Midatech — Update 5 January 2016

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:

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.

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