The $10B Cigarette Alternative

At this point, everyone is familiar with the term “fake news.” But long before the election of Donald Trump, climate change and talk of vaccines dominated the media, a different kind of fake news prevailed.

Although many people don’t realize it, modern fake news has existed since the 1970s.

And it all started with Big Tobacco.

In the summer of 1977, Tony Garrett, the chairman of imperial tobacco, invited leaders from the world’s major tobacco companies to meet at a British country house about 110 miles outside London. 

Garrett’s summit would ultimately lead to a project called Operation Berkshire. 

Among other things, Operation Berkshire sought to devise a strategy to counteract the scientific research demonstrating the adverse health impacts of smoking.

Much like today’s fake news, the fake news of the past relied on questionable science to establish a parallel reality dominated by alternative facts.

Which is to say, the tobacco giants agreed to fund their research to discredit the scientific consensus of the day.

The activities of Operation Berkshire went unknown to the public until 1998 when the tobacco industry came clean of its crimes.

Despite the well-known harms, smoking remains the leading cause of preventable death in the US and is still responsible for 20% of deaths every year.

Now it looks like Big Tobacco could be brought to its knees…

Setting off a gold rush to capture market share of the $100bn US tobacco market.

Researchers are calling it the “next hurricane on the horizon.”

One company, in particular, is poised to take advantage.

But first, some background…

White House Tobacco Policies

This past April, the FDA confirmed what big tobacco had long feared… the agency would be publishing a rule banning menthol cigarettes within the next year and was also considering new rules to limit the amount of nicotine in unflavored cigarettes.

Tobacco stocks like Altria (NYSE:MO), the manufacturer of Marlboro cigarettes, tanked following the report.

The new rule strikes at the heart of the tobacco industry by targeting a segment that currently represents more than 40% of US smokers.

According to a study conducted by the agency, a ban on menthol cigarettes would prompt nearly 1 million menthol smokers to quit smoking in the 12 to 17 months following the ban.

Of course, enforcing the ban would take several years. The agency still needs to publish the proposed regulation and respond to comments from the industry and the public before a ban occurs.

However, at this point, it seems the writing is on the wall. With the federal government now showing cigarettes the door, the market for cigarette alternatives could be set ablaze. However, the beneficiaries may not be who you’d expect.

E-cigarettes Going Up in Smoke

If you followed the tobacco industry in recent years, you might expect that e-cigarettes will naturally pick up the torch when cigarettes get extinguished from the market.

But new regulation aims to slow the growth of the $17.6bn e-cigarette market.

Last year, Congress quietly changed the law to expand the definition of tobacco products to include vaping and e-cigarette products.

Among other things, the rule prevents the postal service from delivering vape products to customers.

The largest private domestic shippers, UPS and FedEx, also voluntarily halted all shipments of vape products in the United States.

And while the law stops short of banning vaping entirely, these laws create substantial hoops for vape sellers.

Over time, we can expect that prices for e-cigarettes will go up, and competition in the market will decrease.

For nicotine consumers, these regulations will reduce their choice and increase prices.

With traditional cigarettes being purged of nicotine and e-cigarettes being regulated into oblivion, where are smokers going to go?

Taat’s Non-Tobacco Alternative

Enter TAAT Global Alternatives (OTCQX:TOBAF).

While other nicotine-free cigarettes have entered the market in recent years (such as herbal cigarettes, cloves, etc.), none of those cigarettes closely imitates a real cigarette enough to address the need adequately.

White House Tobacco Policies

This past April, the FDA confirmed what big tobacco had long feared… the agency would be publishing a rule banning menthol cigarettes within the next year and was also considering new rules to limit the amount of nicotine in unflavored cigarettes.

Tobacco stocks like Altria (NYSE:MO), the manufacturer of Marlboro cigarettes, tanked following the report.

The new rule strikes at the heart of the tobacco industry by targeting a segment that currently represents more than 40% of US smokers.

According to a study conducted by the agency, a ban on menthol cigarettes would prompt nearly 1 million menthol smokers to quit smoking in the 12 to 17 months following the ban.

Of course, enforcing the ban would take several years. The agency still needs to publish the proposed regulation and respond to comments from the industry and the public before a ban occurs.

However, at this point, it seems the writing is on the wall. With the federal government now showing cigarettes the door, the market for cigarette alternatives could be set ablaze. However, the beneficiaries may not be who you’d expect.

E-cigarettes Going Up in Smoke

If you followed the tobacco industry in recent years, you might expect that e-cigarettes will naturally pick up the torch when cigarettes get extinguished from the market.

But new regulation aims to slow the growth of the $17.6bn e-cigarette market.

Last year, Congress quietly changed the law to expand the definition of tobacco products to include vaping and e-cigarette products.

Among other things, the rule prevents the postal service from delivering vape products to customers.

The largest private domestic shippers, UPS and FedEx, also voluntarily halted all shipments of vape products in the United States.

And while the law stops short of banning vaping entirely, these laws create substantial hoops for vape sellers.

Over time, we can expect that prices for e-cigarettes will go up, and competition in the market will decrease.

For nicotine consumers, these regulations will reduce their choice and increase prices.

With traditional cigarettes being purged of nicotine and e-cigarettes being regulated into oblivion, where are smokers going to go?

Taat’s Non-Tobacco Alternative

Enter TAAT Global Alternatives (OTCQX:TOBAF).

While other nicotine-free cigarettes have entered the market in recent years (such as herbal cigarettes, cloves, etc.), none of those cigarettes closely imitates a real cigarette enough to address the need adequately.

Taat’s patent-pending secret sauce has been its ability to replicate the cigarette experience with a non-nicotine product authentically. 

The company has gone to ridiculous lengths to ensure that every attribute of its product resembles a cigarette as closely as possible, including factors such as weight, amount of burn time, and smell. 

While these factors may sound trivial, they can make all the difference between an appealing alternative and a cheap imitation for smokers.

Research has consistently demonstrated that a cigarette’s taste is one of the most important characteristics for smokers who are brand loyal

The rewards for brands that get it right can be massive. Smokers are among the most brand-loyal consumers on the market – the three leading cigarette brands retain an estimated 85-90% of their customers annually.

Meaning that a business that gets the smoking experience right is likely to win customers for life.

According to Taat CEO Setti Coscarella, this ability to offer a compelling replica of the taste of real cigarettes is one of the major reasons that other nicotine-free cigarettes have failed in the past.

If you probe anyone who has been a smoker for some time, you can probably get them to admit they’ve experienced a situation where they’ve chain-smoked more than one cigarette because of the environment. 

This type of “environmental smoking” can be commonly seen in social situations, like bars, nightclubs, or in casinos.

What makes this behavior interesting is because these smokers will be the first to admit that the second cigarette is often not about the nicotine hit (that gets addressed by the first cigarette), a nicotine-free cigarette would be just as appropriate in those circumstances. 

By closely imitating the characteristics of a cigarette, Taat’s product helps to address the many behaviors associated with smoking. These include things like oral fixation and hand-to-mouth gestures that are associated with the smoking habit.

Scientists have long understood that part of the challenge of quitting smoking is “unlearning” these behaviors and have been looking for an acceptable cigarette alternative for over four decades.

Back in 1994, the British newspaper The Independent published an article titled “For Many Smokers, The Attraction Lies Less In The Nicotine Than In The Oral Gratification. Artificial Cigarettes Could Be The Answer”

Here are some quotes from the article, which illustrate this point in more detail.

“The recent emphasis on nicotine addiction has tended to sideline other elements in the tobacco habit. But a century ago, Sigmund Freud was well aware of the complex attractions of smoking. Considering the origins of his own compulsive smoking, he argued that stimulation of the lips was central to the habit’s satisfaction.”

“One reason for this is that there is more to smoking than nicotine. Having something distracting to do with the hands and mouth, especially at times of stress, is clearly part of the habit. ‘As an ex-smoker, I am myself aware that the business of handling cigarettes is important,’ comments Dr. Fowler. ‘People who have given up for years are still playing with paperclips and sucking pencils.'”

The article continues…

“To meet the oral needs of smokers will require the development of some form of artificial cigarette which provides… an opportunity for ritualised hand-to-mouth behaviour.”

Taat’s product, known as Beyond Tobacco, effectively provides a satisfying alternative for smokers, which has alluded researchers for nearly 40 years.

Apart from imitating the characteristics of the cigarette itself, Taat’s products also help customers address their appetite for nicotine by delivering a similar calming outcome through the CBD found in its’ proprietary hemp blend. 

Faux Products

Now, we’ll be the first to admit that the idea of a nicotine-free cigarette sounds ludicrous at first. After all, isn’t a nicotine buzz the point?

But as we researched the topic more, we saw just how big the opportunity is. 

For starters, other industries have successfully launched their own imitation products in recent years with great success. 

More specifically, plant-based meat products have flooded the market in recent years.

Plant-based meats now represent a nearly $21 billion industry or approximately 1.5% of the $1.4 Trillion global meat industry.  

Some analysts anticipate that plant-based meats could grow to a nearly $140 billion industry by 2029.

But plant-based meat is just the start.

In recent years, a growing list of companies has been developing non-alcoholic spirits. 

According to Nielsen, that market has grown more than 5x since 2015 and is expected to surpass $280 million in revenue this year. 

Assuming nicotine-free “tobacco” can achieve a similar 1.5% share of the $925 billion global tobacco market, Taat’s obtainable market is in excess of $13.87 billion. 

Taat’s management is quick to point out that given the massive size of the tobacco market, capturing a small percentage of the market could reap massive dividends. 

For example, a largely unknown brand called “Eagle 20’s” generates upwards of $750 million in revenue annually despite having virtually no name recognition.

At present, the market for smokable hemp products ranges from $70-80mm annually in the US. This number is expected to mushroom as large as $300-400m by 2025, and this is before considering the impact that Taat could have on the market.

According to market research firm Nielson, roughly 29% of cigar and cigarette smokers are open to trying hemp products

Management Team

Taat has put together one of the most impressive management teams I’ve seen to bring its tobacco alternative to the market. 

The company was founded by Joe Deighan, who previously founded and sold vape liquid maker JJuice to a large tobacco company. Prior to Taat, Joe founded and helped commercialize Wild Hemp, a leading manufacturer of CBD pre-rolls. Joe’s experience with Wild Hemp and JJuice lead him to launch Taat in 2019 while searching for a product that could offer an enjoyable alternative to smoking. 

In his quest to build Taat, Joe recruited CEO Setti Coscarella. Coscarella earned his chops in investment banking and management consulting before joining the team at the world’s largest tobacco company, Philip Morris International (PMI).

At Philip Morris, Setti spent nearly three years as the lead strategist for their Reduced Risks Product team, helping to develop products that offered the benefits of tobacco with fewer adverse health impacts. While at PMI, Setti worked with thousands of smokers to better understand their smoking behaviors and develop marketing programs to drive behavioral change. 

Alongside Coscarella is Chief Revenue Officer, Tim Corkum. Like Coscarella, Corkum is a seasoned executive from Philip Morris who has experience in everything from sales, to trade marketing, corporate affairs, and business development in his 20 years in the tobacco industry. Corkum previously worked with Coscarella as director of Philip Morris’s Reduced Risk Products category.

Market Acceptance

Earlier this year, the company conducted a trial with consumers in Ohio to test demand for Taat’s product.

The company identified 200 smokers over the age of 18 to receive a free carton of Taat’s as part of the trial. 

4-weeks following the trial, the company found that a remarkable 80% of Taat users continued to purchase Taat. 

In post-trial surveys, 84% of Taat’s menthol testers rated the product as either “very good” or “somewhat good,” indicating the products’ potential to fill a gap in the market created by the recently announced menthol cigarette ban. 

The company has been expanding aggressively since that trial, and is currently averaging forty new store placements per month. 

Taat also benefits from being a more affordable alternative to cigarettes. 

Because the product forgos tobacco, the company is exempt from the $2 tax per pack levied on cigarettes in the state. For reference, a pack of Marlboro Red cigarettes costs about $7 in Columbus, Ohio, whereas Taat is offering their product for just $3.99.

The affordability of Taat represents a major potential tailwind for the company. Market research commissioned by the company found that 65% of surveyed smokers take issue with the financial cost of smoking.

Although Taat may be cheaper than cigarettes, they’re also more profitable. According to management, Taat is targeting an impressive 60% margin, compared to just 18% for the tobacco industry.

That sort of profitability adds up quickly when considering Taat’s sales volume. With its current retail footprint, Taat is selling two packs/per store/per day. If management achieves their plan of placement in 100,000 stores, Taat will be on pace to generate in excess of $200 million in revenue per year. 

With the Ohio launch, the company took advantage of the lenient regulatory environment for their product by using video advertisements on gasoline pumps at 1097 locations in the state. This is a particularly thoughtful approach as convenience stores represent roughly 78% of cigarette sales in the United States.

The company is working with a sales agency called Crossmark, which previously worked with Juul in its sales expansion efforts, helping the company grow from roughly $50 million in sales to over $1.6bn in sales in 18 months. 

Crossmark’s expansive relationships with over 100,000 points of sale will prove instrumental as Taat makes a push for shelf space in convenience stores to better compete with traditional tobacco products.

However, Crossmark is just one piece of Taat’s larger distribution strategy. In addition to Crossmark, the company is developing a network of distributors to sell its products as well.

In mid-April, one of these wholesalers, WWV, announced its intention to purchase $1.25m CAD of Taat products to sell to its 10,000 retail partners across 38 states.

In late April, the company received its first purchase order outside of North America. Through a partnership with Green Global Earth, Ltd., Taat will begin selling products in the UK and Ireland as early as August 2021.

The UK and Irish markets represent a major opportunity for Taat because of the large population of smokers and the high cost of tobacco products in those countries.  Cigarettes can cost as much as $14.95 per pack in Ireland, where nearly 20% of the legal age population are smokers. 

The company’s decision to limit its sales to Ohio, for the time being, is part of its overall strategy of scaling strategically with its brand. As a consumer product, the company will need to both generate awareness and educate customers on the benefits of its product. 

This requires a very hands-on sales process where Taat and its partners need to educate retailers on the product in order to sell it effectively. 

With the Ohio test market, Taat is currently learning how to place its products while driving consumer education and demand most effectively. 

However, the company has also simultaneously begun offering its products through e-commerce to establish an online presence, grow its audience, educate consumers, and identify potential new market opportunities. 

Investing Alongside the Best

A top consideration when making any investment is the other investors in the deal. I know I’m making a smart bet when I choose investments where other smart people are invested as well. 

And Taat has one of the smartest. 

Back in October of 2020, the company landed an investment deal from Debbie Chang, founder of Horizon Ventures. Although Debbie keeps a low profile in this hemisphere, in her native Hong Kong, she’s a big deal.

Horizon Ventures not only has the backing of Hong Kong’s richest man, Li Ka-shing, but has a long history of making outstanding early investments in companies like Facebook, Airbnb, Waze, Slack, Impossible Foods, Spotify, Siri, and more. 

Seeing a vote of confidence from someone as accomplished as Chang is a no small feat for an early-stage company like Taat.

Risks

Of course, as with all investments, an investment in Taat is not without risks.

For one, there is market risk. As with all early-stage products, it’s still unclear whether consumers will take to Taat’s products. Although we believe that there is a large addressable market and strong need, consumer behavior can be unpredictable.

This is especially true when marketing products that seek to change consumer behavior in a meaningful way. 

That being said, companies that have managed to change consumer behavior — such as Uber, AirBnB, and Amazon — have made homerun returns for their early investors by identifying a market ripe for disruption and opportunity. 

Although the company is not currently accountable to regulatory authorities like ATF or FDA, the products’ positioning could cause regulatory scrutiny. To be clear, the company is not subject to the same limitations on marketing as traditional tobacco. 

Among other limitations, tobacco companies are discouraged from emphasizing the “coolness” of smoking and shy away from displaying youthful, photogenic people smoking cigarettes. 

Taat’s apparent decision to employ those marketing tactics walks a very thin line and could invite regulatory scrutiny from bureaucrats eager not to repeat the mistakes they made with Juul.

In the company’s defense, their position is that the market for existing smokers is large enough that they can do healthy business without introducing new people to the habit. 

Ultimately, it will come down to the specific execution decisions by the company in how they acquire and communicate with customers that will determine whether uncle sam comes knocking on their door. 

Similarly, the company’s current hemp offerings are very lightly regulated in the United States. This, however, could change over time, resulting in a less favorable regulatory environment.

For example, hemp products can be sold fairly universally in the United States, although this is not the case abroad. For example, in Canada, hemp products are classified similar to cannabis products, and retail distribution is limited to cannabis dispensaries.

The changing regulatory environment could potentially also bring new taxes with it, which would diminish part of the “low cost” appeal of the product. However, given the company’s fat margins, they should be able to partially absorb the cost with minimal impact to sales.

It’s also worth noting some of the risk from a product perspective. Although the company by no means tries to market their product as “healthy,” it’s possible that over time adverse health risks could be discovered from Taat’s product, which could create product liability claims.

From a corporate perspective, the company is still at an early stage, which means that there will be risks and big costs associated with marketing the product and acquiring customers. This process is quite expensive so there’s a good chance that the company will need to raise money and potentially dilute shareholders to finance growth in the future.

That said, the company has plenty of runway, with over $10m in cash and a burn rate of roughly $6m per year. This means that unless the company experiences unforeseen circumstances, Taat should have sufficient cash to finance operations through the beginning of 2023. 

Along those lines, at present, the company does not face serious competition in the cigarette alternative market. However, as the company proves demand for its product, it’s likely that others, such as big tobacco, will enter the market. 

However, the upside if Taat successfully converts customers is tremendous. Taat’s first mover advantage could give it a leg up if they can replicate the strong customer loyalty of their peers. 

Of all these risks, we see operational execution as the biggest at this point. Taat’s success will ultimately hinge on getting their packs into smokers’ hands and converting them into lifelong customers. 

However, management has done an excellent job as far as progress and transparency.  

We expect that as the company progresses in its operations, management will provide more detailed plans and forecasts, unlocking shareholder value along the way.

IMPORTANT NOTICE AND DISCLAIMER: All investments are subject to risk, which must be considered on an individual basis before making any investment decision. This paid advertisement includes a stock profile of TAAT Global Alternatives Inc. (OTCQX: TOBAF / TAAT) Wasatch Investment Network is an investment newsletter being advertised herein. This paid advertisement is intended solely for information and educational purposes and is not to be construed under any circumstances as an offer to buy or sell, or as a solicitation to buy or sell, any securities. In an effort to enhance public awareness of OTCQC: TOBAF / TAAT, provided advertising agencies with a total budget of approximately one million five hundred and one thousand dollars to cover the costs associated with creating, printing and distribution of this advertisement July 26, 2021 – September 14, 2021. 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