By Jason Napodano, CFA

We are initiating coverage of Neuralstem Inc. (CUR) with an Outperform rating and $3.00 price target. We believe the companys dual-technology platform focused on cell therapy and traditional pharmaceutical products provides investors with the best of both worlds an early-stage investment in a potentially revolutionary pipeline in regenerative medicine and an attractive and under-valued small molecule pipeline sure to attract interest from larger pharmaceutical partners given the novel mechanism of action and broadapplication potential into multiple indications.

Neuralstems cell therapy technology enables the isolation and large-scale expansion of human neural stem cells from all areas of the developing human brain and spinal cord. Neuralstems technology was created to assist the body in producing new cells to replace malfunctioning or dead cells as a way to treat disease and injury. The companys preclinical research shows these cells both help create new circuitry (neurogenesis) and express factors that protect existing cells (neuroprotective). We believe this platform may be useful in treating many diseases and conditions of the central nervous system (CNS) and neurodegenerative disorders. The lead development programs are currently focused on amyotrophic lateral sclerosis (ALS) and spinal cord injuries (SCI).

Preliminary data from the companys phase 1 clinical trial in ALS (abstract / poster) shows encouraging trends in both safety and efficacy. In this trial, the company is injecting human spinal stem cells (HSSC) directly into the gray matter of the spinal cord. This is no easy task. Management licensed a floating injection platform technology from the Cleveland Clinic that allows the injection of the cells into the spinal cord without risk of trauma. Neuralstems Spinal Cord Delivery Platform and Floating Cannula are being utilized in the current phase 1 ALS program, but have the potential for use in additional clinical applications where injection directly into the cord is needed or advantageous, including spinal cord injury. We believe the Floating Cannula technology alone nearly supports the current market value of only $55 million. Now that safety and feasibility have been demonstrated, if Neuralstem were to spin-out this technology into a separate company, we think given the potential to out-license or commercialize with other companies looking to do direct injections into the spine, it would be worth $25 to $50 million in value.

The phase 1 trial is now progressing into the next six patients, all of which will have direct injections into the cervical spine. The previous twelve patients all had injections into the lumbar spine. The FDA wanted to make sure that the safety and adverse event profile was acceptable before progressing into areas of the spine that affect breathing and upper limb function. So far, three patients have been dosed in the cervical spine with no serious complications. We are excited to see the first efficacy data points in approximately six months.

Neuralstem and the FDA are currently in discussions on potentially expanding the phase 1 program, right now capped at 18 patients, into an additional 9 patients bringing the total to 27 that will include reinjecting patients from previous cohorts and increasing the number of cells per injection from 100,000 to 200,000 or 300,000. We think the more data the company can amass from this phase 1 / 2 program, the better chance the FDA will allow movement into a registration program in 2014. The FDA has already granted Neuralstem Orphan Drug designation for ALS. The FDA allowing Neuralstem to move into phase 3 in 2014 is comparable to Fast Track development status. We see the ALS market as wide open. If successful, Neuralstems HSSC for ALS would be a very attractive treatment option for patients with little hope to date.

We have built a sales model for HSSC in ALS that assumes a U.S. filing in 2016 and approval in 2017. Depending on the magnitude of the efficacy, we think Neuralstems HSSC could capture 15% to 20% market share of the vastly underserved 30,000 U.S. ALS population. We think as many as 50% of these patients could be eligible for Neuralstems HSSC treatment. Our model assumes that Neuralstem commercializes HSSC on its own at a price of approximately $100,000 per treatment. With 20% market share, we see the opportunity for Neuralstem at approximately $300 million (30,000 x 50% x 20% x $100,000).

Given the current market capitalization at only $55 million, we think there is little to no value being assigned to the companys novel oral small molecule platform. Neuralstem has developed the ability to screen and test small molecules on living human neurons in vitro. The companys research into hippocampal atrophy as it relates to neurodegenerative diseases such as major depressive disorder (MDD) and Alzheimers disease (AD) has allowed the company to be granted patents on four first-in-class chemical entities.

The first of these oral small molecule compounds to enter human clinical testing is NSI-189. Preclinical data suggests that NSI-189 significantly stimulates the generation of new neurons (neurogenesis) in vitro and in animal models. The data demonstrates clear evidence of increased hippocampal volume in animals with a model of depression. Neuralstem believes NSI-189 has the potential to reverse the hippocampal atrophy associated with major depressive disorder and other related disorders, and to restore fundamental brain physiology. NSI-189 has the potential to address directly the pathology of the disease itself. This is a major paradigm shift from the traditional oral serotonin or norepinephrine molecules currently approved to treat depression and bipolar disorder.

We think if positive, Neuralstem will seek to strike a development and commercialization partnership on NSI-189 in 2013. We believe that management will be seeking enough cash from partnering NSI-189, and additional hippocampal neurogenesis / neuroprotectant molecules can be brought into the clinic. We expect that milestones on the development of NSI-189 will help fund the pivotal registration trials in ALS or SCI in the companys stem cell pipeline. This is a unique opportunity that many of Neuralstems competitors are lacking the ability to self-fund a potentially revolutionary breakthrough in stem cell technology through the advancement of a traditional small molecule platform.

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CUR - Initiating Coverage of Neuralstem, Inc.