Startup Sees Stock Vaporize

Its industry is booming, its customers are proliferating and it claims to have some of the top products in the business. But Vapor Hub International Inc. remains a two-penny stock. And it’s a case study on the perils of growing a company on the over-the-counter market – even for ambitious entrepreneurs in a hot industry. The publicly traded Simi Valley company manufactures and distributes vaping equipment, the quickly emerging electronic replacement for cigarette smoking. Specifically, it makes “mods,” the battery-powered, handheld vaporizers that turn flavored liquids into inhalable vapor. In addition to its line of five mods, the company distributes about 40 other brands of mods, accessories and liquids to vape shops across the country, as well as directly to consumers in its stores and on its website. “Our goal is to become the Coca-Cola of the industry,” said Chief Executive Kyle Winther, 29. “We think we are the first true vape company to be publicly traded, and we mean to continue to be first in many areas.” Wells Fargo & Co. estimates sales of vape gear in the U.S. will reach $3.5 billion this year, compared to $1.7 billion in 2013. The Smoke Free Alternatives Trade Association in Washington, D.C. estimates sales will reach $10 billion by 2017. However, Vapor Hub faces plenty of competition and turbulence before it will come out on top of the vape business. Large tobacco companies have invested in electronic cigarettes –smaller versions of the mods Vapor Hub makes – and could move into the mod market. And there are other competitors trying to access public capital markets. Vapor Corp., a maker and distributor of vaporizers in Dania Beach, Fla. has a market cap of $26 million. Closer to home, Vape Holdings Inc., a Chatsworth company with a roll-up model to acquire and develop vape brands, has a market cap of $5.6 million. In comparison, Vapor Hub has a stock valuation of just $1.4 million. What’s more, there are increasing calls for regulations, highlighted by the introduction of two bills in the Legislature last week that would treat vaping similar to tobacco. But the company’s primary challenge may be its own financing. Vapor Hub became public in 2012 through a reverse merger, a deal in which a failed public company is acquired, giving the acquirer the legal right to trade its shares without the regulatory hurdles of staging an initial public offering. While Winther said the company went public to access capital, so far the money has come from debt, not equity sales. In November the company struck a deal for $1.6 million in loans from Typenex Co-Investment LLC, a Chicago finance company, using its stock to secure the loan. However, the terms could put Vapor Hub on the wrong side of so-called “death spiral financing,” in which a lender takes payments in shares rather than cash and eventually dilutes the stock’s value to zero. In the last year, Vapor Hub’s share price has declined 966 percent and closed April 15 at 2 cents. Overheated sector Vaping started in 2003 when a Hong Kong pharmacist developed a way for a heated coil to vaporize liquids and imitate smoking – with or without nicotine, depending on the user. Variations have since multiplied, and though supporters say they are healthier than smoking, regulators and public perception often link the practice with tobacco. The first vaporizers were imported from Asia starting in 2007. Specialized vape shops soon opened, with Wells Fargo estimating there are 5,000 vape shops in the United States, up from 3,500 two years ago. But as Winther and others describe it, the vape shop landscape is an unsettled place. Many manufacturers lack the resources to sustain mass production of mods and shops don’t have the capital to make large orders. Customer tastes can change overnight, leaving manufacturers in the lurch and shops with unsellable inventory. “It’s run by amateurs,” said Norm Bour, founder of Vape Mentors, a consulting firm in Newport Beach. “Business is risky, and the vaping business is more risky than most.” Winther got into the business as a marketer. A graduate of Cal State Northridge with a bachelor’s in business administration, he previously co-founded Streamline Results Inc., an Internet affiliate program manager and marketing consultancy in Thousand Oaks. When friends showed him some early electronic cigarettes, he signed up to sell them through a multilevel marketing outfit. Winther moved into retailing, opening a website and two vape shops, but he decided he could improve his margins by making his own product. In 2008, with funding from personal savings and credit from manufacturers, he began to design, manufacture and sell his own mods, His first big hit was in 2012 with the AR Mod, designed to resemble an air-cooled rifle barrel. Today, Vapor Hub owns two shops in Simi Valley and Chatsworth. A recent makeover at the flagship Simi store created a lounge where customers can sample more than 100 flavors of vapor in a bar-like atmosphere. Winther said the stores make money, but they also provide a chance to test new products and hear customer feedback on prototypes before the company invests in large-scale production – crucial intelligence in the fickle mod market. “It’s a unique ability we have over the competition – we own shops, so we can get to the heartbeat of the industry,” he said. But most of Vapor Hub’s revenue – $1.1 million for the most recent quarter – comes from wholesale distribution of its mods and third-party products to vape shops. The company has about 30 employees, including a crew of salespeople who phone shops and solicit business. Company President Jake Perlingos, 34, said the business relationship usually starts with the retailer selling Vapor Hub mods before the company leverages the relationship into more business as a one-stop supplier of merchandise. Vapor Hub’s best-selling product is called the Limitless Mod, an aluminum tube that sells for $100 to $170. The key to its popularity is a detachable metal sleeve that encircles the device, allowing customers to change the look of their mod in step with the latest fashion for as little as $30. Designs include primary colors, bandana motifs and camouflage. “We wanted to create a sustainable product in this industry where there is always something new – nothing is stable,” Perlingos explained. Perlingos said a typical mod costs about $200 to $300, so Limitless is on the economical side, although the sleeves can run as high as $180 each. The company also distributes the so-called eliquids that run about $12 for a small bottle. Flavors range from Cosmic Fog Kryptonite to Holy Grail Cream Supreme. The nicotine content can range from 3.6 percent down to zero. Bour, the consultant, said that while competition abounds in the industry, most of it is at the retail level. Distribution companies such as Vapor Hub have higher barriers to entry and provide a critical function between the mod makers and the shops. The minimum order to make a mod economical is around 500, and a single store or group can’t invest so much in a single model. However, Vapor Hub can buy in bulk from a contract manufacturer or make them in house and distribute the goods profitably. One pervasive challenge in the industry, Bour said, is lack of investment capital. “Because it’s a risky market, banks won’t lend and investment firms won’t touch it,” he said. “Conventional funding is virtually impossible. Vapor Hub is one of the few companies to pull off going public.” Two-penny stock Vapor Hub was born in February 2014 from the ashes of DogInn Inc., a company that tried to develop an Internet directory for pet services. The reverse merger brought together Winther’s mod manufacturing operations and his online and retail operations under one corporate umbrella. But since the reverse merger, costs associated with the transaction and the need for fresh capital have pushed down the stock price. In the last year, Vapor Hub’s share price has declined 966 percent and closed April 15 at 2 cents. In the most recent quarter, Vapor Hub reported a net loss of nearly $190,000 on revenue of $1.1 million. The company explained its losses were due to general and administrative costs of $647,000, which it attributed to higher sales and marketing costs, hiring employees and “costs associated with being a public reporting company,” according to its quarterly filing with the Securities and Exchange Commission. One factor in the company’s stock decline is the potential dilution of shares. Under the loan agreement with Typenex, the company must pay $35,000 a month with either cash or shares. Also, Typenex will get the shares at a 70 percent discount to their trading value. If a lender has access to discounted shares, it can dump those shares at a guaranteed profit, causing the value to spiral down. Since going public, Vapor Hub’s float has grown from 38 million to 68 million shares. In a March 5 letter to shareholders, Winther said the expansion of the float was a requirement for the Typenex loans, but he plans to “repay our financial obligations owed to Typenex with cash generated from our operations to minimize shareholder dilution.” “The stock will grow with the execution of our business plan,” he told the Business Journal. “Our goal is to increase sales to have the money to pay with cash, not shares. … At the same time, we want to release information to shareholders. We want to get their confidence and get our market cap up.” Typenex did not respond to a request for comment. Even if VaporHub can maintain its finances, Bour said a cloud hanging over the entire industry is government regulation. In part, that perception is fueled by the appearance of smoke-like vapor, as well as large tobacco companies Altria Group Inc. and Reynolds American Inc. launching brands of electronic cigarettes – the smaller versions of the mods that resemble traditional smokes. Sen. Mark Leno, D-San Francisco, last week introduced SB 140, which would outlaw vaping in bars, restaurants and other public places where cigarettes are banned. Assemblywoman Cristina Garcia, D-Downey, last week introduced AB 216, which would ban the sales of vaping gear and non-nicotine liquids to minors because the same gear can be used to inhale nicotine or cannabis oil. Vape advocates, meanwhile, maintain that it’s much healthier than tobacco and that it can help tobacco smokers quit. Both sides admit that the practice is too new to know long-term health effects. But Perlingos doesn’t see the vape shop count diminishing any time soon, either from regulation or competition from mainstream retailers. “At this point, there are no big tobacco or major manufacturers that are our competitors,” he said. “And the environment cannot be overtaken by CVS or standard grocery stores because it’s an experience to try a new (vape) flavor. It’s like a cup of coffee and what Starbucks has created. Vape shops will continue to grow, just like the coffee industry.”