers-quit.html?_r=1& gave the company a little exposure, but a recent financing where insiders purchased a massive amount of stock has us thinking the company is close to a very large tipping point.
In 2011, 22nd Century began actively pursuing licensing agreements with major pharmaceutical and tobacco companies. In their Investor Presentation (November 2012), they list "potential out-licensing technology to tobacco company partners" as a Q1 2013 milestone. I believe a licensing deal of this type would drastically change the tiny nanocap's valuation.
I feel the major tobacco companies won't --and really can't -- wait for F.D.A. approval to begin marketing this technology in other countries such as China and India, where the number of smokers is many times that of the U. S.
The world's most effective smoking cessation aid?
The company's lead product, X-22, is potentially the world's most effective smoking cessation aid, as evidenced by an independent University of Minnesota Masonic Cancer Center Phase 2 clinical trial which produced a 47% quit rate. It has been called the "holy grail" of the smoking cessation industry. X-22 contains the lowest nicotine content of any cigarette in the world.
-consists of very low nicotine (VLN) cigarettes which have 95% less nicotine than leading "light" cigarettes
- satisfies smokers' craving for cigarettes while reducing nicotine exposure and dependence
- represents the first product that breaks the association between the act of smoking and delivery of nicotine.
X-22 is more attractive to smokers than other therapies since it smokes and tastes like a typical cigarette, involves the same smoking behavior, and does not expose the smoker to any new drugs or new side effects!
In effect, the six-week treatment calls for the same smoking behavior to which smokers are accustomed - and facilitates a 47% quit rate! Furthermore, as demonstrated by the Minnesota Trial, even the smokers who do not succeed in quitting, are actually able to reduce their daily cigarette consumption by 36%.
All independent clinical trials with very low nicotine (VLN) cigarettes for quitting smoking have increased quit rates, whether VLN cigarettes are used alone or concurrently with nicotine replacement therapy (NYSE:NRT), such as nicotine gums, patches and lozenges:
Two potentially huge catalysts for XXII in Q1 2013 are the results of 2 additional completed smoking cessation clinical trials:University of Minnesota Masonic Cancer Center Follow-up - Phase II - 219 subjects
· Follow-up study to Hatsukami et al. 2010; Dr Hatsukami is 1 of 9 voting members of FDA's Tobacco Product Scientific Advisory Committee (TPSAC)
· ClinicalTrials.gov Identifier: NCT01050569
· Evaluating quitting results of six-week treatment period among: (i) exclusive use of a VLN cigarette (a version of X-22 with slightly higher nicotine content provided by 22nd Century); (ii) 21-mg nicotine patch; and concurrent use of VLN cigarette and nicotine patch
· Trial included a 6-month follow-up periodI found this paragraph in the 10/28/11 NY. Times article very encouraging:
Tests so far on the experimental cigarettes are encouraging enough that Dr. Hatsukami is going into a Phase 3 clinical trial. That means Phase 2 trials have proven effectiveness on humans. Phase 3 measures both effectiveness and safety. 22nd Century is also planning to start Phase 3 trials next yearQueen Mary University of London, in collaboration with Pfizer - 200 subjects
· ClinicalTrials.gov Identifier: NCT01250301
· Evaluating whether the use of a VLN cigarette (same version of X-22 used in above study) in combination with Chantix® (or NRT) increases quitting over use of Chantix (or NRT) alone
· Chantix® is branded as Champix® outside the United States
XXII will evaluate results and data from these recently completed independent clinical trials that utilized the company's proprietary VLN cigarettes to determine which variables optimize quitting. Upon completing analyses of these trials, the company intends to conduct its own Phase III clinical trials.
A few years ago, GlaxoSmithKline and Novartis each signed licensing deals for developmental nicotine vaccines with Nabi Pharmaceuticals and Cytos Biotechnology, respectively. The GSK deal entailed a $40M non-refundable upfront payment to Nabi, plus an additional $460M in milestones and royalties on global sales of NicVAX. The Novartis deal included a $35M upfront payment, up to $600M plus in milestone payments and royalties.
These two nicotine vaccine treatments require 6 or 7 consecutive monthly injections and boosters in just 18 months. Most importantly, shortly after these upfront payments by Glaxo and Novartis, both of these nicotine vaccines failed to show efficacy in clinical trials. Both nicotine vaccine programs are now dead.
Even if these vaccines demonstrated efficacy, X-22 seems to be vastly superior to these vaccines since X-22 is much less invasive - simply switching to a VLN cigarette for 6 weeks versus going to the doctor's office for up to 7 months in a row.
Taking this these deals into consideration, the value of just the X-22 portion of XXII dwarfs the company's current market cap.
A prominent analyst believes that just XXII's X-22 product alone could reach sales of $1B by 2017. That figure does not include revenue from the 4 other revenue streams outlined above. Source (http://www.xxiicentury.com/home/files/XXII_Initiation-5-16-11-restricted.pdf)
XXII is in a unique position considering BOTH tobacco and pharmaceutical companies are chasing this company for licensing opportunities. To best position 22nd Century Group for out-licensing and future buyout opportunities from Big Pharma and Big Tobacco, the company created two dedicated wholly-owned subsidiaries, Hercules Pharmaceuticals for the pharmaceutical side and Goodrich Tobacco for the tobacco manufacturing side. Pfizer is collaborating on a smoking cessation clinical trial evaluating X-22 in combination with one of their largest selling drugs; Chantix®: http://clinicaltrials.gov/ct2/show/NCT01250301
I can imagine doctors actually prescribing XXII's unique smoking cessation cigarette, X-22, to get smokers to quit, because many independent studies have shown it's THAT EFFECTIVE, and most smokers have already failed using currently-approved therapies.
The second mouse gets the cheese
In 1999, XXII exclusively sublicensed their first-generation proprietary technology and VLN tobacco to the fifth largest cigarette company in the U.S., Vector Group Ltd. As part of this licensing agreement, XXII agreed not to grow VLN tobacco or market VLN cigarettes using this proprietary technology.
In 2003, Vector launched a "step down" cigarette called Quest® using XXII's technology and tobacco in eight states to gather data for the F.D.A. approval process of using Quest® as a smoking cessation aid. The "step down" Quest® product had three brand styles that had the same tar yield but decreasing nicotine yields, with the last step being the "nicotine free" cigarette. Vector completed a successful Phase 2 trial in 2006 and reassured their intention to proceed to Phase 3 trials.
A few months later in August 2006, Vector filed an 8-K announcing they would be terminating their genetics operation and would no longer pursue the F.D.A. approval of Quest® as a smoking cessation product:
Why? I believe the company was shopping itself to Imperial Tobacco, the fourth largest transnational tobacco company and, at that time, the idea of having a smoking cessation product in its portfolio wouldn't add value. One week before this 8-K was filed in August 2006, Vector announced that it was restating earnings for the last two+ years resulting in higher earnings of $8.1M:
Six months later, in February 2007, Imperial Tobacco purchased not Vector, but Commonwealth Brands, a U.S. cigarette company of similar size to Vector at the time: www.imperial-tobacco.com/index.asp?page=56&newsid=463&type=18&year=2007
The millions of dollars of royalties XXII generated during these 8 years were reinvested back into R&D, mainly to identify the remaining genes in tobacco responsible for nicotine production. This turned out to be a great success in that 22nd Century now has a monopoly on all the key nicotine biosynthesis genes. In fact, the company's second generation technology turned out to be an improvement over the first generation technology that had been licensed to Vector. Furthermore, after two years of litigation with Vector, XXII was awarded monetary damages, but most importantly, a "right of reference" to Vector's investigational new drug application (NYSE:IND) for the Quest® smoking cessation aid which allowed XXII to use Vector's F.D.A. submissions AND the trial results for XXII's own IND at F.D.A.! All the rights to the patents and the tobacco licensed to Vector were returned to XXII. Quest® was taken off the market.
New government mandates, more IP, and improved technology have created what we think is a very big opportunity.
The timing seems right
22nd Century Group went public via a reverse merger/PIPE in January of 2011. Since then, open market sales of the public shell shares (5.4M shares) have put severe pressure on the stock - until last month, that is. Reportedly, the public shell owners, not interested in the company's fundamentals, have finally exhausted their positions and insiders have substantially increased their holdings. As demonstrated by the recent increase in the share price, there is no longer this unwarranted downward pressure on the stock. Another key is that affiliates, including management, now own approximately 45% of the outstanding shares.
Numerous 2013 Catalysts
Licensing, results from not one, but two, X-22 clinical trials, RED SUN® national distribution, the filing of not one, but two, modified risk applications at the F.D.A. and Phase 3 trials for X-22.
The bottom line:
The current market and potential markets are so BIG for 22nd Century's technology/IP and products, that I feel the major industry players will have no choice but to use and license XXII's technology.
XXII has the IP, technology and products that could disrupt several multibillion dolalr markets.
Disclosure: I am long XXII.