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Evolution SECURITIES www.evosecurities.com GW Pharmaceuticals (GWP.L) ( u p g r a d e d

Evolution

Evolution SECURITIES www.evosecurities.com GW Pharmaceuticals (GWP.L) ( u p g r a d e d t

Evolution SECURITIES www.evosecurities.com GW Pharmaceuticals (GWP.L) ( u p g r a d e d t
Evolution SECURITIES www.evosecurities.com GW Pharmaceuticals (GWP.L) ( u p g r a d e d t

SECURITIES

Evolution SECURITIES www.evosecurities.com GW Pharmaceuticals (GWP.L) ( u p g r a d e d t

www.evosecurities.com

GW Pharmaceuticals

(GWP.L)

(upgraded to) Buy

Price/Target: 130p/160p

Line chart: Absolute price performance, 12m Bar chart: Price relative to sector, 12m

Line chart: Absolute price performance, 12m Bar chart: Price relative to sector, 12m

Evolution Sector

Pharmaceuticals

Listing

AIM

Mkt. Cap

£143m

Net Cash

£18m

Enterprise value

£126m

Market Makers

X

Evo is Broker

X

Questions for the management:

What is the plan to gain approval in the UK?

What is the strategy for managing the cash?

What is the plan for Sativex in the US?

Update

22 February 2005

Choosing the moment

Despite recent setbacks, given that GW Pharmaceuticals has an ‘approvable’ product, we believe the company offers good value. We are therefore upgrading the stock to a Buy recommendation.

Still ’when’…

The opinion of the UK regulatory body (MHRA, Medicines and Healthcare products Regulatory Agency) that the clinical relevance of the spasticity data from the Sativex trials was questionable was clearly a blow for GW Pharma. However, what appears to be a perverse decision by the UK authority (particularly in light of the Canadian authorities Qualification Notice) should not obscure the potential value of the stock even on a short-term basis. We continue to believe it is a case of ‘when rather than if’ Sativex will be approved (see previous GW Pharma notes), but there are two potential timescales for the ‘when’.

We believe there are two strategies to buying GW

Medium risk: Buy between now and May and hope to capture the upside from a potential ‘early’ approval in the summer following the meeting of the Medicines Commission (MC). However, this strategy exposes the investor to the possibility that the MC does not approve Sativex and therefore GW stock will fall and will be effectively ‘dead money’ until the MHRA is presented with new data at the end of 2005 or early in 2006.

Low risk: Buy after the Medicines Commission meeting. If the product is approved the revenue from Canada and UK, deals for Europe licensing rights and development in the US provide the upside to the share price. However, the major upside from the UK approval will not be captured. If the product is not approved, and the MC decides it is prudent to wait for the data from the on-going phase III trial, the share price may fall, but it will provide an opportunity to buy stock, with an expectation of an approval in the UK in the following nine months.

Upgrading recommendation

Using an entirely unscientific methodology, we would estimate that there is a 25% chance of Sativex being approved after the MC meeting (which could be held in May or July this year), but a 90% chance of the product being approved within the next 12 months. On this basis, taking the longer-term view, we are upgrading our recommendation on GW Pharma to a Buy.

Dr Jonathan Senior +44 (0) 20 7071 4355 jonathan.senior@evosecurities.com

Year

Sales

EBITDA

PBT adj

Tax

EPS

CFPS

Net Cash

Net Cash

Cash Burn

R&D

R&D Chg

EV/Sales

DCF Sensitivity

end

£m

£m

£m

%

p

p

£m

p

p

£m

%

x

WACC %

Fair Value p

09/03A

5.0

-9.5

-9.6

CR

-7.8

-7.0

32.0

31.2

-7.4

-12.7

-18.0

22.3

16.0

120

09/04A

0.0

-15.8

-15.7

CR

-12.4

-12.3

17.8

16.1

-14.3

-13.9

-9.9

-

15.0

127

09/05E

2.9

-10.6

-10.8

CR

-8.4

-7.6

8.6

7.8

-9.2

-11.0

21.1

46.3

14.0

134

22 February 2005

2 2 Fe b ruary 2005 More than one product? Sativex: the broader strategy Abbott has

More than one product?

Sativex: the broader strategy

Abbott has coined the term ‘a pipeline in one drug’ for Humira (TNF-inhibitor for the treatment of various autoimmune diseases), but the same could be said of Sativex. This is due to the ubiquitous (and not fully understood nature) and function of cannabinoid receptors in the body.

Product

Indication

Stage

Comments

Sativex THC/CBD 1:1

Multiple sclerosis

MS spasticity

Filed

MS neuropathic pain

Filed

MS Bladder dysfunction

Phase III

Fully recruited, results 1H 2005

Cancer pain

Phase III

Peripheral neuropathic pain

Diabetic neuropathy

Phase III

Trial to start mid-year

Allodynia

Phase III

Trial to start

Central neuropathic pain

Spinal cord injury

Phase III

Fully recruited, results 1H 2005

Brachial plexus injury

Phase II

Trial completed

High THC

Post-operative pain

Phase II

No work on-going at present

High CBD ratios

Rheumatoid arthritis

Phase II

Results of IBD study awaited

IBD

Phase II

Study on-going

Neurogenic symptoms

Phase II

Methadone

Drug dependency

Trial in 1H 2005

Multiple MS trials is part of the strategy

Off-label use can drive sales

While the reason for undertaking multiple trials addressing the various symptoms of multiple sclerosis (MS) is part of the regulatory strategy (which differs in different territories), other studies address entirely differentiated indications. For instance, trials in spinal cord injury and diabetic neuropathy are underway to address the indications of central and peripheral neuropathic pain respectively. In addition, positive phase III data on use of Sativex for the treatment of cancer pain has recently been reported. GW is to discuss the cancer pain data with the various EU regulators to see if further data is required before filing. Moreover, because of the potential sensitivity of the US to cannabis-based medicine, cancer pain is likely to be the first indication for which Sativex is filed with the FDA.

In terms of the symptoms of MS, GW’s strategy is to get the product approved for one aspect and then expand the label (that is, the symptoms for which the drug can be prescribed) as further data become available. In the UK, spasticity has been the primary focus, whereas in Canada the initial submission was for neuropathic pain associated with MS. While the fact that the drug is only approved for one symptom may appear limiting, prescribing physicians have the power to use the drug when necessary even if it is not strictly indicated (so called, “off-label” use). Moreover, while reps cannot promote off-label indications, if doctors ask, they can provide supportive information. Furthermore, data from studies in indications that are currently off-label can be presented at conferences and in journals.

22 February 2005

2 2 Fe b ruary 2005 All the questions answered… ….except one Moving the goalposts? Appeal

All the questions answered…

….except one

Moving the goalposts?

Appeal process

New interpretation on data

Regulatory update

United Kingdom and Europe

At this point, it is worth noting the structure of the UK regulatory system and GW Pharma’s dealings with the agency to date. The process of drug approval is handled by the MHRA. However, a body called the Committee on Safety of Medicines (CSM) advises the MHRA (and ultimately decides whether drugs should be approved or not). It is the CSM that has ‘advised’ the MHRA that an issue relating to efficacy needs addressing. Following the initial batch of 46 questions raised by the MHRA in June, GW has answered all of them except one. Therefore, there are no more outstanding safety or quality issues with the product. It is worth remembering that because Sativex is a botanical product, ensuring the quality of material was always going to be one of the key challenges of the project.

However, the CSM questioned the ‘clinical relevance’ of the data submitted in June 2004. By this, the CSM means that it is unclear how relevant the measured improvement in spasticity associated with MS (the initial indication for which Sativex has been submitted) actually is to patients (that is, do they actually ‘feel’ better). While some of the secondary end-points of the spasticity phase III study were not positive, this does not seem to be have been the primary concern of the MHRA.

In the first instance, GW had been guided by the body to focus on spasticity (using end-points that the regulatory body was apparently happy with) rather then the wider symptoms of MS. Moreover, GW states that it was told that in 2003 and early in 2004, only one positive spasticity trial would be required to prove efficacy. After submitting the data from GWMS0106, GW had assumed it fulfilled the MHRA’s request. However, the CSM stated in December that it is not clear of the clinical relevance of the data supplied to date (despite submissions from independent experts).

GW is planning to proceed to the Medicines Commission (MC), which is effectively an appeal body. The MC will look specifically at the spasticity issue, but can look at the data in a wider context. If the MC decides to approve Sativex, its decision will effectively over-ride the CSM and the drug can be licensed. Importantly, the MC cannot start looking at the issues that have effectively been cleared by the MHRA/CSM already.

The MC is made up of a more eclectic group of people than the CSM and takes information from wider sources, including patient testimonies and presentations by independent clinicians. For instance, GW is hoping Professor Mike Barnes (who has no association with GW), the Chairman of the Royal College of Physicians Rehabilitation Committee, will present in favour of Sativex at the MC meeting.

In addition, GW Pharma has taken the data from the trials already completed and interpreted it in different ways and will submit the new analysis to the MC to support the approval of Sativex. For instance, initially in the placebo-controlled phase III study (GWMS0106) a spasticity score that was based on multiple sclerosis (MS) patients’ own impressions (that is, using a subjective rating scale) was used and analysed in the manner depicted overleaf.

22 February 2005

2 2 Fe b ruary 2005 While the results from the trial indicated that patients treated

While the results from the trial indicated that patients treated with Sativex had statistically significant less spasticity than the patients given placebo, the MHRA were not entirely convinced that the difference was clinically meaningful.

Sativex Efficacy Data

difference was clinically meaningful. Sativex Efficacy Data New trial to start soon European roll out delayed

New trial to start soon

European roll out delayed

Source: Company data

Since the MHRA’s decision, GW has re-analysed the data to try and make the clinical relevance appear more obvious. In general we believe re-analysis (or re- hashing) of data is not looked on favourably by regulatory bodies. However, we believe this instance is different, as the initial data was statistically significant and GW is simply trying to make the clinical improvement clearer.

GW has taken the data and assessed what proportion of patients reach certain levels of improvement. For instance, 40% of patients had a 30% (or greater) reduction in their spasticity score. Clinically, a 30% improvement is taken as meaningful, a view that is supported by further analysis undertaken by the company. The percentage change in spasticity score (the same scoring system as used in the previous analysis) can be correlated with how the patients view the change in their condition (for instance, ‘much improved’ or ‘no change’).

The analysis shows that a 30% improvement correlates (on average) to patients feeling between ‘much improved’ or ‘minimally improved’, an outcome we believe 40% of patients would welcome. GW is hoping that these data (along with other analyses) will help its cause with the MC.

In addition to the submission to the MC, GW is starting another phase III spasticity study as soon as possible. The company was intending to start another trial any way. Therefore, the machinery is in place for this to start early this year. However, the company is currently finalising the methodology with the regulator. Current opinion amongst the MS fraternity is that patient based (that is subjective scales) are the most meaningful and GW hopes that the MHRA will accept this view. The company hopes that the data from this study could be collected and analysed by the end of 2005. Hopefully, the data (if positive) would form the basis for final approval in the UK.

Finally, it is worth noting that while Sativex is not approved in the UK, 500 patients receive the drug on a compassionate basis.

In terms of the rest of Europe, GW was aiming to use the UK as its rapporteur country for mutual recognition. This is obviously now on hold. However, the company has stated that if the process slowed down further in the UK, it might look elsewhere to make another filing.

22 February 2005

2 2 Fe b ruary 2005 Approval in near future Canada offers sizeable market Activity in

Approval in near future

Canada offers sizeable market

Activity in US begins

Other projects can provide upside

Cash for just less than two years

Canada

In our opinion, the Qualifying Notice in Canada was a key event as it indicates that Sativex is approvable in a recognised territory. The Notice (similar in concept to the FDA’s ‘approvable letter’) sets out the conditions (including post-marketing studies) for full marketing authorisation to be granted. GW was required to respond and accept the conditions within 30 days, after which, Health Canada will review the response. If GW’s answers are acceptable, marketing authorisation can be granted. According to GW, most of the issues are procedural and do not require the further submission or analysis of data. Following the receipt of full approval, the licenses for importation and storage need to be granted. This paperwork should be relatively simple to complete and allow launch of the product sometime in mid-2005.

Bayer is GW’s marketing partner in Canada and it will now start instigating its strategy for selling Sativex. GW should receive a milestone when full approval is granted (we estimate the size of the milestone to be in the region of £2m). In addition, GW will receive royalties at a net rate we estimate to be around 30%.

To a large extent, the Canadian Qualification Notice was largely ignored by the market, but there are still 50,000 MS sufferers in the country (compared with 85,000 in the UK) which we believe could support sales of US$20m-US$35m (assuming a price of US$3,500 per annum and 15%-25% penetration). Therefore, the revenue to GW Pharma (US$6m-US$10m) is still meaningful.

Because of its proximity, inevitably Sativex will find its way into the US. While the FDA and the Drug Enforcement Agency (DEA) will be keen to stem the flow. However, illegal importation may provide some impetus for the authorities to look at the whole area of medicinal cannabis (and extracts) which is something of a ‘hot potato’ in the US. Moreover, as GW looks towards an approval in the US (starting with a meeting with the FDA in the near future) the various issues that may impact the regulatory pathway could be highlighted well in advance. As we stated earlier, in the US, GW may look to develop Sativex for cancer pain first because the issue of using a cannabis-based medicine may be less controversial in terminal patients.

Other projects and financing

With all the attention focused on Sativex, the other GW projects are easily forgotten. While much research and development on the various cannabis extract configurations will be required to create value, one near term opportunity is the Advanced Dispensing System (ADS), which is initially being developed for use in methadone rehabilitation programmes (for heroin addiction). However, until further information is available (and remembering that contracts are likely to come from governments), we are not including revenue from this source. We would therefore consider cash and newsflow from the ADS could provide potential upside to the current valuation and share price.

The recent re-organisation should allow costs to be kept in check over the next few months and we expect the current cash balance of £17.8m to last just less than two years even if Sativex was not approved in the UK (for which it would receive a £14m milestone from Bayer). However, with the rights to Sativex outside the UK and Canada available (plus global rights to the ADS), GW has multiple sources of cash before a return to the capital markets is necessary (rather than desirable).

22 February 2005

2 2 Fe b ruary 2005

This document is issued by Evolution Securities Ltd (Evolution Securities) (Incorporated in England No.2316630), which is authorised and regulated in the United Kingdom by the Financial Services Authority for designated investment business and is a member of the London Stock Exchange. This document is for information purposes only and should not be regarded as an offer or solicitation to buy the securities or other instruments mentioned in it. Expressions of opinions are those of the research department of Evolution Securities only and are subject to change without notice. No representation or warranty, either expressed or implied, is made nor responsibility of any kind is accepted by any Evolution Group company, its directors or employees either as to the accuracy or completeness of any information stated in this document. Evolution Securities or persons connected with it may provide or may have provided corporate services to the issuers of securities mentioned in this material and recipients of this document should not therefore rely on this report as being an impartial document. Accordingly, information may be known to Evolution Securities or persons connected with it which is not reflected in this material. Evolution Securities may make a market or deal as principal or agent in the securities mentioned in this document and its employees and directors may from time to time have long or short positions. The stated price of any securities mentioned herein is as of the date indicated and is not a representation that any transaction can be effected at this price. No personal recommendation is being made to you; the securities referred to may not be suitable for you and should not be relied upon in substitution for the exercise of independent judgement. Evolution Securities shall not be liable for any direct or indirect damages, including lost profits arising in any way from the information contained in this material. This material is for the use of intended recipients only and only for distribution to professional and institutional investors, i.e. persons who are authorised persons or exempted persons within the meaning of the Financial Services and Markets Act 2000 of the United Kingdom.

22 February 2005

2 2 Fe b ruary 2005

Price / Target

GW Pharmaceuticals

130p / 160p

 

Buy

Business

Market info

Issued equity

Major holders

 

Biotechnology company deriving prescription medicines from cannabis

Market cap

£143m

RIC code

 

GWP.L

Directors

44%

Free float

56%

Issued shares

 

110m

Morley

3%

 

12 mth high / low

234p / 92p

Avg weekly volume

 

432,723

HSBC

2%

Geography (Sales, Dest. %)

 

EVO Sector

Pharmaceuticals

Beta / R 2

2.2 / 0.09

 

UK:100

Eur: 0

US:

0

ROW:

0

No. of employees

 

0.00

Pensions surplus (deficit)

     

P&L (£m)

2003A

2004A

2005E

Cash Management (£m)

 

2003A

2004A

2005E

Sales (excluding joint ventures)

 

5.0

0.0

2.9

Closing net cash

 

32.0

17.8

8.6

EBITA

-10.3

-16.7

-11.5

Net cash per share

 

31.2

16.1

7.8

Net Interest

0.7

1.0

0.7

Gross cashflow post-capex

 

-7.4

-14.3

-9.2

Evolution PBT

-9.6

-15.7

-10.8

R&D expenses

 

-12.7

-13.9

-11.0

Exceptionals and other adjustments

 

0.4

0.4

0.4

Change in R&D spend (%)

 

-18.0

-9.9

21.1

Per share data (p)

 

Graph

Evolution EPS

-7.8

-12.4

-8.4

 

Consensus EPS

 

-7.8

-12.4

-6.8

DPS

0.0

0.0

0.0

Evolution CFPS

-7.0

-12.3

-7.6

Cash flow (£m)

 

EBITDA

-9.5

-15.8

-10.6

Change in working capital

 

0.8

-0.6

0.0

Interest, tax & pref dividends

 

1.5

2.8

2.2

Capex and acquisitions net

 

-0.3

-0.8

-0.8

Share issues / (buybacks)

 

19.2

0.1

0.0

Dividends (paid)

 

0.0

0.0

0.0

Other items

0.1

0.0

0.0

Change in net cash

 

11.8

-14.2

-9.2

Balance sheet (£m)

 

Valuation Matrix

 

DCF sensitivity

Closing net cash

 

32.0

17.8

8.6

WACC (%)

 

16.0

15.0

14.0

Net assets

37.0

23.5

14.2

Fair Value (p)

 

120

127

134

Capital employed

 

4.9

5.7

5.6

Fair Value (£m)

   

Assumptions behind forecasts

 

Evolution view

 

Canadian approval in 2005

 

With the issuance of a Qualifying Notice (similar in nature to the FDA’s ‘approvable ‘ letter) by the Canadian regulatory body, the approvability of Sativex appears to be confirmed.

UK approval 2006

 

US phase III trials start 2005

   

Risks to forecasts

 

In the UK, GW is undertaking a two-pronged approach to try and get Sativex approved; undertaking a further phase III study and appealing to the Medicines Commission.

No Canadian approval

 

UK approval delayed

   

No further out-licesing deals

 
Share Price Significant events Performance Absolute Relative Canadian approval in 2005 1 month 11% 6%
Share Price
Significant events
Performance
Absolute
Relative
Canadian approval in 2005
1
month
11%
6%
220
194
MC
meeting May/July 2005
3
month
-19%
-18%
168
142
UK
approval mid-2005/2006
12 month
-43%
-44%
116
90
Out-licensing deals
5
years
FM
A
M
J
J
A
S
O
N
D
J
F
Source: JCF
Clinical data

PBT and EPS numbers exclude goodwill amortisation and exceptional items.

numbers exclude goodwill amortisation and exceptional items. 100 Wood Street London EC2V 7AN Tel: 44 (0)20

100 Wood Street London EC2V 7AN Tel: 44 (0)20 7071 4300 Fax: 44 (0)20 7071 4457 Email: research@evosecurities.com