DARA: Mea Culpa - Downgrading DARA Bio

Zacks Small Cap Research

By Jason Napodano, CFA

NASDAQ:DARA

DARA Files Amended S/1 – Seeks $20M in Cash

Last week, DARA BioSciences, Inc. (DARA) filed an amended Form S/1 with the U.S. SEC announcing its intension to raise up to $20 million in cash over the very near-term. The offering will be led by Ladenburg Thalmann and H.C. Wainwright & Co. We remind investors that the company just recently raised $6.0 million in February 2014 under the previously filed Form S/3. The company exited 2013 with $3.4 million in cash on the books. We model operating burn in the first quarter of roughly $2.0 million, meaning that after fees, DARA should have exited the first quarter 2014 with still nearly $7 million on the books. DARA seeking $20 million now tells us two things: 1) There is no partnership on KRN5500, and 2) The commercial business that we originally stood strongly behind is going to take a lot longer than expected to reach profitability.

…No Partner For KRN5500…

On February 25, 2014, DARA BioSciences, Inc. announced that the U.S. Food and Drug Administration (FDA) has granted Orphan Drug Designation (ODD) to KRN5500 for the parenteral treatment of painful, chronic, chemotherapy-induced peripheral neuropathy (CCIPN) that is refractory to conventional analgesics. In our previous reports, we note that the target population of approximate 165K patients clearly qualifies KRN5500 under the Orphan Drug designation; and, if we assume a price for the drug comparable to branded Lyrica® or Cymbalta®, with 25% market penetration, then KRN5500 is a $300 million drug at peak. At the time of the Orphan Drug announcement, we told investors that DARA management now has two options on the table: partner it or keep-it for themselves and do a Phase 2b study.

A drug that has been granted Orphan Drug designation and Fast Track status with $300 million in peak sales should be a highly coveted asset by any specialty pharmaceutical company. Management at DARA had noted being in active discussion with potential partners over the past year while the ODD application was pending. We had long believed that the granting of ODD solidified partnering interest in KRN5500 because the seven year market exclusivity that comes with ODD eliminates any concern by potential partners on a generic substitution shortly after launch. We even stated that partnering a drug like KRN5500 could bring in as much as $20 million upfront to DARA Bio plus mid-teens royalties on sales.

DARA seeking to raise cash now tells us that there is no partnership for KRN5500 coming. In fact, management seems clearly moving forward with running a Phase 2b study themselves. If this study is successful, then perhaps DARA will be able to partner the drug for $50 million or $75 million in 2016. However, we do not think it is prudent for DARA Bio investors – ones that we have specifically told to buy the stock because of the specialty oncology commercial business – to stick around and wait two years while management changes focus and goes back into clinical development with KRN5500. This is not the strategy that the company has been pitching to investors over the past two years. This is a dramatically different risk profile and one that significantly delays profitability on the commercial standpoint. It also creates greater shareholder dilution and a potential distraction from what we believed was the primary focus of the company with Soltamox and Gelclair.

New Dilution & A Confounding Strategy

As of DARA’s last Form 10-K and the recent $6.0 million private placement, we estimate the basic share count at roughly 8.4 million. There is another estimated 5 million in convertible securities and warrants at or near the money. At today’s price of $2.54 per share, the reasonable diluted market capitalization is around $34 million. Raising an estimated $20 million is over 40% dilutive to the current shareholders. These are investors that we have specifically told to buy the shares because of Soltamox and Gelclair; because of a potential surging top-line and absolutely no clinical development costs or risks. That’s not the case anymore.

If we assume DARA can get the deal done at $2.00 per share – which we believe will be a significant challenge – that’s still 10 million new shares, plus another 5 million warrants according to the S/1. Note the S/1 lists "up to" 8.064 million shares and 4.032 million warrants, but that's back when the stock was $2.48 per share. Either the raise will be smaller or the S/1 will be amended again to increase the number of shares. Either way, this is not something we think investors should stick around to watch happen. Mea culpa, but DARA Bio is not a name we believe investors should own at this juncture.

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