Insights

22nd Century Group’s Road to Cannabis May Have Some Potholes

22nd Century Group (NASDAQ: XXII) is a biotechnology firm making plants like tobacco and cannabis less dangerous, more potent, and more lucrative. Recognizing the enormous potential that cannabis bioscience offers, the company — 22CG for short — undertook several funding rounds to raise money to secure its partners and improve company infrastructure to become, in its own words, the “Monsanto of cannabis.” But the company is quickly using up its cash and may need to undergo more funding rounds in the near future, watering down current investors’ holdings in the process. 

22CG uses advanced technology to improve popular plants

Alongside efforts to improve hops for brewers, 22CG is developing very low nicotine (VLN) tobacco and new cannabis varieties that yield more of the CBD and THC increasingly used in consumer products.

The VLN tobacco products are helping the company grow its revenue — up 30% year over year from Q1 2021 to Q1 2022 — and its hemp/cannabis franchise could have similar potential. To reach its goals, the company has purchased or is partnering with other cannabis companies to improve their products, rather than developing its own production lines in-house.

22CG began bringing on hemp/cannabis partners in 2019 with the acquisition of Panacea as a CBD packaged goods company — a way to turn the cannabinoids 22CG produces into products for sale. It later bought companies like Cannametrix and Keygeene to help with testing and advanced plant breeding. It has increased its growing capacity by buying up Needle Rock Farms, which now has a USDA organic certification. And 22CG’s partnership with Aurora  Cannabis (NASDAQ: ACB) licensed a process that uses microorganisms to synthesize CBD and other cannabinoids to Kronos Group (NASDAQ: CRON), in an effort to help all three companies improve and refine that technology.

Raising funds — and then quickly spending them

Two fundraising events stand out in the past five years that helped 22CG find funds for its two major cost-intensive franchises, VLN and hemp/cannabis. 

On Oct. 9, 2017, with shares trading around $3, the company offered $54 million in common stock options by selling 20.57 million shares at $2.625 each, diluting its existing shareholders by roughly 20%.   Four weeks later, the stock had fallen by 32% to $2.07 — more than half again as much as the actual amount of dilution! By a year later, though, the price had climbed back up to $3.04.

In similar fashion, in early June 2021 the company put up 10 million of its common stock at $4 per share to raise $40 million, with its shares trading around $5.20 apiece at the time. The new shares it issues diluted shareholders by around 6%. Four weeks later the stock had dipped to $3.92, a 25% drop; it fell even further, to $1.09, a year later,  a nearly 80% trim year over year. Shareholders don’t seem to have appreciated the company’s previous dilutive stock sales, which could be an issue if the company is counting on stock prices to rise again before doing additional stock sell-offs to raise money.  

True to its word, the company has been spending heavily over the past year to prepare for additional VLN expansion and to create a smooth path for its cannabis endeavors, as shown in the table below. 

Metric

Q2 2021

Q3 2021

Q4 2021

Q1 2022

Cash

$62.3 million

$55.1 million

$48.7 million

$38.6 million

Free cash flow (burn)

($8.65 million)

($6 million)

($4.9 million)

($8.1 million)

Inventory

$2.3 million

$2.7 million
$2.8 million

$3.7 million

Data sources: Yahoo! Finance and 22nd Century Group.

Noting the table, you can see the bump in cash after the June 2021 fundraising event — from $30.9 million to $62.3 million. But if cash continues to dwindle at the average rate of 14.75% sequentially, by Q1 2023 22nd Century Group’s cash may fall to just a little over $20 million, potentially sparking a new round of stock fundraising. 

Meanwhile, inventories have steadily risen, partly due to harvests in Q4 2021 and additional VLN stock. But inventory growth could also signal the company may be having trouble raising cash from selling its goods. 22CG does say, however, that its 2022 hemp harvest is already sold, establishing a possible ceiling for the inventory increases.     

22CG says it has the pieces in place to become a global leader in cannabis technology by selling its in-house manufactured legal cannabinoid products and its plant intellectual property breakthroughs. However, unless it dampens its cash burn, it may have to sell more shares to raise money. That worked out in 2017, as stock prices returned to pre-sale prices a year later. But history did not repeat itself after the 2021 sale. This year, stock prices remain low, which may require the company to sell even more stock next time around to raise the money it needs, diluting its shareholders’ value even more.

The company does have one bright spot: its 30% year-over-year revenue growth, courtesy of its VLN tobacco sales. Sales growth could continue to rise as VLN becomes more popular and 22CG sells its 2022 hemp harvests. But cannabis stock investors should still keep a close eye on its cash in the bank as the new year approaches.   

Lukas Barfield has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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