re: XXII
gfp,
Here's a company that might interest you:
22nd Century Group Is Primed For Huge Upside
Aug. 23, 2016 2:01 PM ET|15 comments | About: 22nd Century Group, Inc. (XXII)
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XXII is likely to exceed revenue expectations for the current year.
With the WHO increasing awareness on the effectiveness of very low nicotine (VLN) cigarettes towards helping smokers quit, XXII's future looks quite promising.
Concerns over Crede Capital's lawsuit are overblown as I believe they aren't based on merits.
22nd Century Group (NYSEMKT: XXII) is a relatively underfollowed company with a market capitalization of about $60 million which has forced it to fly under the radar of most investors. In my conservative estimates, I expect the stock price to average at least $2 by early next year as a result of revenue growth exceeding expectations and the realization that concerns over the lawsuit were overblown.
Background
XXII can briefly be summarized as a plant based biotechnology company whose mission is to reduce harm caused by smoking. To effectively do this, the company has more than 200 patents in its possession that give it the ability to increase or decrease the level of nicotine in tobacco plants as well as the level of cannabinoids in cannabis plants. The company's main products include:
RED SUN and MAGIC cigarettes - These are super premium priced cigarette brands available in both regular and menthol for sale in the U.S.
SPECTRUM cigarettes - These are government sponsored research cigarettes with modified levels of nicotine (from very low to high) developed under a contract agreement with the National Institute of Drug Abuse (NIDA). They are distributed to the scientific community free of charge to ascertain the effects of varied nicotine levels in cigarettes.
BRAND A and BRAND B - These two cigarette brands are expected to be the first modified risk tobacco products (MRTP) to go into distribution should the FDA approve XXII's application. Compared to commercial cigarettes BRAND A has the lowest nicotine content (approximately 95% less) while BRAND B's blend of high nicotine tobacco allows the smoker to achieve a satisfactory amount of nicotine per cigarette while inhaling less tar.
X-22 smoking cessation aid - This is a tobacco-based botanical medical product for use as an aid to smoking cessation. The X-22 therapy protocol calls for the patient to smoke XXII's very low nicotine (VLN) cigarettes over a six-week treatment period to facilitate the goal of the patient quitting smoking by the end of the treatment period.
While not all investors may readily discern the massive opportunity that the company's technology has to offer, the FY2015 annual report gives a small glimpse as to why value investors should closely keep an eye on it. Between 2014 and 2015 XXII was able to grow revenue by more than 10 times booking about $8.5 million for the year.
Furthermore, XXII managed to keep its momentum going into 1Q16 as other major tobacco companies posted mixed results for the period. While Reynold's American (NYSE: RAI) missed analysts 1Q16 sales estimates, both Vector Group (NYSE: VGR) and Altria Group (NYSE: MO) were able to exceed Wall Street's revenue expectations for the quarter signaling that the tobacco sector was still thriving in spite of the persistent headwinds it continued to face.
(Source: YCharts)
XXII booked $3.02 million in revenue for the quarter representing a $2.4 million increase compared to the year ago period. This increase was partially attributed to the sale of its SPECTRUM research cigarettes as well as a substantial increase in other product sales. Although some pundits would like to paint a grim picture of the tobacco sector as a whole, I believe that XXII is likely to post higher revenue figures by the end of the year.
Revenue likely to exceed expectations
While XXII may have had a great FY2015, the million dollar question on every investor's mind is whether these results are likely to be replicated this year. On my part, I believe that even if the company doesn't necessarily grow revenue 10 fold like in the previous year there is still plenty of room for further growth.
First, XXII expects a $7 million payment from British American Tobacco (BAT) as a result of a research licensing agreement between the two parties which is supposed to extend through October 2017. According to the management, the payment will be for four different milestones with two being for $1.5 million and the others being $2 million each. This means that even if XXII gets only the first two milestone payments by the end of the year, revenue for the FY2016 could probably grow by at least 20 percent.
Leaving the milestone payments aside for a moment, there is another positive catalyst developing that is sure to spur even more sales of XXII's proprietary tobacco. Public health agencies around the world have begun strongly announcing their support for low nicotine tobacco with the World Health Organization (WHO) leading the charge.
In a recently released WHO report ( Global Nicotine Reduction Strategy) that would provide tobacco regulation recommendations to member countries, one of the conclusions reached was that:
Nicotine is the primary addiction chemical common to combusted and non-combusted tobacco products, and therefore, because non-nicotine components of tobacco are critical to the sensory experience of smoking, very low nicotine tobacco is more effective in reducing craving and producing greater pleasure in smokers than nicotine without tobacco.
The report further continued to state that although no specific amount of nicotine was yet to be identified as the absolute threshold for addiction, it was likely to be equal or possibly less than 0.4 milligrams per gram of dry cigarette tobacco. CEO Henry Sicignano points out that since XXII is the only company capable of producing tobacco cigarettes with such low levels of nicotine without any artificial extraction or chemical process, the opportunity here could be massive.
With the WHO recommending a policy of limiting the sale of cigarettes to brands with an overall nicotine reduction intake of about 90-95 percent, one other plausible growth scenario would be for XXII to license its technology to big tobacco companies in order to use with their own brands of VLN cigarettes.
Additionally, I expect that new regulations for the smokeless products or e-cigarettes that require manufacturers to submit product approvals to the FDA will give XXII a chance to grab market share once its BRAND A cigarettes get approval. Investors should note that the FDA approval process for MRTP products usually takes an average of 360 days and BRAND A has been with the agency for seven months now which means that a decision will be reached before the end of the year.
Going forward, I expect the impressive performance of big tobacco to factor heavily in XXII's growth story if the past couple of years are anything to go by. Compared to other sectors such as retail or consumer goods which have had to price their products lower in order to attract more customers who are keen on spending less, tobacco companies have been able to keep raising their prices.
In fact, U.S tobacco prices increased by 3.5 percent in June compared to consumer related segments which rose only 1 percent from last year. It is also important to note that tobacco stocks have outperformed the S&P 500 in the last five years and have also proven quite resilient even in times of recession.
(Source: Yahoo! Finance)
Ultimately, the main takeaway here is that tobacco companies' pricing power will go a long way in ensuring that the effects of declining smokers in more developed markets are canceled out which bodes well for XXII as this guarantees that they will continue outperforming the market.
Concerns over lawsuit overstated
On June 22, 2015, XXII disclosed that it had terminated its joint venture with Crede Capital and another third party as a result of non-performance and other breaches by Crede, Terren Piezer and its principals. Almost one year later (April 26, 2016), Crede initiated a frivolous, "sour grapes" lawsuit against XXII.
For investors who are not familiar with Crede's joint venture with XXII, I would like to provide you with a summary. Back in 2014, Crede was supposed to help facilitate the entry of XXII into China which is currently the world's largest market for cigarettes. This joint venture hinged on the claim by Terren Peizer, the CEO of Crede and advisor to XXII, that he had extensive ties to China via joint ventures with the Chinese Communist Youth League which would be instrumental in penetrating the market.
For his services, Peizer would receive 2.25 million warrants as well as an additional number of warrants if the venture became cash flow positive and met the revenue targets outlined in the agreement. However, after being given adequate time to execute on these initiatives, Peizer abjectly failed to deliver any as there was limited to no communications from anyone at CNCT in China, and the inaction on Mr. Piezer's part led to XXII's decision to terminate the joint venture.
In March 2016, 22ndnd Century repudiated the exchange right of the Tranche 1A warrants owned by Crede because of violations of the "activity restrictions" in the warrants. This class of warrants had an exchange feature which would have allowed Crede to exchange into more and more shares of common stock of XXII the lower the shares went with a maximum of 5 million shares.
On May 19th, 2016, Crede filed a motion for preliminary injunctive relief and preliminary declarative relief directing 22nd Century Group to immediately deliver 2,077,555 shares of XXII's common stock with the intention of selling the stock and placing the proceeds in an escrow account until the suit had been resolved.
XXII's position was that Crede violated an activities restriction provision of the Warrant and was therefore not entitled to the Exchange Right. On June 14th 2016, a hearing on this grant for injunctive relief was held in the Southern District of New York before the Honorable Katherine Polk Failla. The Court rejected Crede's motion and further stated:
I don't think I can say on this record that the plaintiff has demonstrated a likelihood of success on the merits
suggesting the case against XXII was tenuous at best.
This reaffirms XXII's statement that the evidence will show without a doubt that XXII acted appropriately, pursuant to the terms of the warrant, when they terminated the exchange right. 22nd Century introduced six emails from Peizer that were addressed to 22nd Century's CEO and others, which showed Peizer's violations of the activity restrictions provision of the agreement, the evidence couldn't be more compelling. The emails demonstrated how Peizer began suggesting changes in 22nd Century's management and board which the court ruled "transcended his job as a consultant."
While Peizer denied he asked for changes in management, instead asserting he merely was relaying information that China National Tobacco (CNTC) wanted someone else in charge of 22nd Century and offered suggestions on how to allay CNTC's fears, the court was able to see through this as is evident from the ruling.
The court stated:
I think there is a likelihood that the plaintiff violated the activities restrictions that are contained in Section 1(h).
It also stated that Crede's claim that it would suffer irreparable harm if it did not receive the shares was not accurate when, in fact, XXII would suffer irreparable harm if Crede received the shares and sold them aggressively into the market.
For long-term followers of 22nd Century, this lawsuit shouldn't come as a surprise. The timing of the lawsuit is suspicious if not malicious. It is important to note that at the time of filing the suit, the number of shares that Peizer was asking for happened to be the exact short interest of 22nd Century's stock. It appears that Crede may have wanted to drive down the company's stock price after which Peizer would then proceed to take over the company.
However, this ploy has been stopped in its tracks thanks to the favorable ruling of the court. The judge's strong ruling should give comfort to shareholders. Since the ruling, the share price has stabilized and has boosted confidence among shareholders. XXII's fundamentals are as strong as ever with its low nicotine cigarette seeking FDA approval and continued exploration of the Chinese and other international markets.
Risks
Investors should be aware that XXII is not yet cash flow positive and it recorded a net loss of $11.03 million or $0.16 per share in FY2015. Management cited the underutilization of the company's North Carolina manufacturing facility as one of the reasons and has been working on expanding its contract manufacturing partnerships.
On a positive note, the company has very little long term debt on its balance sheet which stood at $616,520 by the end of last year. Current assets stand at $6.8 million compared to $3.3 million in current liabilities while cash and cash equivalents stand at about $2.84 million which will be enough to sustain operations till May 2017.
While the balance sheet may appear solid, investors should be prepared for the risk of additional dilution based on the fact that XXII will need to raise additional capital in order to fund operations and the FDA approval for its products.
Summary
At current share price level of about $1 (Now at $1.40.), I believe that investors with an appetite for risk should consider looking into XXII. The company's fundamentals are solid and now that concerns over the lawsuit which were putting downward pressure on the stock are close to being resolved, the stock should definitely inch higher.
Bladerunner
