Alexza Pharmaceuticals — Update 7 March 2016

Alexza disclosed on 26 February 2016 that on 15 February 2016 it entered into a non-binding letter of intent (LOI) from Ferrer to acquire all outstanding Alexza common shares, and Alexza agreed to proceed with non-binding discussions to help further facilitate Ferrer’s due diligence. The LOI does not represent a binding agreement to consummate such a transaction and it entitles either party to terminate discussions at any time. Ferrer indicated in its LOI that it had already completed a significant amount of due diligence and that it has a strong belief in the eventual success of Adasuve in patients with agitation. Ferrer’s LOI indicated it believed it could complete the due diligence process and negotiate terms/pricing for an all-cash deal within 20 days. Ferrer is the beneficial owner of 2.367m shares (about 10.8% of all shares outstanding, after considering the recent allocation of 2.173m shares to Teva as described below).

In September 2015, Alexza retained an investment bank (Guggenheim Securities) to examine strategic options. Hence, even as Alexza engages with Ferrer, it continues to explore potential discussions (including licensing transactions for its Adasuve interest, its other Staccato-based products, or outright sales of the company) with other potential parties as well. But given that Ferrer is the longstanding licensee and marketer for Adasuve rights in Europe, Latin America, and other territories (including Russia, the Middle East and certain Asian countries), and already has an established familiarity with the company, its management, and the Staccato technology, it would appear that Ferrer would be an ideal potential acquirer.

In late October 2015, Alexza and Teva Pharmaceuticals disclosed that they were in discussions to finalize an agreement for Alexza to reacquire the US commercial rights for Adasuve from Teva. A headline risk was the potential treatment of the $25m loan from Teva (‘Teva note’) to Alexza (which accrues interest at 4%), as nominally this note was slated to require repayment on dissolution of their business partnership, and Alexza’s Q315 cash position was $11.3m. On 23 February 2016, both firms finalized a transaction whereby US Adasuve rights were returned to Alexza, and terms of the Teva note repayment were restructured to eliminate the need for immediate cash repayments.

As part of the restructuring, Alexza issued 2.173m shares to Teva in exchange for a reduction of the outstanding balance of the Teva note by $5m, plus accrued interest (which we estimate at about $1.5m). After the share issuance, Teva will own approximately 9.9% of Alexza’s outstanding common stock. For the remaining $20m outstanding balance of the Teva note, repayment will only be required once annual US net sales of Adasuve or any other Staccato-based products reach $50m, and will then be allocated as four consecutive annual payments of $5m starting in the following year. We view these terms as very favorable to Alexza, given that much of the principal repayment obligations have been deferred until when Adasuve sales reach a commercially sustainable critical mass in the US market, and given that for the share issuance component of the note restructuring, the stock was effectively issued at an approximate price of $3.00 per share, considerably above recent market prices. Alexza will not be required to pay Teva any commercial royalties on future US Adasuve sales.

Further positive aspects of the transaction for Alexza are that it will receive, with no additional cost, Teva’s existing supplies/inventory of Adasuve as well as all related commercial and medical materials, documents and relationships (including with the parties needed for REMS compliance and for the ongoing Phase IV study and pharmacovigilance programs). Alexza will be allowed to sell Teva-labelled Adasuve product for at least 12 months.

Even without considering the Ferrer LOI or potential takeover scenarios, Alexza management had reiterated previously that while it would market Adasuve in the US in the short term upon regaining commercialization rights, its longer-term strategy would be to out-license or transfer marketing and commercialization responsibilities to a partner. Regaining US Adasuve rights and clearing the overhang of a pending near-term repayment obligation for the Teva note help de-risk the company and pave the way for future US Adasuve transactions, and/or could make Alexza more attractive as a potential acquisition target. This in part could explain Ferrer’s interest in buying the company.

Alexza reported interim results in late 2015 of its Phase IIa study of AZ-002 (Staccato alprazolam) in epilepsy patients with acute repetitive seizures (ARS). This study uses the intermittent photic sensitivity (IPS) model1 as a means to assess AZ-002’s therapeutic ability to potentially modulate seizure activity by measuring changes on the electroencephalogram (EEG) following exposure to varying frequencies of flashes of light. The double-blinded trial started in January 2015 and is designed as an in-clinic, randomized, placebo-controlled, five-way crossover study, measuring EEG effects after a single dose of AZ-002 at three dose strengths (0.5mg, 1.0mg and 2.0mg) vs placebo (administered twice during the six-week protocol for each patient).

The interim data were based on an enrolment size of three patients (out of six planned) at three US sites. AZ-002 produced a dose-related decrease in mean standardized photosensitivity range (SPR), the primary endpoint, and was safe and well tolerated. At the two higher doses, the maximum effect was achieved at the two-minute time point (post-inhalation), which was the first timed measurement in the study. This demonstrates the rapidity of the alprazolam effect onset, attributable to intravenous-like pharmacokinetics associated with the Staccato drug delivery technology. There were also dose-related changes in visual-analogue scales for sedation and for alertness, which were also demonstrated at the two-minute time point.

The observed reduction in SPR had a duration of about four hours and six hours for the 0.5mg and 1.0mg doses, respectively. For the 2.0mg arm, mean SPR remained below baseline at the six-hour time point (the last time point measured).

While the observed results to date are encouraging (in terms of showing efficacy vs placebo), they are based on a very small sample size. Patient recruitment has been taking longer than expected, given in part the time commitments required for study participants. Alexza plans to finish recruitment and complete the study by mid-2016. If trends to date are maintained, Alexza aims to meet with FDA officials to gain approval for an at-home study in H216, where recruited participants will take the experimental drug device (or placebo) on experiencing a seizure, and aim to quantify the number of seizure attacks experienced afterwards. The FDA may require additional evidence of pulmonary safety before allowing an at-home study to proceed.

Alexza reported total debt on 30 September 2015 of $67.7m, which includes adjusted amounts of the $25m that were drawn from the Teva note facility, and also consolidates the $45m royalty securitization debt financing from March 2014 (secured by the Alexza subsidiary that holds US Adasuve rights). The $45m royalty securitization-based notes (bearing 12.25% pa) have no other recourse to the parent company. Given $11.3m cash and equivalents, Q315 net debt is $56.4m.

Alexza’s cash burn rate (operating cash flow plus net capex) in Q315 was $7.5m, but we expect it to have decreased given the suspension in Adasuve manufacturing and significant headcount cuts in H215. We project a cash burn rate of $5.1m in Q415 and $4.8m in Q116. Alexza’s most recent guidance is that its current cash resources, and up to $2m available under a Ferrer note facility, should be sufficient for it to meet its cash needs into Q216. As Ferrer is interested in buying the company, we believe that Ferrer would be willing to expand its loan facility to Alexza in the short term, if required or requested. With Teva transferring its existing Adasuve inventory back to Alexza, and Alexza booking top-line sales in the interim before a new commercial partner is identified, we now assume modest US Adasuve product sales of $0.3m to be recorded by Alexza in 2016, versus zero previously.

We are placing our valuation under review pending the outcome of Ferrer’s letter of intent to acquire the company. We note that our last published equity valuation, as determined through a relative net present value (rNPV) approach, was $20.9m, prior to the Ferrer LOI and the Teva debt restructuring. Our base case scenario (prior to any formal acquisition offer) assumes that as a standalone firm, Alexza will partner its US Adasuve rights by 2017 and then be entitled to a 20% sales royalty on net US sales by the partner. Please see our 1 December 2015 update note for our Adasuve sales forecasts for 2017 and beyond, and for a detailed description of the commercial and licensing assumptions.