Expert Financial Analysis and Reporting

Purpose of this Report

Neuralstem has been silent for nearly three months on when the critical phase 2b trial of its NSI-566 neural stem cells in ALS might begin and on providing details of the trial design. This silence may about to be broken as the Company has just announced that it will be presenting at the Biotech Showcase 2016 Conference in San Francisco 0n January 12. The presentation will be webcast at 5:00 PM EST on that date. I think it is possible that investors might be given some anxiously awaited information on this phase 2b trial as well as an update on the Company’s extensive pipeline that will clarify what is now a murky investment situation.

 Summarizing My Thinking on the Stock Price

I think that Neuralstem’s technology is extremely unique in the world of biotechnology. I think that we have seen strong signals of efficacy in human trials of NSI-566 in ALS that suggest that these cells can slow the progress of ALS or even stabilize it for a period of time in some patients, something that no other treatment has been able to do. If these results can be replicated in some component of the ALS population, it would be a major therapeutic and commercial breakthrough.

We may be able to see proof of concept for NSI-566 in the 2017 or 2018 time frame. The NSI-189 small molecule program is also a novel approach to treating depression and schizophrenia, disease areas which have seen little progress in the last two decades. This program could also show proof of concept in this same 2017 or 2018 time frame. The major issue for the Company is its weak financial position which will probably cause it to do a financing in coming months on onerous terms that likely will cause substantial weakness even from this depressed price. Because of this possibility, you might want to consider trading out of the stock and re-entering at some future point. I would not be adding to an existing position at this price.

Investment Thesis

Background

Neuralstem’s stock has performed extremely poorly this year as it began 2015 at $2.81 and is currently trading at around $1.00. There was much anticipation early this year that the reporting of data from the phase 2 trial of NSI-566 neural stem cells (the second trial in humans) would replicate very promising results seen in a previous (first in humans) phase 1/2 trial. This would then be the springboard for beginning a new, larger phase 2b trial (the third trial in humans) that either on its own or in combination with one more trial could be the basis for a regulatory filing assuming positive results. In its November 9, 2015 press release discussing 3Q, 2015 results the Company said that it is currently in discussions with the FDA for a “larger, controlled, registration directed clinical trial”. This suggests that an announcement of the trial beginning is a matter of when and not if.

Partial results from the phase 2 trial (second in humans trial) were reported on March 12, 2015 and the stock initially rose in pre-market trading on what appeared to be positive news, but then was hit with an avalanche of coordinated short selling. This caused the stock to end the day at $2.37 down from the prior day’s close of $3.74 and then go into a long slide through the balance of the year. Despite the price action, I viewed the data as encouraging, but I acknowledge that it was not as clean and robust as investors had hoped and there was a troublesome question that some patients treated with NSI-566 seemed to experience an acceleration in the course of their disease. In its 3Q, 2015 press release the Company said there “appeared to be no acceleration in disease progression due to the therapeutic intervention with NSI-566”, but the Company has not yet explained how it arrived at that conclusion. Overall, the data was quite supportive of going forward as judged by me and more importantly by key opinion leaders involved in the trial who strongly recommended starting the next phase 2b trial.

It is important for investors to understand all of the available clinical data on NSI-566 in order to reach an investment conclusion. I gave an in-depth analysis of the data from the phase 2 trial (second in humans) in a report of September 29, 2015 called Neuralstem: Initial Thoughts on Just Released Encouraging Phase 2 Data on the Use of NSI-566 Stem Cells to Treat ALS. Neuralstem Will Proceed to a Potentially Registrational Trial in 2016  and then followed this with an October 16, 2015 report called Neuralstem: My Analysis of Phase 1 and Phase 2 Results for NSI-566 Neural Stem Cells in ALS Indicates Encouraging Signals of Efficacy . I am not going to repeat the detailed discussion of the clinical data in ALS which I view as quite promising; I would urge investors to reread those reports

Neuralstem’s Silence Has Caused Investor Uncertainty

Neuralstem has consistently stated over the past year that it would start a phase 2b trial (the third trial in humans), but did not give precise guidance on when. Management did hint on various occasions that the trial would start in 2015. At one point, I thought the trial would begin in mid-2015, but this date came and went. As time went by, there was no word from the Company on why the trial was not starting. I have known the CEO of Neuralstem for over 15 years and have always found him to be open and balanced on the issues affecting the Company. Also, he would respond promptly to my phone calls and e-mails. However, for nearly three months I have been unable to get a response from him.

Why the Silence and When Will It End?

What is going on? I obviously don’t know the reasons for this radio silence from the Company. However, based on my industry experience I think that it almost certainly relates to interactions with the FDA on the phase 2b trial design. I have seen in prior situations involving other companies that when such discussions are underway, the Company will not talk about the issues being discussed for fear of alienating the FDA. I very much suspect this is the case here.

So what might be the reason for the delay? One reason might be complex discussions on details of the design of the trial. At one point, Neuralstem had thought that it would be unethical to have a control arm in the study. However, language in the Company’s 2Q, 2015 10-Q and the press release on 3Q, 2015 results suggested that there would be a control arm presumably at the request of the FDA. This would complicate the planning of the trial protocol and could be a reason for the delay. Another potential reason could be that the FDA might want to see more mature data from the phase 2 trial, i.e. they might want to see ALSFRS-r data on all patients for perhaps six, nine or more months. Or, it could be something entirely different.

Along with all other investors, I have been in a state of limbo without any information from management that would enable me to judge if my thinking that on the phase 2b trial prospects is correct or ominously that I am wrong. In what has been a three month hiatus, there has only been silence from the Company. The reason for writing this report is that on January 6, 2016 Neuralstem announced that it will be presenting at the Biotech Showcase 2016 Conference in San Francisco. The presentation will be webcast at 5:00 PM EST on that January 12. I am hoping that this long awaited update will bring clarity on questions arising from the previous phase 2 trial and understanding of the details of the new phase 2b.

What about the Stock?

In spite of the concerns raised by the lack of news and the steady decline in the stock, I have held my position. My investment style toward small biotechnology companies is to focus on the key fundamentals that are responsible for my investment judgment and as long as my views are not substantially altered, I stay with my position. This can be painful at times as these stocks can go through enormous price fluctuations. Also, the extensive amount of short selling conducted by hedge funds against stocks like Neuralstem makes fluctuations even more pronounced but that is another story. You may want to read my report Illegal Naked Short Selling Appears to Lie at the Heart of an Extensive Stock Manipulation Scheme  http://smithonstocks.com/neuralstem-my-analysis-of-phase-1-and-phase-2-results-for-nsi-566-neural-stem-cells-in-als-indicates-encouraging-signals-of-efficacy-cur-buy-1-25/?co=neuralstem My core belief is that trading in and out of these stocks too often leads to buying high and selling low and in the latter case getting out of a stock and never getting back in. Obviously, this has not served me well over the last year.

Weak Financial Situation Needs to be Understood

The weak financial position of Neuralstem is a major factor in thinking about the stock. Neuralstem has had a cash burn rate of about $5 million per quarter in the first three quarters of 2015 and if that rate holds in 4Q, 2015 it will end the year with just $13 million of cash. I would expect that the full year burn rate will accelerate in 2016 from the approximate $20 million burn in 2015 with NSI-189 for major depressive disorders progressing into phase 2 and NSI-566 for ALS progressing into phase 2b. The Company hasn’t given any burn rate guidance (perhaps we will hear something on January 12) but it appears that the Company has as little as one half year of cash.

Barring some partnering deal which I don’t expect at this early stage of product development, I think that we will see an equity deal on onerous terms. I think that to raise $20 million (a likely amount needed to run begin these trials), the Company would have to sell 25 million shares at perhaps $0.80 per share (a 20% discount to the current price) and issue a like number of 25 million warrants at a strike price of about $1.00. This would give the Company the cash needed to start its important trials for NSI-189 and NSI-566 with a cash runway into probably 2017, when it would have to return to the market.

Thinking About the Stock Price

If an equity deal with terms similar to what I just outlined is undertaken, we are likely in for a further rough stretch with the stock. Such deals by small companies like Neuralstem must usually be done with a group of collaborating hedge funds who paradoxically have been actively shorting the stock. It is illegal to participate in an equity offering if an investment firm is short the stock. However, some of the hedge funds in the group position themselves as not short while others are short allowing the non-shorts to participate in the deal. Based on prior experience, they may well then sell their stock acquires in the deal to other members of the group to cover short positions and then short against the warrants. This can lead to further pressure on the stock after completion of the deal.

The above is the negative scenario. I hope that new information coming out of the upcoming presentation and afterwards will be so positive as to cause the stock to strengthen and allow a financing at higher prices. However, I want to alert you to this negative scenario which has a meaningful probability of occurrence. I intend to maintain my position even faced with this ugly financing possibility in which Neuralstem would increase its fully diluted share count from about 130 million to 180 million. This is under the hypothetical financing terms I earlier laid out and at a price of $0.80 per share; it would then have a market capitalization of $144 million after the deal.

I believe a valuation of $144 million is extremely, extremely low in a relative sense. I think that if the Company were somehow still private and elected to come public that it would probably be priced at a market capitalization of $500 million or more with the uniqueness of its technology and mid stage clinical trial status of its products. Granted that the Company is pursuing a paradigm shifting and unproven technology that involves very high risk. Still, when I look at the gene therapy company bluebird.bio I see a lot of comparability in terms of development risk and quality and extent of data. In fact, in terms of quality and extent of data, I think Neuralstem has an edge. bluebird.bio has a market capitalization of $2.2 billion which is 16 times higher than $144 million. One reason I am staying in the stock is the hope that this market disparity could be closed, most likely with Neuralstem going up and bluebird.bio going down.

I would also point out that Neuralstem has been very much affected by shorting. However, hedge funds can manipulate stocks to the upside as easily as the downside. Hedge funds prey on one another and the extensive short situation with Neuralstem could be enticing to other hedge funds to run the stock up. Remember what Martin Shkreli did with KaloBios. See my report.  KaloBios was about to file for bankruptcy on November 9, 2015 when Shkreli and a group of hedge funds took a large position in the stock. They used a strategy that combined squeezing existing shorts and used naked shorting, high frequency trading and dark pool tactics to drive the stock. By November 23 (just two weeks) Shkreli ran the stock from $0.99 on November 9 to an intraday high of $45.82 on November 23. After Shkreli was arrested (good work by the FBI) the scam collapsed and KaloBios is filing for bankruptcy. A similar upside manipulation scenario is a possibility for Neuralstem although the probability is difficult to assess. 

Pipeline Update

I am hopeful that the upcoming January 12 presentation may also update the status of Neuralstem’s extensive pipeline which I describe below:

NSI-566 Stem Cells for the Treatment of Chronic Spinal Cord Injury (cSCI)

The same NSI-566 stem cells used in the ALS trial are also being developed for the treatment of chronic spinal cord injury. The trial is a four patient phase 1 safety study. The last patient was dosed in July, 2015 and there will be a six month post-transplant observation period. While the primary goal is to establish safety, investigators will be looking at any signal of restored activity of nerve cells below the site of injury. (Stem Cells is also doing a study using its similar neural stem cells in this type of patient and has indicated that it is seeing some signals of renewed activity in nerve cells.) There could be some discussion of these results at or sometime after the January 12 presentation.

In October, 2015 the study’s lead investigator, Dr. Joseph Ciacci of UCSD School of Medicine, presented initial safety data from this trial. He reported that there had been no serious adverse events that implantation of stem cells in cSCI patients is feasible and, that implantation of stem cells in the spinal cord injury patients has been safe and well tolerated. The last surgery was completed in July and the last patient is nearing the end of a 6-month post-observation period.

NSI-566 Stem Cells for the Treatment of Motor Deficit Impairment Caused by Ischemic Stroke

NSI-566 stem cells are also being studied in ischemic stroke in a trial that is being run in China. This is planned as a phase 1/2 trial with the phase 1 part intended to establish safety. The trial is now proceeding to the phase 2 portion. Neuralstem continues to proceed in this collaborative phase 1/2 ischemic stroke trial with BaYi Brain Hospital in Beijing. The phase 2 portion of the study, a controlled proof-of-concept study, is expected to commence in 2016. The trial is sponsored by Neuralstem's wholly owned subsidiary, Suzhou Neuralstem Biopharmaceuticals Co., Ltd. ("Neuralstem China").

NSI-566 Stem Cells for the Treatment of Acute Spinal Cord Injury (cSCI)

A South Korean partner is expected to start a phase 1 trial of NSI-566 stem cells in acute spinal cord injury in 2016 in South Korea. The difference between acute and chronic is that acute treatment is initiated immediately after the spinal cord injury has occurred while chronic takes place many months later after the patient has stabilized. It is much harder to recruit acute patients because the injury must occur close to the treatment site. Geron conducted a similar trial in acute spinal cord injury that had extreme difficulty in patient recruiting and was stopped.

NSI-189 Small Molecule Program for Major Depressive Disorder (MDD)

NSI-189 is a small molecule that was screened using an assay based on neural stem cells. This allowed the Company to screen for unique molecules that could structurally rebuild the hippocampal region of the brain. This has produced an entirely new and unique class of drugs that are proprietary to Neuralstem. The vast majority of central nervous system drugs primarily aim to modulate neural transmitters. NSI-189 is a completely new approach and if successful would represent a paradigm shift in treating mental disease. The results of the phase 1 trial of NSI-189 are discussed in the report called Neuralstem: Phase 1b Results for NSI-189 are Very Encouraging but It Is Early Days .

Neuralstem filed its phase 2 clinical trial protocol for the treatment of MDD with the FDA in September, 2015. Maurizio Fava, M.D., Slater Family Professor of Psychiatry at Harvard Medical School, Massachusetts General Hospital will be the principal investigator. The Company expects to enroll its first patient in this study in the first quarter of 2016.The study may enroll approximately 200 patients. Major depressive disorder is characterized by episodes of all-encompassing low mood, low self-esteem and loss of interest or pleasure in normally enjoyable activities. NSI-189 may provide an effective treatment for patients suffering from MDD by structurally rebuilding the hippocampus.

NSI-189 Small Molecule Program for Schizophrenia

Neuralstem has expanded the NSI-189 program to investigate a second indication for the treatment of cognitive deficit in schizophrenia. Cognitive deficit is a prominent characteristic of schizophrenia that is correlated with the occurrence of hippocampal atrophy in this patient population. The Company plans to commence a phase 1b clinical trial protocol for the treatment of cognitive deficit in schizophrenia in 2016.