At the beginning of March, the 23rd Annual Meeting of the Society for Research on Nicotine & Tobacco (SRNT) took place in Florence, Italy. Anyone familiar with the space will know that this is the premier event on the tobacco calendar, and it's a must-attend event for industry players big and small. It's also widely attended by scientists, public health officials and regulatory insiders from agencies like the FDA.
The Abstract Book for the event is here.
Of the circa 140 abstracts detailed in the book, and presented at the conference, a large number addressed a trend that's becoming increasingly relevant in the space, on a global scale – nicotine reduction. Specifically, the reduction of nicotine in tobacco products (predominantly cigarettes) to a level below that which is likely to cause addiction in smokers.
Of the abstracts that dealt with this trend, fourteen were put forward on the back of research conducted by a company that stands to benefit from any policy driven action that leads to a reduction in nicotine levels in cigarettes – 22nd Century (NYSE:XXII).
The company is a plant biotechnology company based in New York, and it's developed a technology that allows for the creation of tobacco plants with extremely low nicotine content. As per the World Health Organization's recommendation in this arena, the level of nicotine generally regarded as not likely to cause addiction in the majority of tobacco consumers is less than 0.4 mg/g of dry cigarette tobacco filler.
22nd Century is the only company in the world that is able to produce tobacco that contains this level of nicotine and below, without having to use any sort of post-processing technique (chemical extraction, hat type of thing). That gives the company a real advantage as and when policy that cements the above discussed global industry trend into law comes in to force. Said trends suggest it will, it's just a matter of when.
The science behind the grow method is relatively complicated, but for those interested, it's illustrated in the image below.
As a brief description of what the above diagram shows, it details the chemical process that results in the creation of (or more specifically, the biosynthesis of) the alkaloid nicotine. A stream of processes results in the production of two outputs – what's called N-methyl-Δ1-pyrrollidium, and niacin. These two outputs then link up (through a process called coupling) and the resulting product is the nicotine. 22nd Century's technology basically inhibits the coupling to a large degree, meaning a far smaller amount of nicotine is biosynthesized as the plant matures.
To repeat; no other company can do this using 22nd Century's patented approach, and right now at least, no other company is doing it using an alternative approach; at least not on a commercial scale.
The company's operational focus to date has been to try and get a very low nicotine product to market with an FDA approved label that promotes it as such, having a low enough nicotine level to remove, or at least largely negate, the potential for addiction. It's not an easy task, however, and so parallel to the FDA regulatory efforts of 22nd Century, the company has also devoted time and capital to marketing a couple of other commercial cigarette brands. This strategy has borne fruit, and the company generated $3.3 million revenues in the most recent quarter (Q4, 2016) and revenues of $12.3 million for the full year 2016.
This low double digit million-dollar commercial potential isn’t where the real value is long term, however. If the above discussed regulatory scenario plays out, there's a more than 10 times multiple available for 22nd Century on its annual revenue figure. As the company's CEO pointed out in his most recent letter to shareholders, a large portion of the shareholder base has pushed to try and get management to reallocate operational capital away from the commercial efforts, and towards the regulatory side of the business.
In other words, said shareholders feel that there's long term value in an approach akin to a development stage biotechnology company – forego revenues from commercial activity at present and spend on regulatory efforts, then derive benefit from this opportunity cost type allocation once the agency green lights the development product for commercial sale.
And again as highlighted in his most recent communication to shareholders, that's what CEO Henry Sicignano is now trying to do.
This year should bring with it the resubmission of an application to the FDA in the US for a license to sell what's called BRAND A, the company's very low nicotine cigarette, and then the submission of a second application, the approval of which will allow 22nd Century to market BRAND A as very low nicotine. The approval of these applications will be an inflection point for the company, and will signal the point at which it moves from generating the above discussed revenues, and towards the hundreds of millions of dollars in revenue potential that an FDA supported asset has.
The opportunity for shareholders here, then, is in backing a company that is uniquely positioned to take advantage of global policy trends in the tobacco space. 22nd Century is pushing to get its BRAND A cigarettes to market with the label they will require to meet policy that mandates non-addictive nicotine levels, before said policy comes in to force. When it does, therefore, it's going to be the only company that is ready to meet the market demand that the policy creates.
So what are the risks?
As ever for a company at this end of the market, the primary risk is rooted in capital balance and access. The company had $13.4 million on hand at the end of 2016, and as stated in its most recent 10K, expects that this cash, combined with its commercial sale revenues, should last through at least May 2018. At this point, or likely a little earlier, 22nd Century is probably going to have to raise through equity issue.
If the company can get an FDA green light on its BRAND A product before the raise, its share price will rise on the approval and said raise should be on good terms from the perspective of a shareholder that takes a position near term. If the BRAND A product isn’t yet approved, or if it gets turned down outright by the agency (unlikely, but must be taken into consideration), then the raise is going to hurt an early shareholder.
There's also industry and political risk. Any industry wide changes, such as the one discussed above that is going to benefit 22nd Century, take time to materialize. This is one that is well established, and the industry is nearing a shift, but a policy like this is going to suffer resistance (from Big Tobacco, if no one else) and this resistance could delay implementation.