Initiating Spherix: Outperform - Analyst Blog

We are initiating coverage of Spherix, Inc. (SPEX) with an Outperform rating and price target of $3.50 per share. We are optimistic about D-tagatose, a functional sweetener and a naturally occurring L-epimer of D-Fructose currently under phase III development for the treatment of type 2 diabetes.

D-tagatose, or Naturlose as it is branded, was originally developed as a natural sugar-substitute (sweetener) for food and OTC product applications. The molecule has a similar taste and texture to sucrose (table sugar), is 92% as sweet, but has only 38% of the calories.

Spherix used chiral carbohydrate research to create L-sugars that would not be metabolized by the body, but would retain sweetness. The body lacks the enzyme necessary to efficiently metabolize this molecule, and thus it is poorly absorbed in the small intestine. As a result, D-tagatose does not stimulate insulin secretion or raise blood glucose levels.

In fact, previous clinical data demonstrates that D-tagatose has the potential to lower blood glucose (HbA1c) levels in type 2 diabetic patients, as well as provide key secondary benefits including a reduction in triglycerides, LDL, and body mass index (BMI). D-tagatose also mutes the body’s response in the presence of glucose, thus allowing for effective HbA1c control through mealtime dosing in a diabetic population.

More importantly, D-tagatose looks to be a very safe molecule. D-tagatose has been generally recognized as safe (GRAS) by the U.S. FDA (Food and Drug Administration) since 2001, the WHO (World Health Organization) since 2004, and the EFSA (European Food Safety Authority) since 2006. It is FDA-approved for use as a low calorie sweetener in foods.

Data Looks Encouraging

Clinical development of D-tagatose is currently progressing in a phase III program called NEET (Naturlose Efficacy Evaluation Trial). This trial completed enrollment in January 2010. Preliminary blinded data released by the company in November 2009 demonstrated a significant reduction in variability of HbA1c levels.

The data also confirmed that the current protocol is sufficiently powered to achieve the statistical significance as per the primary endpoint of differences between control and D-tagatose in HbA1c. The blinded analysis noted that the results of the secondary variables, LDL, HDL, triglycerides, and BMI, are in agreement with that of the HbA1c results.

The blinded interim analysis also looked at a summary of HbA1c "responders" (i.e., subjects achieving HbA1c target of <6.5%). The incidences of responders achieving an HbA1c target of <6.5% at 1, 2, 4 and 6 months of treatment were 4%, 13%, 19% and 18% respectively. Because the trial is randomized 1:1 in terms of drug and placebo, approximately 50% of the patients received placebo. 

A Partnership or Takeout

Management’s goal is to complete the ongoing NEET program around the middle of the year and then file for U.S. FDA approval late 2010 or early 2011. We expect management to secure a commercialization partnership for D-tagatose around the NDA (new drug application) filing.

We have built an assumption for what this potential partnership may look like using historical partnership terms from the Zacks database for post-phase III pharma-biotech licensing deals. We have adjusted these data relating to key attributes surrounding Spherix and D-tagatose, and we arrive at a fair-market value of approximately $60 million. With a current market capitalization of only $20 million, we believe the shares are significant undervalued.

We believe the shares are undervalued due to a number of circumstances. Firstly, there is a misconception that there are manufacturing and supply issues on D-tagatose. These are misguided, in our view. The company signed an agreement with a full-scale cGMP commercial supplier for D-tagatose in Inalco S.p.A. in 2009.

Secondly is that the company's financial position is weak. While the financial position could be better -- as are 95% of all biotech companies -- the current cash position is sufficient to fund operations into 2011. By then, the full phase III NEET data will be presented and the NDA should be under review. True, Spherix will not come to the negotiating table with a larger organization from the position of financial strength. The truth is management will have to do a deal with someone; but with over a year of cash on hand, the financial position should not be a primary concern for investors at this point.

Finally, we believe investors are spooked by the intellectual property (IP). However, as long as the drug is under FDA review or discussions are ongoing, the IP will be protected under Hatch-Waxman and a commercialization partner should get five to six years of non-genericized sales post-approval. Thus, we do not see a substantial IP risk on D-tagatose until 2017 or beyond. This level of protection is in-line with other specialty pharmaceutical products that have a peak sales level between $250 and $300 million.

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