On July 28, Scott Gottlieb,the commissioner of the U.S. Food and Drug Administration, gave a speech in White Oaks, Maryland. The speech detailed the current landscape of tobacco use in the U.S. and, specifically, outlined a number of areas of said landscape within which there exists opportunity; opportunity to take action and potentially reduce not just the number of individuals suffering or dying from smoking-related conditions, but also the costs associated with treating these patients at various stages of their lives.
One of the major talking points was the potential of very low levels of nicotine in cigarettes to reduce aggregate consumption. At a glance, this seems counterintuitive – nicotine is the addictive component of a cigarette so, surely, a reduction in the level of nicotine would just lead to people needing to smoke more cigarettes in order to satiate their cravings.
Look a little deeper, however, and that is not the case.
Eric Donny is a University of Pittsburgh psychologist who studies smoking. In a study conducted by Donny and his team, it was demonstrated that a reduction in nicotine actually leads to an individual smoking less over a set period than those smoking cigarettes that contain normal levels of nicotine.
How is this the case?
The lungs are only able to tolerate a certain amount of smoke. As such, there is a threshold that cannot be passed for an individual who is smoking more cigarettes with lower nicotine content in an attempt to reach the standard levels of nicotine associated with smoking normal cigarettes. Because there is less nicotine, once the smoker becomes somewhat used to the level he or she is getting from the low nicotine cigarettes, the reduced addictiveness (again, rooted in the lower nicotine levels) outweighs the necessity to compensate, leading to reduced overall consumption.
During the days subsequent to Gottlieb's presentation, Big Tobacco in the U.S. took a dramatic hit.
On July 27, the day before the speech, the Dow Jones U.S. Tobacco Index (DJUSTB) traded at $962.71. By July 31, it had dipped to $904. At market close on Sept. 19, the index traded around $880.
That is 6% wiped off overnight and just shy of 10% wiped off overall.
The trend is the same among the index's constituent companies and is all the more visible when said companies are looked at individually.
British American Tobacco PLC (LSE:BATS, Financial) lost 11% market capitalization between July 27 and July 31. That amounts to around $12 billion. Philip Morris International Inc. (PM, Financial) lost around $6 billion in market capitalization between Jul 28 and Aug. 2.
Against this backdrop of tobacco industry bloodshed, however, one tobacco company bucked the trend – 22nd Century Group Inc. (XXII, Financial).
Between July 25 and Aug. 5, 22nd Century Group gained more than 80% in market capitalization. As measured across the eight weeks subsequent to July 25, bringing us to the present day, this number rises to 127%.
So why has 22nd Century Group been rising while the tobacco industry and some of the biggest players in it have been falling?
The answer is pretty simple: 22nd Century Group is the only company in the world with the technology (patented technology) to grow and produce tobacco that contains the levels of nicotine generally regarded as being low enough to have the desired effect on aggregate cigarette consumption in the U.S.
In a study conducted by Donny and his team at the University of Pittsburgh, the researchers sought to establish a particular level of nicotine in cigarettes that might be most effective in achieving the desired goal.
The outcome of the study suggested a cigarette containing 0.05 milligrams and below, or what the study refers to as a "very low nicotine," or VLN product, is what is required for this concept to be effective in the general U.S. population. And again, 22nd Century Group is the only company capable of producing tobacco that contains this level of nicotine.
Indeed, the U.S. government is currently contracting 22nd Century Group to produce so-called "research cigarettes" with which it can investigate the potential impact of a VLN product on the smoking population. As reported in a press release, the company received a new purchase order back in June from the federal government for 2.4 million of its proprietary SPECTRUM research cigarettes.
This SPECTRUM brand is the subject of numerous government-sponsored studies, most notably of which is a newly completed, but not yet published, phase III study featuring 1,250 participants and funded by the National Institute on Drug Abuse (NIDA). This study is similar in concept to Donny's study in that it is trying to work out what approach brings about the best results in U.S. smokers – a gradual reduction approach or an immediate cut. Whatever the outcome, the 22nd Century Group technology is going to play a central role in the production of the winning approach longer term.
There is a reason the U.S. government has gone to 22nd Century Group for these products, and it is because they are not available anywhere else.
If the FDA and other government agencies do take steps to enforce lower nicotine products, therefore, Big Tobacco is going to have to license the technology 22nd Century Group has created in order to satiate consumer demand for the revised products. It is a technology covered by a number of patents, which makes the company highly valuable based on the value of its intellectual property portfolio alone.
A licensing deal announced a few years ago supports this statement.
In 2013, the company reported it had secured a research license agreement with British American Tobacco, granting the latter access to 22nd Century Group's patented technology. If a company like British American comes to you for a licensing deal instead of developing its own version of your proprietary technology, you know the IP is solid.
But it is not all about licensing.
22nd Century Group is also trying to bring its own VLN products to market in an attempt to capture a portion of the newly mandated demand outright as opposed to having to rely on licensing revenues from big names in the space. The company's X-22 is its flagship product right now and – again – is subject to considerable investigation in collaboration with universities and research centers spread across the U.S.
Additionally, 22nd Century Group announced back in May the FDA had authorized the initiation of a trial to investigate the impact of a cigarette type called BRAND B on U.S. smokers. BRAND B is a low tar-to-nicotine ratio cigarette, which is essentially the opposite of the VLN concept and is designed to reduce the cancer-causing agents usually present in cigarettes to less harmful levels while keeping the nicotine level high in an attempt to induce satiation.
The bottom line here is this company was under the radar throughout the majority of this year and has since become a very highly watched stock based on the FDA's validation of its core concept and technology. With that said, however, it does not seem to have appreciated to the degree it might have, given the implications of a potential regulatory shift in this space. To put this another way, while British American Tobacco lost $12 billion off its market capitalization, 22nd Century Group only gained around $100 million during the week subsequent to Gottlieb's speech.
There could be an opportunity, therefore, to jump in ahead of what could be a longer-term rebalancing of these two metrics.
Disclosure: The author has no positions in any of the stocks mentioned.
