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Introduction

I think that the potential of stem cell therapy has captured the imagination of most biotechnology investors who see it as a new potential driver for the biotechnology industry. Paradoxically, large pharmaceutical and biotechnology companies are in a wait and see mode, as are large institutional investors. This means that most of the cutting edge development is going on in academic centers and small, risk-taking biotechnology companies. The lack of large investor interest and analyst coverage means that, despite the tremendous promise of the technology, stem cell companies have small market capitalizations and are largely ignored by Wall Street.

This report focuses on Neuralstem (CUR), which, I think you will agree as you read this report, is a fascinating situation. I believe that it is the global leader in neural stem cell development and it has some "attention getting" results using this technology to treat a small number of amyotrophic lateral sclerosis or ALS (also known as Lou Gehrig's disease) patients. For those of you who have followed my work, I see this as another asymmetric investment opportunity. There is huge upside potential if Neuralstem is successful, which must be weighed against significant downside or even company failure if the development efforts fail. I think that there is a fair chance for success, hence this article.

Product Development Overview

This report provides an introduction to stem cells and the cells that comprise the central nervous system. Basic knowledge of both is needed to understand the investment thesis for Neuralstem. Its technology platform is based on first isolating neural stem cells from fetal tissue and then expanding them in cell cultures to produce enormous quantities for clinical studies and hopefully eventual commercial use. The neural stem cells, when transplanted, can differentiate into the three key cell types of the central nervous system: neurons, astrocytes and oligodendrocytes. These newly transplanted cells can integrate with existing tissue to repair or create new neural circuitry.

Most investor attention on Neuralstem has centered on its ALS clinical trial using neural stem cells. However, its technology also has promise for developing novel small molecule drugs. It can isolate and grow stem cells found throughout the brain and spinal cord, something that few, if any, other companies can do. It can then screen for molecules that have a desired effect on those cells. Using this approach, it has developed a new small molecule drug that works through a novel mechanism of action for the potential treatment of depression, Parkinson's, Alzheimer's, and other diseases of the central nervous system. The company is currently dividing spending about equally between the stem cell transplantation and its small molecule programs.

A Perspective on Investing in Stem Cell Therapy

I recently attended the MD Becker Conference on Immunotherapy and listened to a panel discussion of four well-known Wall Street biotechnology investors. I found some of their comments to be an excellent starting point for presenting the investment thesis on Neuralstem. While stem cell therapy companies were not featured in this conference, their investment issues are very similar to those of immunotherapy companies.

The four investors were unanimously negative on small companies who were focusing on immunotherapy and by extension of their thinking, would also be negative on stem cell therapy companies. The most important point that all four investors pressed was the riskiness in investing in small companies pioneering potentially paradigm shifting technologies. They dismissed these companies as "science projects" feeling that the clinical outcomes were too uncertain and the timelines for development were too long to warrant investment consideration.

When asked about the types of companies in which they liked to invest, they said that they favored companies whose lead products had data from well controlled, randomized phase II trials. They also favored companies working with proven technologies such as small molecules and monoclonal antibodies. They essentially dismissed small companies doing pioneering work in immunotherapy and stem cell therapy.

I point out their views not to disparage or argue with them, although I do disagree. The importance of understanding their viewpoint is that they represent consensus thinking on Wall Steet. They have no interest in investing in companies like Neuralstem or immunotherapy companies like Northwest Biotherapeutics (NWBO) and NovaBay (NBY), small companies that I have recently highlighted. The collateral problem that this causes is that Wall Street analysts provide coverage on companies that large institutional investors are interested in. This results in redundant coverage of the large and medium sized biotechnology companies, but almost total neglect of small pioneering companies like Neuralstem.

These four investors are trying to minimize risk by investing in evolutionary advances in science on the premise that reducing risk makes for a more favorable reward/risk ratio.

However, I am not sure that this strategy really accomplishes that. An audience member pointed out to them that ArQule (ARQL) and Keryx (KERX) fit their investment criteria to a tee. They were developing small molecule drugs for oncology that had shown statistically significant effectiveness in phase IIb trials. Both subsequently reported disappointing data and that has led to a 50% drop in their stock prices. These experiences show that there is considerable risk as well in investments based on consensus thinking.

I think there is room in a diversified portfolio of biotechnology companies to have some "science projects." There are some amazing technologies, like stem cell therapy, that hold the potential for dramatic medical breakthroughs. However, big companies seem to avoid these opportunities for the same reason as big investors; they see it as just too risky. There aren't many employees of large company research departments that would spend 14 years of their careers sponsoring an unproven technology as the management of Neuralstem has been willing to do. The paradox in biotechnology is that big companies aren't willing to go after the potential paradigm shifting technologies. These are left to small companies, largely ignored by investors, which struggle with modest market capitalizations and have difficulty attracting capital.

I believe biotechnology trials and investments in companies conducting them are risky - period. If you are investing in biotechnology, there is no way to avoid this. This argues for diversification, but why not include some companies in which the reward in the event of success gives the skyrocket investment returns that are a biotech investor's dream? Relative to current investor consensus thinking, the risks are not dramatically different, but the returns could be dramatically higher. This is not to argue that investors go out and buy every small company with an interesting story. I place an emphasis on companies with promising clinical data, but I don't always demand that it be from a large trial. I believe that Neuralstem is one of the "science project" companies that warrants serious investment consideration.

Key Investment Issues with Neuralstem

Let's now turn from the macroeconomic investment issues confronting Neuralstem and other small stem cell therapy companies to those that are Neuralstem-specific. This company has spent 14 years developing its regional neural stem cell therapy and has the leading position in the world with this specific approach to stem cell therapy. For another company, large or small, to try to replicate what the company has done would be a daunting challenge that would take many years. It has a highly proprietary technology base and strong intellectual property. Its products, if successfully developed, should have a very long commercial life.

The stem cell transplantation program is first targeting amyotrophic lateral sclerosis (ALS) and will soon open trials for treating neurological damage caused by trauma and stroke. These are devastating conditions for which there are no effective treatments. The company is now reporting maturing data from an ongoing phase I trial in ALS. In the first phase of the study, twelve ALS patients received neural stem cell transplants in the lower lumbar region of the spine. The primary objective was to establish safety for both the implanted cells and the surgical procedure.

The first six of these twelve patients were non-ambulatory (the first three treated were also on breathing machines) which indicates that motor neurons in the lumbar regions of their spine that control walking were already dead. There was no expectation that transplanting neural stem cells in the lumbar region would give any therapeutic signal. Determining safety was the primary objective. It was shown to be safe to the satisfaction of the FDA in these first six patients so that Neuralstem was allowed add another six patients to the trial.

The stage of ALS in the next six patients was less advanced. They were still ambulatory which indicated that some motor neurons in the lumbar region were still functional. This raised the possibility that Neuralstem's neural stem cells could integrate with remaining nerve tissue to improve neural function. One of these six patients died of a heart attack which was determined not to be connected with the transplantation and could not be evaluated.

This left five patients out of the first twelve treated for whom there was some possibility of seeing a signal of efficacy. Encouraging results were seen in four of these patients as the disease was stabilized for nearly one year. This was noteworthy because ALS patients almost always experience a steady decline over this length of time. The fifth patient experienced an extraordinary improvement, which was unprecedented in the experience of ALS investigators involved in the trial. This is not a disease in which there are occasionally spontaneous remissions. Physicians did another diagnostic workup to confirm that he indeed had ALS.

Ted Harada, who was the 11th patient treated in trial (he had 10 bilateral injections of cells in the lumbar region), experienced an extraordinary result and went public with the information. He wrote on his blog that in 2010, he was diagnosed with ALS at the age of 38. He said "my left leg fatigued easily. I was short of breath, my energy tapped. I needed a cane to walk. Then came the barrage of tests, the results the same. There is no hope. You are without hope. Then I heard about a clinical trial transplanting neural stem cells into the spinal cords of ALS patients. It was the first of its kind. The Food and Drug Administration approved it and I qualified. I was treated at Emory University Hospital in March 2011. Since then, the deterioration from ALS has temporarily slowed. I even completed a 2 1/2-mile walk to defeat ALS."

Mr. Harada was later interviewed by Fox television and on that interview one of the investigators in the trial, Dr. Eva Feldman, the principal investigator in the trial, was quoted as saying, "We have found the procedure to be extremely safe. In some patients, it appears that the disease is no longer progressing, but it is too early to know if the result from that small number of patients is meaningful."

Mt Harada has now been given an additional five unilateral injections in the cervical (upper) region of the spine as an ongoing part of the trial. As explained later in this report, injections in the lumbar region would be expected to have an effect on walking while injections in the cervical region are expected to have more of an effect on breathing, speech and swallowing. Most ALS patients die because they no longer can breathe. Initial results of Mr. Harada and five other patients who received cervical injections should be available by year end 2012 or early 2013.

Analysts like me are conditioned by experience to be skeptical about drawing conclusions from data based on small numbers of patients and to dismiss extraordinary improvements such as Mr. Harada's as occurring by chance. The most dangerous words in the English language are "this time it's different," but the situation with ALS may be different. It is caused by deterioration and death of spinal cord motor neurons and once they die they are not replaced by the body. The disease usually starts in the lower lumbar region of the spine and spreads up the spine over time. This suggests that the condition can only get worse and this has been the clinical experience with ALS. Preventing progression in the four patients and Mr. Harada's extraordinary improvement takes on more meaning in this context.

ALS is an orphan drug disease with only 5000 new cases per year in the U.S. and a prevalence of 35,000. However, pricing for orphan disease drugs for life threatening conditions can be set very high. Insurance companies regularly reimburse such drugs at $200,000 to $300,000 per year as opposed to $10,000 per year for drugs dealing with less severe diseases. At these prices, the U.S. addressable market based on incidence of ALS is $1+ billion and based on prevalence is $7+ billion. Neuralstem's neural stem cells could achieve very quick penetration of the market based on replication of the results seen in the phase I trial. Each 1000 patients treated could produce $200 to $300 million of revenues.

Most of investor attention on Neuralstem has centered on the neural stem cell transplantation programs. However, its technology also has promise for developing novel small molecule drugs. It has isolated neural stem cells from throughout the spinal cord and brain. These can be screened to find molecules that work through novel mechanisms of action.

The first small molecule drug is NSI-189. The hypothesis underlying the development of this drug is that age and disease can cause the hippocampal region of the brain to atrophy. This is the part of the brain associated with memory. Some investigators think that this atrophy may contribute to diseases like depression, Alzheimer's and Parkinson's. Based on screening against its proprietary hippocampal cell line, Neuralstem, studies conducted in vitro (cell cultures) and in animals indicated that NSI-189 may re-stimulate the growth of neurons in the hippocampus. Research on central nervous system drugs has been largely based on the manipulation of neurotransmitters such as serotonin and dopamine. While this approach has led to the creation of drugs like Prozac and Zoloft that produced billions of dollars of sales, this research course has largely exhausted itself and CNS drug research is floundering. Also these drugs had only mediocre efficacy.

Against this back drop just laid out, the novel hypothesis explored and novel mechanism of action make NSI-189 an interesting project. The product is in a phase I trial to primarily determine safety. Unlike the ALS program, this is likely to be a drug that will require lengthy and costly trials as depression does not pose the risk to life as does ALS. It might take six to eight years, costly clinical trials involving thousands of patients and as much as a billion dollars to develop this drug. Neuralstem can only pursue development of this drug through a partnership.

Investment Thesis

My investment interest for Neuralstem is driven by its novel and enormously exciting stem cell transplantation and small molecule technologies. I can get a little bored following the evolutionary technologies that Wall Street focuses on. It may be a science project, but there is more than just "hype" with the story. Although, we have data on only five ALS patients that suggest that its neural stem cell therapy is effective, I think that in the context of the progressive nature of the disease that the phase I trial has given an important signal on efficacy and has shown that the surgical procedure has acceptable safety.

As an investment, Neuralstem, with its $78 million market capitalization, is valued like a venture capital investment that faces many years of clinical development. However, it has already gone through 14 long years of development. In an optimistic scenario, its stem cell transplantation product could begin phase III trials in 2014, an NDA could be filed in 2016 and US marketing could begin in 2017. Assuming 1000 patients treated in 2017 at a price of $200,000 per patient, this could create $200 million of revenues. I think that the multiple placed on sales would be five to ten times resulting in a $1 billion to $2 billion market capitalization. The company currently has about 85 million fully diluted shares outstanding counting all in the money as well as out of the money options and warrants. Based on some rough assumptions for financing, there might be 125 million shares outstanding by 2017 resulting in an $8+ share price.

The company also has an interesting business development strategy in China. In cooperation with the Chinese military, it is beginning a phase I trial in patients who have suffered neurological damage due to ischemic stroke. In this procedure, the same neural stem cells used in the US trial for ALS are implanted into the brain of an ischemic stroke victim rather than the spinal cord. A phase I trial will be starting by yearend or early 2013. I discuss the timeline for development in detail later in this report, but assuming success in the clinical trials, the product could be approved in 2015 in China.

Neuralstem has planned another clinical trial program in Mexico that will also study the same neural stem cells. If the company can close a partnering deal, a phase I trial could begin in 1H, 2013; it will not start the trial without a partner. The development timeline is discussed in detail later, but assuming success in the trials, the product could be approved in Mexico in 2016.

Clearly, the upside in the stock is extraordinary if these scenarios all develop successfully but this must be balanced against the many risks that I outline in this report. The clinical trials may report disappointing results or safety issues could emerge that in the bleakest scenarios could lead to liquidation of the company. This is another of the asymmetric investment opportunities that I sometimes focus on.

The performance of the stock over the next one to three years will be primarily driven by clinical results from the neural stem cell transplantation program. The small molecule program is not likely to produce meaningful phase IIb data before then. I think that the hypothesis behind NSI-189 is very interesting, but it just has a slower development timeline. Neuralstem is confident that it can partner NSI-189 in 1H, 2013. The terms and the partner chosen could have a short term impact on the stock price.

Clinical Trial Timelines

The stock performance in 2013 and 2014 will be driven by milestones on clinical trials. I have laid out potential timelines under the assumption that all trials are successful and complete on time. These are shown below:

Neural stem cell clinical studies in U.S. for ALS:

· 1Q, 2013: Six more surgeries were performed after the initial twelve patients on whom data has been released. These injections were in the cervical region. The last surgery was performed in August 2012. The first interim data on these six new patients will be available around the end of the year.

· 1Q, 2013: If there are no safety issues in the 18 surgeries that have been performed to date, the FDA may allow Neuralstem to begin a phase II trial that will involve higher concentrations of cells per injection and more injections in both the lumbar and cervical regions of the spine.

· 2Q, 2014: Results of phase II reported.

· 4Q, 2014 Phase III trial involving 40 to 50 patients begins

· 3Q, 2016 Initial results of Phase III trial reported

· 4Q, 2016 NDA filing for ALS

· 2Q, 2017 US approval

Neural stem cell clinical trials in China for ischemic stroke patients with neurological damage

· 1Q, 2013 Phase I/II trial starts in 9 to 18 ischemic stroke patients

· 3Q, 2013 Initial data relating to safety is available

· 4Q, 2013 Phase II trial involving 100 ischemic stroke patients with neurological damage begins

· 4Q, 2014 Results available

· 3Q, 2015 Approval based on phase II results may be possible

Neural stem cell clinical trials in Mexico for ALS and spinal cord injury

· 2Q, 2013 Start of trial is dependent on partnering deal

· 2Q, 2013 Phase I/II trial begins in twelve to eighteen ALS and spinal cord injury patients subsequent to partnering

· 1Q, 2014 Results of trial

· 2Q, 2014 Phase II/ III trial starts in 100 ALS and spinal cord patients

· 2Q, 2016 Results are available

· 4Q, 2016 Regulatory filing

· 3Q, 2017 Product approved

NSI-189 clinical development

· 1Q, 2013 Phase Ib results

· 2Q, 2013 Partnering deal with potential upfront payment of $5 to $20 million depending on strength of phase Ib data

· 4Q, 2013 Phase IIa trial in depression involving 200 patients begins under sponsorship of partner

Financial Issues

Neuralstem operates as a virtual company with a burn rate of $500,000 to $600,000 per month or $6 million to $7 million per year before any expenses for clinical trials. This should remain the case for the next few years. The company will bear no costs after 1Q, 2013 either for the NSI-189 trial or the Chinese and Mexican trials of its neural stem cells.

The primary incremental cost over and above the $6 to $7 million burn rate will be the cost of the US trial in ALS. Each ALS patient costs about $130,000. In the phase II trial that could start in 2Q, 2013, the company will enroll 18 patients at a potential cost of $2.3 million; this will be spread over 2013 and 2014. The total expenditures in 2013 and 2014 could be $12 to $14 million in intrinsic burn and $2.3 million for the phase II trial plus a small amount for beginning the phase III trial late in 2014. This adds up to $15 to $17 million of spending in 2013 and 2014.

The company currently has about $10 million of cash on its balance sheet and by year end this could be about $8 million. The partnering of NSI-189 could bring in $5 to $20 million in 2Q, 2013. At the lower end of the range, Neuralstem would need to raise additional cash in 2014. At the upper end of the range it would have $10 to $15 million of cash at the end of 2014. There also could be potential upfront fees from partnering neural stem cells in the US in 2014 and the Mexican deal in 2013.

Source: Neuralstem Is Speculative, But Its Work In Stem Cell Therapy Can't Be Ignored