Navidea Biopharmaceuticals (NAVB) is one of the most attractive short opportunities we have seen in some time. The company resubmitted its long-awaited drug candidate, Lymphoseek, to the FDA on October 31, 2012. Any “emotional” pop in NAVB’s share price that arises from the approval of Lymphoseek would likely more than retrace since at best, we calculate the company to be worth $1.66 or about 40% downside from today’s levels and more realistically $0.68 or less, greater than 70% downside from today’s levels, assuming our most likely scenario and even some generous assumptions. If Lymphoseek does not gain FDA approval, even our most realistic scenario will prove to be optimistic.
Two Significant Shareholders Selling Big Stakes in NAVB Speaks Volumes
Platinum-Montaur Life Sciences, LLC (“Montaur”) is a firm that provided a credit facility to Navidea. As of November 27, 2012 Montaur owned 3.8 million shares of NAVB basic outstanding shares compared to 9.5 million it owned as disclosed in NAVB’s April 2, 2012 SC 13G filing. Furthermore, as of April 2, 2012, Montaur owned 55.9 million shares on a fully diluted basis if one assumes that all of its NAVB preferred stock and warrants are converted to common stock compared to the“ 42+ million” it now owns on a fully diluted basis. Thus, it appears that Montaur has gotten rid of around 14 million shares since April 2, 2012. Furthermore, it seems that Platinum is restricted from owning more than 9.99% (see Footnote 1) of NAVB common stock. Given this restriction, it is unclear to us how Montaur will manage its conversion decisions to own the bulk of its fully diluted interest. This is highlighted by the fact that on November 27, 2012 Platinum converted 3 million shares of its common stock into preferred stock, seemingly to keep its ownership interest under 9.99% upon the conversion of its NAVB series W warrants, as inferred by Montaur’s April 2nd Press Release.
Regarding the debt facility platinum has extended to NAVB:
“Montaur has committed to extend up to $15 million in debt, which is available immediately, to the Company at a prime-based interest rate currently at approximately 10 percent per annum. Montaur has committed an additional $20 million upon approval of Lymphoseek on consistent terms, with yet an additional $15 million potentially available on terms to be negotiated. No conversion features or warrants are associated with the facility.”
If Montaur did sell 13.9 million shares of stock, the associated profits should cover the first $15 million of its “funding” arrangement with NAVB and most of the entire $50 million; so at this point Montaur may be playing with house money. Do we see this as a show of confidence? Some would say yes. We say not necessarily. It’s apparent to us that Montaur has made a savvy investment that ensures profitability. The only remaining question is how much more profit from current share prices will they make? They’re betting more, we’re betting less.
Aside from Montaur, a prospectus filed on October 22, 2012 that revealed that Alseres Pharmaceuticals, Inc. (ALSE.PK) wants to sell its entire 300,000 share position in NAVB. Alseres received these shares as a result of a July 31, 2012 arrangement where it licensed a drug intended to help diagnose Parkinson’s disease to NAVB for development. We found this move intriguing since ALSE is a biotechnology company engaged in the development of therapeutic and diagnostic products mainly for disorders in the central nervous system. So we need to ask ourselves: why is a company that specializes in the testing of medical disorders and has knowledge of the FDA process bailing on a peer with cancer in its cross-hairs. These clues are too important to ignore.
Important Summary Points:
- Even when we assume the best case scenario for Navidea’s drugs, we still do not arrive at a valuation that justifies the current market cap
- Investors who value NAVB using a share count of 107 million as disclosed in the most recent 10Q are making a big mistake. In reality, we calculate that the share count should be 145 million when considering deep in-the-money convertible securities. (Note 8 and Note 12 of third quarter 10Q).
- The average chemical approval time frame for the FDA is 7-10 years. Lymphoseek has now been in the approval process for 10 years, with at least another year before the possibility of approval.
- Navidea has had chemistry, manufacturing, and controls (“CMC”) issues with its main product, Lymphoseek, since 2006 and is still having CMC issues today. A recent September 2012 FDA rejection letter delaying the drug’s submission further drives this point home. These control issues must still be considered by investors even though the company was able to resubmit Lymphoseek to the FDA on October 31, 2012.
- Navidea has substantial liquidity issues. Even if it draws on its credit facility, it will run out of cash in the next 18 months unless additional capital is raised or if Lymphoseek is approved by the FDA. Although we are aware that management turnover has occurred over the years, the company’s track record as a whole has not been good; it has been trying to get approval for drugs for 16 years, albeit unsuccessfully. This track record indicates that regardless of who is at the helm, the monetization of the company’s capital as well as the ability to get drugs approved remains elusive.
Navidea has one primary product candidate, Lymphoseek, which we believe, even if approved, does not justify the current market cap of $420.5 million on a fully diluted basis. The company currently generates no revenues. Through lymph node mapping procedures, Lymphoseek is expected to improve the lives of patients who have cancerous tumors, such as breast cancer and melanoma (i.e. the drug can help identify cancer in indicated areas). When we value the various aspects of the business on very generous assumptions, we still cannot arrive at the current value of the business. When we look at the most realistic assumptions for Lymphoseek, which is just approval for breast cancer and melanoma with no additional approvals, we see over a 70% downside in the stock from these levels.
On top of our concerns with issues surrounding NAVB’s drug line up we are equally concerned about the company’s dire financial standing:
- Zero revenues
- 145 million shares outstanding
- $2.90 share price
- $420.5 million market cap
- $415 million enterprise value
- $22 million annual cash burn
Liquidity Problems Seemingly Apparent
Navidea has $16 million in cash and while it has a $50 million revolver, it can currently only draw down $15 million of that revolver for its cash needs. On December 11, 2012 the company drew $2 million from this facility. It needs approval of Lymphoseek in order to get any more than the initial $15 million. This means NAVB could run out of cash within 18 months, if not sooner, if it is unable to secure additional financing or if it is not granted FDA approval for Lymphoseek.
Background
Navidea’s main product, Lymphoseek, is in the late stages of Phase 3, although it was recently rejected with a Complete Response Letter (“CRL”) by the FDA, related to its manufacturing. Phase 3 testing requires that companies complete a number of studies. As part of Lymphoseek Phase 3, NAVB has completed two efficacy studies (05 and 09) for breast cancer and melanoma. The company is currently administrating a study for the neck (06), yet has still been unable to complete enrollment for that study for three years. Studies 05 and 09 were almost exactly the same study, and the completion of both have allowed NAVB to apply for Lymphoseek approval from the FDA for both breast cancer and melanoma, for a total of 300,000 cases in the United States. On September 10, 2012 the company received notice that the FDA denied the initial application for phase 3 approval, and on October 30, 2012 the company reapplied for approval.
Navidea has two products other than Lymphoseek that we believe will not have any positive impact on the company’s operations; AZD4694, a phase 2 product for which comparables from other companies have failed to be approved, and Rigscan, which has been in phase 3 since 1998. Through its licensing agreement with ALSE the company is also developing a diagnostic test, E-IACFT, for Parkinson disease. E-IACFT is still in the middle of Phase 2b which makes it way too early to assess the economic benefit of an unknown approval to the company although we feel it is safe to assume that it is unlikely that this project will be of material value to the company.
Valuation
Below we are going to value the assets of Navidea assuming various scenarios of approval and market penetration rates for the company’s drugs. Keep in mind that none of our EPS scenarios include an assumption that NAVB will likely have to raise additional capital, potentially leading to dilution. We also used a fully diluted outstanding share count of 145 million which takes into account 107.4 million shares outstanding as of 2012 third quarter 10-Q and 37 million deep in-the-money convertible securities:
- 17.5 million from warrants with an average exercise price of $0.56
- 19.7 million from convertible debt and preferred stock with an average exercise price below $0.50
We are also forced to value NAVB on gross profit since it would be losing money and have negative EBITDA even with the approval of Lymphoseek.
In Depth Valuation Scenario Analysis for Breast Cancer and Melanoma (Studies 05 and 09)
| Best | Neutral | Worst | |
| Breast cancer | 229,000 | 229,000 | 229,000 |
| Melanoma | 76,000 | 76,000 | 76,000 |
| Price per patient | 450 | 400 | 350 |
| Require Lymphoseek | 70% | 70% | 70% |
| Market penetration rate | 60% | 60% | 60% |
| Gross margin | 40% | 37.5% | 35% |
| Possibility of approval (management’s range) | 80% | 75% | 70% |
| Total gross margin | 18,446,400 | 14,411,250 | 10,984,575 |
| Total outstanding shares | 145,000,000 | 145,000,000 | 145,000,000 |
| Price per share, no NPV assumption | 0.64 | 0.50 | 0.38 |
| Year to Achieve sales goals | 3 | 3 | 3 |
| NPV (15% discount rate) | 0.48 | 0.37 | 0.28 |
- Number of Annual Patients. NAVB states , “according to the American Cancer Society, approximately 229,000 new cases of breast cancer and 76,000 new cases of melanoma are expected to be diagnosed in the United States in 2012.” (Source: Any recent press release)
- Patients Who Require Lymphoseek. For these patients, around 70% require a procedure that Lymphoseek addresses.
- Final Sale per Patient. Based upon NAVB’s disclosure, in different scenarios, we assume that the final sale price per patient should be $450, $400 and $350.
- Require Lymphoseek. Management estimates that 70% of cases will require Lymphoseek.
- Market Penetration. Management estimates that it can gain approximately 60% market share.
- Gross Margin. We assume that from the final sale per patient, in different scenarios, NAVB can achieve 40%, 37.5% and 35% gross margin per patient. Cardinal Health, as the selling partner for Lymphoseek, will share 50% of its revenue with Navidea. Our gross margin assumptions take this into account.
- Approval Possibility. As seen in the table above, management estimates a 70% to 80% chance that Lymphoseek could be approved by the FDA.
- Total Gross Margin (Company Acquisition Value). Let’s aggressively assume that an acquirer would be willing to pay 5x gross margin for NAVB’s various assets to value the stock’s share price.
- Shares Constant. We assume that NAVB does not issue more shares and/or repurchase shares from the market.
- Year to Achieve. The earliest NAVB could gain FDA approval for studies 05 and 09 would be April 30, 2013. A reasonable expectation is that after the FDA approval, Lymphoseek needs at least another 2 years to reach the assumed sales volume.
- Net Present Value. In other words, when we give a current value to NAVB, we still need to use a reasonable discount rate to discount those projected stock prices three years from now to its current price in our scenarios. This task would result in a reduction of our already depressed price targets with a current stock price $0.48, $ 0.37 and $0.28 in different scenarios. We used 10% as our discount rate since this is the rate of its loan agreements with Platinum-Montaur Life Sciences, LLC and Hercules Technology II, L.P. However, in addition to the 10% interest rate cost of capital, these companies also received stock convertible into over 30 million shares of NAVB. Thus, the true cost of capital is higher than 10% and would result in even lower price targets, but we choose to be conservative.
Valuing NAVB at No More Than a Potential Call Option
Call Option One: Expanded Use Of Lymphoseek Beyond Breast Cancer And Melanoma
NAVB has expressed its intention to pursue the approval of Study 06 in the United States. A greater label in the U.S. would expand the total market Navidea could potentially capture by an additional 200,000 to 300,000 cases annually. The greater label would come if the FDA passes Study 06 for use of Lymphoseek on the neck, which has already been ongoing for 3 years and for which the enrollment is still not complete. If the company were able to get this label, it would address an additional 1 million cases with an estimated 20-30% penetration rate (it has been reported that management stated the penetration rate for neck would be much lower than the penetration rate for melanoma and breast cancer). More importantly, it is uncertain if it will ever be able to get full enrollment for Study 06. In addition, once the study gets full enrollment, there is no guarantee that the study would pass. These two reasons are why we place a low probability on the FDA approval for Lymphoseek ever occurring for head and neck cancer.
Even if the study did pass (and we think that’s a big if), it would be a long time before NAVB could reap the financial benefits of Lymphoseek sales. So it is very difficult to value the contribution of Study 06 to NAVB’s stock at much more than a call option because there are so many “ifs” in the scenario for the study to be successful. We believe that it is highly unlikely that shareholders ever see value from 06.
Study 06, which is necessary for a greater label, began enrolling in May 2009. Navidea has still not gathered enough patients for an interim analysis, as discussed in its 2012 first quarter 10Q. In addition, Navidea has had to close 6 out of the 13 clinical centers initially opened for this treatment. As it has been very difficult to get enough subjects for this study, it is unclear whether the company will be able to successfully complete the study.
So if we use similar price per patient and gross margin and multiple of gross margin (5X) assumptions as we did in our analysis of 05 and 09, and apply more appropriate assumptions with regards to certain factors to reflect the characteristics of Study 06, we are able to estimate the contribution that 06 could have on each share of NAVB. We believe it is impossible that NAVB can obtain the approval for expanded use by the FDA before the approval for breast cancer and melanoma. However, we will be conservative and assume that NAVB is granted approval for Study 06 in 2013 and will achieve maximum penetration two years later. Since we believe that it is highly unlikely that shareholders will ever see value from this study we have assigned a very low probability for FDA approval. If we use 10% as a discount rate, the present value per share contribution of Study 06 to NAVB works out to be $0.50, $0.20 and $0.07.
| Best | Neutral | Worst | |
| Expanded user cases | 1,000,000 | 1,000,000 | 1,000,000 |
| Price per patient | 450 | 400 | 350 |
| Require Lymphoseek | 30% | 25% | 20% |
| Market penetration rate | 60% | 60% | 60% |
| Gross margin | 40% | 37.5% | 35% |
| Possibility of approval | 60% | 40% | 20% |
| Total gross margin | 19,440,000 | 9,000,000 | 2,940,000 |
| Total outstanding shares | 145,000,000 | 145,000,000 | 145,000,000 |
| Price per share, no NPV assumption | 0.67 | 0.31 | 0.10 |
| Year to achieve sales goals | 3 | 3 | 3 |
| NPV (15% discount rate) | 0.50 | 0.20 | 0.07 |
Call Option Two: European Adoption of Lymphoseek
NAVB has expressed its intent to pursue the approval of treatments for melanoma and breast cancer in Europe. We feel that approval is unlikely to occur.
The next low probability event to predict is whether NAVB gets a part of the large European market. According to management, the potential market presents 300,000 to 400,000 cases for breast cancer and melanoma. The company currently has no partner to help with sales in Europe, and no guarantee of getting approval from the European regulatory body. We used similar price per patient and gross margins, the 5X multiple of gross margin and “require Lymphoseek” assumptions as we did in our earlier analysis of 05 and 09, and applied more appropriate assumptions with regards to certain factors to reflect European approval.
The potential approval in Europe would still be years away. Still, if we assume that NAVB reached European approval in 2013, it is reasonable to expect that management’s projected numbers could be achieved two years later. If we use 10% as a discount rate, the per-share present-value contribution scenarios to the stock would be $0.26, $0.11 and $0.04.
| Best | Neutral | Worst | |
| Expanded user | 400,000 | 350,000 | 300,000 |
| Price per patient | 450 | 400 | 350 |
| Require Lymphoseek | 70% | 70% | 70% |
| Market penetration rate | 40% | 30% | 20% |
| Gross margin | 40% | 38% | 35% |
| Possibility of approval | 50% | 40% | 30% |
| Total gross margin | 10,080,000 | 4,410,000 | 1,543,500 |
| Total outstanding shares | 145,000,000 | 145,000,000 | 145,000,000 |
| Price per stock | 0.35 | 0.15 | 0.05 |
| Year to achieve | 3 | 3 | 3 |
| NPV (15% discount rate) | 0.26 | 0.11 | 0.04 |
Any way you slice it, an investment in NAVB does not look compelling.
When we add all the best case events calculation without factoring in present value…
- In Depth Scenario Analysis Valuation Analysis of $0.64
- Call option one of $0.67
- Call option two of $0.35
…we arrive at a valuation target of $1.66, which is more than 40% lower than NAVB’s current stock price of around $2.90.
If we more appropriately add the present values of our best case scenario…
- In Depth Scenario Analysis Valuation Analysis of $0.48
- Call option one of $0.50
- Call option two of $0.26
…we arrive at a valuation target of $1.24, which is over 55% lower NAVB’s current stock price of around $2.90.
The point is that the best case scenario is still much lower than the value of where the shares are currently trading. But if you look at the summation of our more realistic (neutral) scenario…
- Without present value assumption: $0.96 ($050 + $0.31 + $0.15)
- With present value assumptions of $0.68 ($0.37 + $0.20 + $0.11)
…you are staring at a stock with downside risk from today’s levels ranging from 67% to 77%.
When we look at businesses, we like to get various call options for free as pleasant surprises to an already meaningfully undervalued scenario. In the case of NAVB, even if you get ALL the call options, you are at best likely going to lose money. This is a terrible investment scenario and not a good probability investment. Heads I lose 80% of my money, tails I still lose. We were also very generous in our assumptions for the adoption rates of the product. Analysts we have spoken with think the market penetration rate could be as low as 10-30%.
If that is the case, our numbers are very optimistic. Also keep in mind there is no guarantee a company would be willing to pay 5x gross margin for NAVB’s products (we feel this is a very generous number). Finally, there is absolutely no guarantee of market adoption for Lymphoseek in any markets. If Lymphoseek never gets approval, we believe NAVB is nearly worthless.
On The Numbers
When valuing biotech companies, investors need to make assumptions that may be less than precise. Management also does not know for certain the answers to questions that affect the value of NAVB; whether Lymphoseek gets approved, whether Lymphoseek gets approved in Europe, whether the company completes Study 06 and gets a broader label approval in the US.
But as Warren Buffett says “It is better to be approximately right, than precisely wrong.” Being an investment analyst requires making assumptions and looking at a range of outcomes and then determining the value of a business. That is what we have done here, and the results are scary for NAVB shareholders.
Additional Red Flags
Flag One
We believe Lymphoseek might end up being a dead product similar to its RIG Scan product that has not advanced to Phase 3 after 16 years. Navidea announced on September 10 that the FDA had issued a Complete Response Letter (“CRL”). We interpret this as a nice way of saying Lymphoseek was rejected. Lymphoseek tries to make it appear like the problems will be easy to fix, but keep in mind NAVB has had various CMC issues since 2006. The press release states:
“the decision was focused on issues with third-party Lymphoseek contract manufacturing, and was not related to any efficacy or safety data filed within the Lymphoseek NDA.”
Management’s attempt to seemingly downplay this event is somewhat troubling given that a meta-analysis of lymphatic mapping agents including Study 05 was published in the journal of Clinical and Experimental Metastasis where it was revealed that Navidea had excluded 2 sites from its analysis for protocol violations:
“Subjects from the NEO3-05 sites 05 and 06 were excluded from the analysis…”
This is a red flag for Study 05. However at this point Study 05 has already passed, and so is not important. The issue is with Study 06, which as we mentioned earlier has not been passed and for which 6 out of the original 13 clinical centers have been closed. This makes it seem highly unlikely that Study 06 will pass.
Flag Two
Chemistry, manufacturing, and controls (“CMC”) is a substantial issue for Navidea. In April 2012, Navidea had substantial issues that were only supposed to delay the decision for 3 months. Then on September 10, 2012, it announced new and different CMC issues that would need to be dealt with.
On September 10, the FDA denied Navidea’s application for Lymphoseek for Chemistry Manufacturing and Control issues. Navidea’s management claims that the CMC issues are easily solvable, but we are not confident this is the case. The FDA has already delayed the application decision once earlier this year for other reasons. Navidea has publicly stated that it has had CMC issues since 2006.
On October 31, 2012, NAVB announced that it was finally able to submit Lymphoseek for FDA approval. If the drug were to be approved, we believe this event would not occur until at least the summer of 2013, although we believe late 2013 would be more likely. Keep in mind Navidea will have burned 22 million dollars in cash over that time frame. Furthermore, as we have already discussed, we believe that an approval does not justify a higher stock price for NAVB.
Management’s Track Record
AZD4694 INDICATION
We are not ascribing value to this. It is currently in phase 2, and enrolled its first patient on September 18, 2012. When we look at comparable products, we see two failures:
They both were similar to AZD4694 in that they were intended to bind to amyloid and both failed in phase 3 studies.
Rigscan INDICATION
Rigscan has been in phase 3 since 1998. It is very difficult to imagine that after 16 years of testing, any value would accrue from Rigscan. If anything, we believe Rigscan is NPV negative, and clearly has been for the past 16 years. This is indicative of very poor capital allocation on the part of management.
Lymphoseek
The average chemical approval timeframe for the FDA is 7-10 years. Lymphoseek has now been in the approval process for 10 years. Even if Lymphoseek is approved on April 30, 2013 (the PDUFA due date), we believe it will be at least one year before the drug reaches viable commercialization.
E-IACFT
Through its licensing agreement with ALSE the company is also developing a diagnostic test, E-IACFT, for Parkinson’s disease. E-IACFT is still in the middle of Phase 2b which makes it way too early to assess the economic benefit of an unknown approval to the company although we feel it safe to assume that it is unlikely that this project will be of material value to the company. We even question why ALSE (a penny stock with no revenues) looked to NAVB (a company with no revenues and potential liquidity problems) to monetize its product.
Conclusion
Navidea is a simple story of a company with a substantially overvalued stock with several catalysts for the stock to come back to earth. We believe that either a dilutive financing or a rejection by the FDA could be the catalyst for the stock to drop substantially in value.
Footnote 1
The Certificates of Designation of the Preferred Stock, the Series W Warrant, the Series X Warrant and the Series AA Warrant each provide that the holder of shares of the Preferred Stock, the Series W Warrant, the Series X Warrant and the Series AA Warrant, respectively, may not convert any of the preferred stock or exercise any of the warrants to the extent that such conversion or exercise would result in the holder and its affiliates together beneficially owning more than 9.99% of the outstanding shares of common stock, except on 61 days’ prior written notice to Navidea that the holder waives such limitation. (Source: 2011 10K)
Disclosure: Short NAVB
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