What Next For Neuralstem?

Shares of Neuralstem Inc. (NYSE: CUR) have begun to retreat from their explosive September rally, which gave CUR shareholders gains exceeding 125% in less than a month, which overcompensated for the crash in share prices halfway through August.

While Neuralstem’s overall value has been making progress (meaning that the company has been appreciating in value this year).

On Thursday, the company did announce that it has been approved to commence a clinical trial to treat motor deficits due to ischemic stroke with its spinal cord stem cells (NSI-566) at BaYi Brain Hospital, in Beijing, China, through its subsidiary, Neuralstem China, causing a bit more volume than usual, but trading activity had definitely been drying up.

Unfortunately, the unlucky shareholders of CUR have been pummeled by share dilution. August’s ~35% drop can be largely explained by a public offering of 6 million common shares. Recent retreats from the 52-week high of $1.96/share can be mostly explained by a $7 million offering by Neuralstem at $1/share – announced on the same day that the new top was made. When are we going to see tighter controls on the total pool of outstanding shares?

That answer can be found on Neuralstem’s balance sheet. With only $2.5 million in cash, and a substantial amount (~$1.5 million) is short term liabilities, we can infer that Neuralstem is barely scraping by on its current budget. In its current stage, Neuralstem has no source of revenue other than share dilution and runs a quarterly deficit of ~$2.4 million (or about $10 million per year). The total number of shares has increased about 11% in Q2 2012 versus Q2 2011, which implies that given the current rate shareholders would have to see at least 11% appreciation in CUR to break even while providing the company it’s only source of revenue. Why would anyone be buying a company with such a proportionally high cash burn rate anyway?

Neuralstem, like many other young biotechnology companies, is basically a lottery ticket where the odds aren’t actually known. CUR, specifically, is a lottery ticket for a (small )chance of winning a slice of the future in stem cell therapies. Since the field of stem cell therapy is brand new (and even newer to the United States due to political barriers), it’s really tough for anyone to guess what’s coming next. Biotech stocks were difficult enough to predict already – can we even gauge how much a fledgling stem cell company like CUR could be worth at this point? The obvious answer is no – we can’t confidently determine what a stem cell therapy project is worth until we see similar examples that have already hit the market.

Even if a stem cell therapy was targeting a well-known therapeutic market, highly innovative therapies tend to bring surprises once they are set free in the healthcare industry. A great example to bring up is Dendreon (NASDAQ: DNDN), and it’s immune system-based prostate cancer therapy Provenge. Provenge was (and is) an extremely novel and high-tech approach to tumor eradication that seemed ready to revolutionize medicine itself and make DNDN shareholders an absolute killing in the process (some early estimates placed Provenge’s expected revenue ten or more times its current value).

Sadly, Provenge ended up an unprofitable treatment that Dendreon is now trying to save through cost cutting measures. The takeaway lesson is that it’s nearly impossible to quantify the sales potential of a truly revolutionary product without making some errors along the way. I ‘d argue that we can gauge Neuralstem’s ballpark potential, based solely on its intentions to treat ALS with stem cells, but since the company is exploring alternative uses for “NSI-566” we have no idea where CUR is going yet.

As mentioned before, Neuralstem’s main therapeutic target is Amyotrophic Lateral Sclerosis (ALS, also known as “Lou Gehrig’s Disease”). The disease comes from the unavoidable destruction of motor neurons in the spinal cord and brain, which continues to compromise a patient’s ability to control the body and eventually leads to death. One FDA-approved compound known as riluzole can slow the progress of ALS considerably, but does not prevent the eventual degeneration of motor neurons. The French pharmaceutical giant, and creator of riluzole Sanofi-Aventis (NYSE: SNY) is estimated to generate around $50 million/year in US sales (according to a quote by analyst Eric Schmidt of Cowen & Co.).

The same Businessweek article that quoted the $50 million/year estimate for Sanofi’s riluzole also discussed Biogen Idec (NASDAQ: BIIB) and its phase III mitochondria-stimulating ALS drug called “Dexpramipexole”. Analyst Eric Schmidt made a $1 billion/year estimate on Dexpramipexole’s market potential upon FDA approval, which either implies a very expensive price for future ALS treatment or greater incidence of the disease. Still, we can see that Neuralstem’s current total worth of about $70 million is a fraction (perhaps 1/10, or less) of its intrinsic future value given acceptance of three big conditions:

1 – Neuralstem’s NSI-566 neural stem cells can actually cure ALS, or completely stop its progression. This means that they work well enough to give statistically significant improvements in patient outcome when it undergoes phase II/III clinical trials.

2 – ALS incidence continues (something around 5,000 new cases each year), and the $1 billion/year estimate was somewhat accurate for the ALS drug market in a few years

3 – NSI-566 is superior or at least highly competitive in both efficacy and cost-efficiency compared to dexpramipexole and other future competitors, so that it will have acceptable market penetration

If I bet against the overwhelming odds and say that Neuralstem is going to meet all these conditions down the road, and generate something like $700 million/year in the process, CUR’s future gains in the market will far exceed the erosion that the company is causing through constant share dilutions.

Still, it’s far more likely the CUR will stagnate for many years – much like a zombie. Many biotech companies can simply survive on useless data releases that show no real signs of progress (which can still trigger a large jump in the stock price on nothing but hope). Subsequent share dilutions can essentially “harvest” the value added by these rallies overnight, giving the company revenue that can be used to continue operations.

I am not implying the Neuralstem dilutes its shares out of anything but necessity, but investors should keep their eyes open. If a company actively dilutes its shares on the rallies, make sure that the extra money (out of your pocket) is being actively used for progression. Until now, Neuralstem has been doing that.