Biotech Stock Mailbag: Neostem

BOSTON (TheStreet) --Welcome to the Biotech Stock Mailbag: Memorial Day 2010 edition.

Preston M. kicks things off, asking, " Adam, I appreciate your critical eye when it comes to evaluating drug stocks. What do you think of Neostem (NBS), which seems to be doing quite well these days and is generating a lot of buzz? Thanks."

To learn about Neostem -- and to understand why I'd be wary about sinking investment dollars into the company -- read Neostem's most recent 10-K annual report filed with the Securities and Exchange Commission. Read the SEC filing first -- before you visit Neostem's web site, before you read the company's press releases, and before you visit the stock message boards.
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Neostem runs a money-losing adult stem cell collection business. Basically, this service harvests stem cells from the blood of healthy adults and stores them for later personal medical use. Think of this business as a cord-blood bank for adults -- except smaller and less successful. Outside of bone marrow/stem cell transplants for blood cancers, there are no approved medical uses for adult stem cells. No one has yet figured out a way to trick adult stems cells into growing new heart tissue or curing diabetes. Adult stem cells aren't remotely close to stopping Alzheimer's or Parkinson's disease.

Accordingly, Neostem generated only $178,400 in revenue from the stem-cell banking business in 2009, according to its annual report.
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Neostem is looking ahead to day when scientists might figure out a way for adult stem cells to play a broader role in disease cure. Towards that end, Neostem licensed some early university research involving VSELs, or very small embryonic-like stem cells. These are adult stem cells that appear to have some of the regenerative properties of embryonic stem cells. VSEL research isn't even out of the lab yet, which means any potential drugs or treatments are many years -- and tens of millions of dollars -- away. Read the 10-K; the clinical and regulatory risks and warnings are in there.

The partnership announced this week between the Catholic Church and Neostem to support VSEL research was nothing more than a publicity stunt. Unless divine intervention brings about a scientific miracle, VSELs are just one of numerous, early research efforts using adult stem cells which may or may not work. For investors, it's nothing more than a lottery ticket. Need a reminder of the risk? Look at Neostem adult stem cell competitors Cytori Therapeutics ( CYTX) and Osiris Therapeutics ( OSIR). Placing any significant market value on VSELs seems foolish to me.

That leaves Neostem's 51% ownership in Suzhou Erye Pharmaceuticals, a small Chinese drug maker, which Neostem acquired last October through a merger with China Biopharmaceuticals Holdings. Eryre sells mostly antibiotics into the Chinese hospital market, posting net income of $12.3 million on total sales of $61 million last year, according to Neostem.

Neostem's majority interest in Erye for two months last year salvaged the company's financial performance. Erye contributed $11.4 million, or 98%, of Neostem's $11.6 million in total revenue in 2009, according to Neostem's annual report.

Neostem's joint-venture control over Erye is significantly limited, which means Neostem may be unable to rely on the Chinese drug maker for future growth.

Among the issues related to Erye raised in Neostem's 10-K:
  • Neostem will only be able to repatriate 6% of Erye's net profit to use for the company's operating expenses. "As a result, we Neosteom will not be able to supplement our cash flow fully from the operations and income expected to be generated by Erye."
  • Even though Neosteom owns 51% of Erye, the company has limited ability to manage or direct the Chinese drug maker's operations.
  • The merger between Neostem and China Biopharmaceuticals Holdings has not yet received all the necessary approvals from the Chinese government.
  • Neostem's internal control over financial reporting does not meet the necessary U.S. accounting standards due to "material weaknesses" in the China Biopharmaceuticals Holdings/ Erye business. In other words, Neostem lacks the auditing and accounting records and processes to verify that Erye is generating the revenue and profits that it claims.
  • Maybe if Neostem were a super-cheap stock, all these risks and concerns would be worth the price of a lottery ticket. Neostem, however, is not a cheap stock. Fully diluted share count, including warrants and options, totals just under 73 million shares. Wednesday's $2.90-a-share closing price values the company at almost $212 million.

    Assuming Erye drug sales grow modestly in 2010, Neostem's 51% stake plus the stem cell banking revenue would total around $32 million. That means Neostem today is trading at almost 7 times forward sales, making this an expensive stock.

    Sticking with stem cell stocks, Michael H. emails, " I am interested in your comments on Cytori Therapeutics. I am a longtime stockholder and it has done well for me, but your comments have made me rethink some of my assumptions. (A good thing.) But at the same time I am wondering why you seem to focus only on the cardiac applications (which if true could be a game changer) and not what is going on with the cosmetic and regenerative applications? Further, I notice that you take a lot of heat on their message board, I, for one, appreciate a well thought out contrarian view. Keep it up!"

    Cytori sells the Celution Systems device in Europe and Japan. Celution harvests adult stem cells from belly fat but European regulators forbid Cytori from making claims about any therapeutic benefits of these fat-derived stem cells.

    In Europe and Asia, a few doctors are mostly using the Celution Systems device for breast reconstruction and breast enlargement procedures although there is no clinical data from controlled studies demonstrating that stem cell-enriched fat is superior to "regular" or unprocessed fat.

    It's fair to say that Cytori's sales efforts are still early, but financial results reported to date haven't been particularly impressive.

    Earlier this month, Cytori reported a first-quarter net loss of six cents a share on total revenue of $4.4 million. The results beat top- and bottom-line consensus estimates but were mostly cosmetic because product sales, the revenue line that matters most, came in at an underwhelming $2.3 million for the quarter. On a sequential basis, the number of Celution System devices sold was down and consumables shipped were flat. Accounts receivable and days sales outstanding were both up sequentially, suggesting that increases in inventory -- and not end-user demand -- is what's driving top-line growth.

    Cytori ended the first quarter with $22.7 million in cash and has three more tranches of stock to sell through its existing equity arrangement with Seaside. After that, Cytori will likely need to raise more money next year.

    No one has yet proven that adult stem cells can cure disease or repair damaged organs by regenerating into new cells and tissue. None of the studies conducted by Cytori to date demonstrate conclusively that the adult stem cells harvested via the Celution Systems device do anything beneficial for patients, whether they're heart attack victims, women undergoing breast reconstruction following breast cancer surgery, or even women wanting larger breasts without resorting to saline implants.

    European regulators allow the Celution device to be sold solely on the basis that the machine, when used safely, harvests adult stem cells from fat tissue. That's it. The U.S. Food and Drug Administration is taking a tougher stance. It won't even allow Cytori to sell Celution in the U.S. until the company proves through clinical studies that the end product of the device -- the adult stem cells -- have some therapeutic benefit for patients.

    Cytori's best shot to date at making an "approvable" medical claim about adult stem cells is probably the "Restore 2" study, which showed a high level of patient and doctor satisfaction with breast reconstruction performed using stem cell-enriched fat harvested using the Celution device.

    Whether or not European regulators accept this study as sufficient for a regulatory approval of adult stem cells isn't known, although that's the case Cytori plans to make.

    Cytori executives have already said that the Restore 2 study data are not going to fly with the FDA. The company will need to design a new study, or studies, to get Celution approved by FDA. What kind of study has not yet been determined, according to Cytori executives.

    One major shortcoming of the Restore 2 study is the lack of a control treatment to which the benefits of stem cell-enriched fat can be compared.

    "The patient satisfaction data from Restore 2 are meaningless without a comparison to an alternative (or no) therapy. It's like asking a kid, 'how much do you like ice cream?' Compared to what?," Dr. Karol Gutowski told me in a recent interview. Gutowski is a plastic surgeon affiliated with the University of Chicago and chairman of a 2009 task force of the American Society of Plastic Surgeons that examined the safety and efficacy of fat grafting procedures.

    Gutowski added, "While I think this Cytori's Celution has potential applications and would be willing to try this personally in a more scientific way, as of now, the satisfaction graphs and MRI images are smoke and mirrors to hide the lack of comparative data."

    Not that anyone needs a reminder, but the American Society of Clinical Oncology (ASCO) annual meeting kicks off a week from today in Chicago. I'll be there to cover the meeting.

    On a related note, BuggyFunBuggy writes, " What's with Ziopharm Oncology (ZIOP) running a secondary into ASCO???? Oral session, Best of... What gives? Anyone done this before? What happened next?"

    I'll repeat what I said on Twitter Thursday after Ziopharm priced a $35 million stock offering:

    For those squawking about Ziopharm raising money before the big ASCO cancer meeting, remember rule No. 1 -- biotechs always raise money when they can. Always.

    Why would Ziopharm raise money before ASCO, especially since the company is expected to present strong mid-stage data on its sarcoma drug? Again, see Rule No. 1. If the money is there, take it. Rule No. 1 is especially important given Rule No. 2: Hot stocks running into ASCO become investor sources for cash after ASCO.

    Scott M. writes, "As a two-year holder in Gilead Sciences (GILD), do you have an opinion on what is driving the stock down? I just don't understand what is killing this one."

    Gilead, at $35, is trading at a three-year low. Unbelievable.

    Ballooning budget deficits and mounting debt problems in Europe have compelled European governments to propose and/or enact price cuts for branded and generic drugs. (In Europe, governments set drug prices, unlike in the U.S.)

    Gilead sells of a lot HIV drugs in Europe, so investors worry that steep price cuts there will eat into the company's growth. Of Gilead's European sales (about 30% of total revenue), 80% are derived from the "Big Five" countries -- France, Spain, Italy, U.K./Ireland and Germany, according to Citi research.

    European HIV pricing pressure is already factored into the Gilead's 2010 HIV sales guidance, according to the company, and some of the realized drug price cuts taken in Europe so far (like in Spain) haven't been as deep as expected.

    But still, add European drug pricing to the long list of worries -- patent issues, lack of diversification outside of HIV, fears of a large, expensive acquisition, etc. -- that have compelled investors, rightly or wrongly, to shun Gilead.

    I'm still a believer in the company and the stock, but I seem to be in the distinct minority these days.

    Via Twitter, @raleon23 asks, "Why not Onyx Pharmaceuticals (ONXX) long-term? Multiple cancers, adaptive clinical trials and potential takeover at some point by Bayer."

    Worse-than-expected Nexavar sales in the first quarter coupled with lowered 2010 Nexavar sales guidance are the latest woes to pinch Onyx's stock price. (At $22, it's down 26% for the year.)

    I wouldn't own Onyx betting on a Bayer takeout. What Onyx needs to revive its stock price is a big clinical trial win. Two studies to watch for in the near term: A phase III study of Nexavar in non-small cell lung cancer and a phase II (although possibly approval worthy) study of carfilzomib in relapsed/refractory multiple myeloma patients. Both studies should have data ready for release in the third quarter.

    Happy Memorial Day weekend!

    -- Reported by Adam Feuerstein in Boston.

    Follow Adam Feuerstein on Twitter.

    Adam Feuerstein writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. Feuerstein appreciates your feedback; click here to send him an email.

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