DARA – acquiring US presence in oncology

Midatech 6 January 2016 ADR Update

Midatech

DARA – acquiring US presence in oncology

DARA acquisition

Pharma & biotech

6 January 2016

ADR research

Price

US$5.00

Market cap

US$83m

ADR/Ord conversion ratio 1:2

Net cash ($m) at 30 June 2015

16.3

ADRs in issue

16.6m

ADR Code

MTP

ADR exchange

NASDAQ

Underlying exchange

AIM

Depository

Deutsche Bank

Business description

Midatech is a pharmaceutical company founded in 2000. The patented gold nanoparticle technology platform is developing therapeutics for several diseases such as diabetes and various cancers. A microsphere platform ensures predictable engineering of micro-particles. DARA BioSciences, acquired in late 2015, markets speciality oncology support products in the US.

Next events

OpsiSporin preclinical
package completed

H1 2016

FY15 results

April 2016

Sales progress on DARA portfolio

Ongoing

Analysts

Katherine Genis

+1 646 653 7026

Christian Glennie

+44 (0)20 3077 5727

Midatech is a research client of Edison Investment Research Limited

Midatech closed its all-share acquisition of DARA BioSciences on 7 December (first announced in June), thereby acquiring a presence in the US oncology market via DARA’s 20-strong sales force and portfolio of marketed cancer support products. On 18 December, Midatech announced the acquisition of anti-emetic drug, Zuplenz (from Galena, for $3.75m), a strong fit with DARA’s existing anti-cancer support products. The new Midatech shares are listed as ADRs on NASDAQ on the back of its recent IPO in the US. Our valuation for Midatech, with our calculations now including DARA and Zuplenz, moves to $221.0m from $200.7m (or $13.29/ADR from $14.45/ADR due to greater share count).

Year end

Revenue
($m)

PTP*
($m)

EPADR
($)

DPADR
($)

P/E
(x)

Gross yield
(%)

12/13

0.22

(7.3)

(212.9)

0.0

N/A

N/A

12/14

0.23

(12.0)

(243.7)

0.0

N/A

N/A

12/15e

1.15

(17.4)

(113.1)

0.0

N/A

N/A

12/16e

11.67

(24.5)

(135.8)

0.0

N/A

N/A

Note: Converted at US$1.49 to £1. Investors should consult their tax advisor regarding the application of any domestic and foreign tax laws.

DARA and Zuplenz bring an existing revenue stream

Midatech acquired DARA through the issue of 5.42m of its own new shares, which valued DARA at approximately $21.7m (£14.4m) at the time of the announced acquisition, or a 51% premium over DARA’s value. We forecast sales for DARA in excess of $30m by 2021 and believe the DARA business could reach profitability in 2017 with the help of ~$500k in annual cost savings. That said, profitability could be reached earlier depending on the ramp-up of Zuplenz sales, which we forecast to peak at $10m in 2021-23.

The formation of a niche pharmaceuticals company

Midatech’s core technology platforms offer potential to transform bioavailability and delivery of existing therapeutic agents. The gold nanoparticle platform underpins numerous clinical programs, led by transbuccal insulin delivery. The polymer microsphere technology tailors a drug’s release over extended periods. Applications that target larger markets will likely be out-licensed, while niche indications – especially those focused on oncology and neuroscience – will likely remain in house. The acquisitions of DARA and complementary product Zuplenz creates a speciality pharma company with a market presence for such future products.

Valuation: Increased to $221.0m from $200.7m

Our valuation for Midatech increases to $221.0m from $200.7m previously (or $13.29/ADR from $14.45/ADR, as we now incorporate the acquisitions of DARA and Zuplenz. Our valuation for DARA is based on forecast future operating cash flows (excluding potential payments on contingent value rights that are dependent on sales milestones, which exceed our relatively conservative projections). Additionally, we adjust our valuation for Midatech upward as our model has been rolled forward by six months and rebased to 2016.

Transforming into a speciality pharma company

DARA BioSciences is a pharmaceuticals company operating in the US, with central functions based in Raleigh, North Carolina. Its portfolio consists of five oncology support products, which help cancer patients manage some of the side effects that arise from their treatments.

Midatech acquired DARA through an all-stock transaction of 5.42m new shares. Each DARA share was exchanged for 0.272 Midatech ordinary shares. At the Midatech price of 265p at the time the acquisition was announced, DARA was valued at $21.7m (£14.4m), or $1.20 a share. This is a premium of 50.8% over the closing price of $0.796 on 3 June 2015 when the deal was announced, and a premium of 55.6% over the previous 30-day volume weighted average closing price of $0.771. Additionally, there are contingent value rights (CVRs) up to a maximum of $5.7m (£3.8m), which are payable in cash if certain sales milestones are achieved: in 2017 CVR holders will receive between $0.07 and $0.11 per CVR if gross sales of Oravig and Gelclair exceed $15-18m. In 2018 CVR holders will receive between $0.11 and $0.16 per CVR if gross sales of Oravig and Gelclair exceed $26-31.2m. In conjunction with the closure of the sale, Midatech shares became available for trading on NASDAQ on 7 December 2015. The new Midatech shares, in the form of ADRs, represent 16.3% of the current total issued share capital.

The acquisition looks to fit well in Midatech. Operationally, it provides it with the US infrastructure to commercialise its own in-house developed products. In the near term, we would expect management to devote efforts to identifying additional in-licensed products to broaden the existing portfolio. Although the deal is clearly not driven by cost synergies, management believes it has identified at least $0.5m of potential annual savings.

DARA’s portfolio is marketed by a specialist sales force of 20 reps. Its products are as follows:

Gelclair is a bio-adherent gel rinse used for the painful symptoms of oral mucositis, a condition often associated with chemotherapy and radiation-based treatments (particularly in head and neck cancers). There are an estimated 400,000 cases annually of therapy-induced oral mucositis in the US. Gelclair was licensed for the US from the Helsinn Group of Switzerland in September 2012, launched in Q413 and is the leading gel barrier prescribed in the US retail market. Company guidance calls for $3.7m in sales of both Gelclair and Soltamox (detailed below) together in 2015. Since launch, numerous national players and cancer institutions have approved Gelclair for preferred formulary position. Patent expiry is in 2021.

Oravig is the established anti-fungal miconazole in a novel buccal tablet that dissolves rapidly in the mouth and is indicated for oral thrush. This is often a side effect of therapy as the reduced immune activity can result in fungal overgrowth. The exclusive rights for the US were acquired from Onxeo in March 2015 and the treatment was launched into the US in October. Oravig is the only local once-daily treatment for oral thrush, with other treatments administered a minimum of four times per day. DARA sells Oravig to the specialist clinicians in oncology (which account for ~80% of prescriptions for oral thrush) directly and has an agreement with Mission Pharmacal to promote to primary care where the highest prescribing physicians of oral thrush are targeted. Patent expiry is in 2022.

Soltamox is the only oral liquid formulation of tamoxifen available in the US. Tamoxifen is widely used in the treatment and prevention of breast cancer in women, with nearly 2m prescriptions written annually. Soltamox gives a useful alternative to women who have difficulty in swallowing or cannot take solids. This is licensed from Rosemont Pharmaceuticals (UK) and is patent protected through to 2018.

Ferralet 90 (iron supplement for anaemia) and Aquoral (artificial saliva spray) are both Mission Pharmacal products, which DARA has rights to co-promote to its specialist oncology audience.

Additionally, there is a program, KRN5500, in-licensed from Kirin that is in Phase II development for chronic chemotherapy-induced neuropathic pain. A Phase IIa proof-of-concept study was completed successfully, with the FDA granting Fast Track and two Orphan Drug designations. It is not clear at this stage whether Midatech would pursue further development or seek to out-license or divest this program.

In Q315 to September, DARA reported gross product sales of $1.5m and net revenues of $1.2m (vs $0.6m in Q314), with a loss before tax of c $2.7m ($2.1m Q314). As of September 2015, net assets were $10.1m and cash and equivalents were $4.7m. Operating expenses in Q315 were $3.6m ($2.7m in Q314). Based on our forecasts, DARA is expected to become cash flow positive in the latter part of 2017.

Anti-cancer product Zuplenz added to US oncology portfolio

Subsequent to the closure of the DARA acquisition on 7 December, Midatech announced the acquisition of oncology product, anti-emetic treatment Zuplenz from Galena, on 18 December. Zuplenz is an oral soluble film formulation of 5-HT3 receptor antagonist Zofran, a preventative for post-operative, chemotherapy- and radiation-induced nausea and vomiting, which dissolves on the tongue in about 10 seconds. It is individually packaged, enabling faster absorption, increased convenience and better compliance for patients compared with other easy-to-use Zofran formulations, which are dissolvable and therefore require water. We note that sales of Zofran were $1.7bn in 2007 before patent loss, of which an undetermined amount was used off-label to expectant mothers. Zuplenz, which is patent protected until at least 2029, should slot in easily with the current DARA portfolio of three supportive anti-cancer treatments.

Midatech purchased marketing rights to Zuplenz for $3.75m from Galena, which had originally in-licensed it from MonoSol Rx. While detailed terms of the deal have not been disclosed, we expect Midatech to pay royalties on sales similar to those paid by Galena, in addition to the reported up to $26m in cash if certain sales milestones are achieved. Marketed by other firms in the past, Galena relaunched Zuplenz in July 2015 and we currently forecast peak sales of $10m before patent expiry in 2029.

Link ups with with Emergex and the Bristol Royal Infirmary

On 4 January Midatech announced an exclusive out licensing deal with private UK biotechnology firm Emergex Vaccines, a specialist in infectious diseases. While specific terms of the deal have not been provided, Midatech reports the agreement includes initial milestones and royalty payments. Emergex will utilize Midatech’s technology for the development of vaccines to prevent/treat infectious diseases, the first application of Midatech’s gold nanoparticle technology in this disease category.

The company also announced on 6 January the selection by oncologists at the Bristol Royal Infirmary for the delivery of a treatment for a compassion use program for a rare brain disease. The treatment brings forward first human trials of a Midatech product – albeit in a single program for a highly rare disease – enabling a potential fast track distinction in a market with high unmet medical needs.

Valuation

Our valuation for Midatech increases to $221.0m from $200.7m previously (or $13.29/ADR from $14.45/ADR) due to the greater share count. We include the impact of the DARA acquisition for the first time in our fair value for the company, which at $22.2m is calculated on forecast future operating cash flows and includes a small residual cash component. We forecast sales of the DARA portfolio to peak at $34m in 2022, the year that Oravig loses market exclusivity, trailing off thereafter. Given that sales are still at nascent levels, we err on the side of caution in our assumptions of an operating margin moving to 26% in peak years (DARA management has forecast 37% in 2019), also allowing for added cost-cutting merger synergies of $0.5m (Midatech management guides to at least $0.5m). We do not include potential payments on the CVRs in our valuation, which are dependent on sales milestones in 2017 and 2018 and exceed our more conservative top-line forecasts. The maximum aggregate value of the CVRs is $5.7m. Pending clarity on a development plan or potential divestment for KRN5500, we have excluded this program from our valuation. We also exclude any benefit to Midatech on possible sales and marketing synergies potentially gained through DARA’s distribution expertise in the US. Finally, we value Zuplenz at $6.4m.

In addition, we move our valuation for Midatech’s core portfolio (ex-DARA) upward as we roll forward our model and rebase to 2016.

Our valuation of Midatech ex-DARA is based on the rNPV model of the pipeline alone, which we discount on our standard rate of 12.5%. This excludes a contribution for the inherent value of the GNP technology platform allowing for upside when the preclinical programs progress into the clinic and partners/funding for the later-stage compounds are secured. Based on expected progress, the newsflow for programs over the next 12-18 months should result in value inflection points

Exhibit 1: Midatech rNPV valuation

 

Indication

Launch timing

Peak sales
($m)

Operating margin/
royalty rate

Success
probability

rNPV
($m)

rNPV
($/ADR)

Transbuccal insulin

Diabetes

2021

1,000

15%

30%

105.6

6.4

Transbuccal GLP-1

Diabetes

2023

750

15%

7.5%

15.7

0.9

Oncology GNP program

Variety of solid tumours

2022

2,000

15%

7.5%

46.3

2.8

Diabetes program milestones

37.6

2.3

Zuplenz

Oncology

marketed

10

30%

100%

6.4

0.4

DARA

22.2

1.3

R&D costs

(16.2)

(1.0)

G&A costs

(25.9)

(1.6)

Tax

(12.8)

(0.8)

Q Chip contribution (book value)

20.2

1.2

Net cash (FY15e)

21.9

1.3

Total

221.0

13.3

Source: Edison Investment Research

Exhibit 2: Financial summary

$'000s

2013

2014

2015e

2016e

2017e

2018e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

219

234

1,153

11,699

21,558

32,546

Cost of Sales

0

0

0

(2,590)

(4,500)

(6,631)

Gross Profit

219

234

1,153

9,109

17,059

25,915

EBITDA

 

 

(6,335)

(11,272)

(16,796)

(22,676)

(15,794)

(7,997)

Operating Profit (before GW and except.)

(6,702)

(11,750)

(17,446)

(24,615)

(17,679)

(9,864)

Intangible Amortisation

(1)

(1)

(0)

(2)

0

0

Exceptionals

0

0

(745)

0

0

0

Operating Profit

(6,704)

(11,752)

(18,191)

(24,617)

(17,679)

(9,864)

Other

0

0

0

0

0

0

Net Interest

(572)

(228)

69

91

(75)

(699)

Pre-tax profit (norm)

 

(7,274)

(11,978)

(17,377)

(24,524)

(17,754)

(10,562)

Pre-tax profit (FRS 3)

(7,276)

(11,980)

(18,122)

(24,526)

(17,754)

(10,562)

Tax

1,191

980

1,450

1,962

1,420

845

Profit After Tax (norm)

(6,084)

(10,998)

(15,927)

(22,562)

(16,333)

(9,717)

Profit After Tax (FRS 3)

(6,085)

(10,999)

(16,673)

(22,564)

(16,333)

(9,717)

Average number of ADRs outstanding (m)

2.9

4.5

14.1

16.6

16.6

16.6

Earnings per ADR - normalized (c)

(212.9)

(243.7)

(113.1)

(135.8)

(98.3)

(58.5)

EPS - (reported) (c)

 

(212.9)

(243.7)

(118.4)

(135.8)

(98.3)

(58.5)

Dividend per share (c)

0.0

0.0

0.0

0.0

0.0

0.0

Gross Margin (%)

N/A

N/A

N/A

N/A

N/A

N/A

EBITDA Margin (%)

N/A

N/A

N/A

N/A

N/A

N/A

Operating Margin (before GW and except.) (%)

N/A

N/A

N/A

N/A

N/A

N/A

BALANCE SHEET

Fixed Assets

 

1,608

28,222

52,410

53,985

55,756

57,691

Intangible Assets

6

25,330

44,110

45,896

47,738

49,635

Tangible Assets

1,019

2,259

7,748

7,537

7,467

7,506

Other

583

633

551

551

551

551

Current Assets

 

6,102

47,126

27,451

5,103

5,023

11,400

Stocks

0

0

203

203

203

203

Debtors

1,354

688

2,374

2,374

2,374

2,374

Cash

3,557

45,184

24,057

564

1,027

7,574

Other

1,191

1,253

818

1,962

1,420

1,250

Current Liabilities

 

(3,420)

(4,220)

(9,053)

(10,703)

(10,703)

(10,703)

Creditors

(1,560)

(3,488)

(8,930)

(10,579)

(10,579)

(10,579)

Short term borrowings

(1,860)

(732)

(124)

(124)

(124)

(124)

Short term leases

0

0

0

0

0

0

Other

0

0

0

0

0

0

Long Term Liabilities

 

(3,157)

(6,419)

(2,628)

(2,628)

(20,508)

(38,388)

Long term borrowings

(3,157)

(2,217)

(2,101)

(2,101)

(19,981)

(37,861)

long term leases

0

0

0

0

0

0

Other long term liabilities

0

(4,202)

(527)

(527)

(527)

(527)

Net Assets

 

1,132

64,709

68,179

45,756

29,568

20,001

CASH FLOW

Operating Cash Flow

 

(7,486)

(9,311)

(14,215)

(20,885)

(15,649)

(7,847)

Net Interest

(22)

(60)

45

91

(75)

(699)

Tax

876

1,183

1,788

818

1,962

1,016

Capex

(75)

(1,535)

(4,817)

(3,516)

(3,656)

(3,802)

Acquisitions/disposals

0

171

(3,700)

0

0

0

Financing

8,638

50,439

1

0

0

0

Dividends

0

0

0

0

0

0

Other

0

0

0

0

0

0

Net Cash Flow

1,931

40,889

(20,898)

(23,492)

(17,418)

(11,332)

Opening net debt/(cash)

7,922

1,460

(42,236)

(21,832)

1,660

19,078

HP finance leases initiated

0

0

0

0

0

0

Other

4,531

2,807

495

0

0

(0)

Closing net debt/(cash)

1,460

(42,236)

(21,832)

1,660

19,078

30,410

Source: Company accounts, Edison Investment Research

Solely for the convenience of the reader the financial summary table has been converted at a rate of US$1.49 to £1. Midatech reports statutory accounts in pound sterling. These translations should not be considered representations that any such amounts have been or could be converted into US dollars at the assumed conversion rate.

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London +44 (0)20 3077 5700

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New York +1 646 653 7026

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