Value Investors Club / ACELRX PHARMACEUTICALS INC (ACRX)

Description

DESCRIPTION

AcelRx (the “Company” or “ACRX”) is a clinical stage specialty pharmaceutical company focused on the development and commercialization of drugs for the treatment of moderate-to-severe acute pain. The Company’s first product up for approval is Zalviso (or ARX-01), a combination opioid drug and patient controlled analgesia medical device for the hospital and acute care setting. The opioid is a reformulated version of the long standing generic, Sufentanil, allowing it to be taken sublingually (ie under the tongue). ACRX’s New Drug Application (“ NDA”) currently has a PDUFA date (ie the FDA decision date) of July 27^th after having gone through years of successful testing with minimal safety issues and significant efficacy.

The current standard of care for patients with moderate-to-severe pain in the hospital (especially postoperative) is intravenous patient controlled analgesia pumps (“IV PCA”), which has been shown to cause harm (most opioids have significant side effects to older and sicker patients, ie the people who actually have most of the surgeries) and inconvenience to patients (they are tethered to the pump via the IV) and healthcare providers (many unintentional overdoses and constant nurse focus on the pump and the alarms – IV PCA pump alarms are what you will hear at all times of day and night in an ICU or recovery ward).

AcelRx also has a legitimate pipeline of additional pain treatment products. The most significant product is ARX-04 which is a product for short term acute care pain that can be utilized outside the hospital setting. ARX-04 was originally funded by the US Army in hopes of it becoming a replacement to morphine syringes. ARX-04 also is a potential substitute for acute care pain treatment in the emergency room and for paramedics at emergency sites.

Zalviso Product Description

Zalviso is a pre-programmed, handheld device that delivers a sublingual formulation of Sufentanil, a synthetic opioid analgesic. The Zalvis New Drug Application (“NDA”) was accepted for filing by the FDA on November 26, 2013 with a PDUFA date of July 27, 2013, as a combination product led by the CDER arm of the FDA. Like an asthma inhaler, the approval will be for the combination of drug and device, providing significant patent protection.

Sufentanil is a rapid onset opioid which typically doesn’t get used as it peaks fast and is then metabolized by the liver very fast, making administering the drug very burdensome, even though it is highly efficacious and much safer than other opioids (multiple studies over time showing less oxygen desaturation, the most severe adverse event for opioids). However, packaged in a patient controlled device that only allows one table every twenty minutes (so is non-programmable unlike IV PCA pumps) , Zalviso avoids the hassle of constant administration by nurses while allowing for very fast and significant pain relief.

Zalviso is fast to set up for nurses, requiring only a new mouthpiece (to be attached to the dispenser), a tether for the device to the bed that sets automatically with the device, and the cartridge of 40 nanotabs. Then the patient, who wears a bandaid like identification strip on their thumb, just presses the botton with that thumb on the dispenser to release a nanotab under their tongue. The device is pre-programmed to dispense a nanotab no more than every 20 minutes, ensuring no overdose is possible.

Investment Thesis

AcelRx is an extremely attractive investment because it is mispriced due to a lack of understanding by many investors into the probability of its first product of being approved by the FDA and subsequently the fact that Zalviso is a vastly superior treatment for moderate-to-severe pain from a safety and efficacy standpoint to the current standard of care, such that it will have quick success in its commercial launch. With such a small market cap, even relatively small penetration rates would lead to significant upside in ACRX, because the profitability of the product is so significant even at pricing of just $100/day (the low cost will also help drive fast and substantial penetration). With several pharma and biotech companies looking to further leverage their existing hospital focused salesforces and the fact that AcelRx has a very attractive pipeline, it is highly likely ACRX gets taken over within the first two years of approval of Zalviso. Importantly, AcelRx has more than enough cash on hand to be able to launch Zalviso and hit breakeven without needing to raise any more capital, something many small biotechs reaching their PDUFA are never able to claim. Altogether, this results in a 3 year price target of $50, based on a 12x forward FCF multiple.

Binary Event In ACRX’s PDUFA Date Is Being Mis-Priced As A Coin Flip – First and foremost of why AcelRx is an attractive investment is that the stock is being priced as if there is an equal chance for Zalviso to be approved or unapproved come July 27th. We think the odds of approval are greater than 90% and that there is less than a 5% chance of a Complete Response Letter from the FDA with no actions recommended for correction (an outright no, with little chance for approval in the future). The reason investors think this is that they don’t understand the specifics of Zalviso and are using the long term average of FDA approval rates (approximately 50%) as a means of handicapping Zalviso’s approval. So while the stock could go up 50-80% ($15.00-$18.00/share) on approval and down 50-80% ($2.00-$5.00/share) if not approved, with the stock trading recently between $9-$11/share would it would strongly suggest that investors see the same probability of Zalviso being approved as not approved. We would agree that the situation is somewhat binary in nature (somewhat because there are several distinct and materially different shades of non-approval), but that does not mean the distribution of results is even close to being no

Approval Will Lead To At Least 50% Upside, Potentially 100% – On the upside following an approval, the company should be valued closer to its fair value on a DCF basis using conservative uptake rates, pricing and market share gains from IV PCA. Our math suggests that using $200 for a 2 day scrip (with 1.5% annual price inflation) and reaching in year 3 of launch 5.6% market share (3.5% in ’17 in Europe) of addressable surgeries, generates $220 million of revenue. Applying today’s 2016E Pacira revenue multiple of 6.7x (discounted 15% to 5.4x) to our forecasted ACRX revenue in 3 years and then discounting that EV back to today using a 12.5% discount rate results in an NPV price per share of $23.69 or 136% more than ACRX’s current price. This conservative valuation backs up the view that the stock could trade substantially higher if Zalviso is approved, potentially up as much as 100% or to $20.00, as post approval, the right discount rate is somewhere between 8.5-10%. At a 8.5% discount rate, today’s fair value jumps from $23.69 to $25.93, which is probably closer to fair value for ACRX once Zalviso is approved by the FDA.

AcelRx Pharmaceuticals

Comparable Company Future Valuation

PCRX 2016E Sales	$475.9
PCRX Enterprise Value	$3,037.5
PCRX Multiple	6.4
		2017E
ACRX 2017E Sales - Conservative Case (4.5% US & 3.5% EU '17 market share)		$219.9
PCRX Multiple Discount			15.0%
ACRX Forward EV/Sales Multiple			5.4
ACRX 2016E Market Cap			$1,193.0
Pro Forma Q2 2014 Net Cash			$71.8
Cummulative Free Cash Flow Q2 2014 - Q4 2016E			$118.3
Estimated Year End 2016 Enterprise Value			$1,383.2
Discount Rate			12.5%
NPV of 2016E EV to Today			$23.69
% Upside From Current Stock Price			136%

Downside Is Cash And Value Of The European Royalties & Milestone Payments - On the downside, cash is 18% of market cap, there is another $215 million of potential payments from Grunenthal, ACRX’s European partner, and there would still be residual value for the three other products in the Company’s pipeline. Down 80% would essentially value the company at cash and a liquidation and down 50% provides some value for the European filing (filed in July of 2014) and the pipeline. Overall, this would suggest the market is equally weighting the chance for approval and non-approval, which we believe grossly underweights the skew in the distribution of outcomes in favor of approval. Moreover, the fair value today of the cash, milestone payments and the European royalties is $8.17 using a 12.5% discount rate and a forward multiple of 12x in 2017 on 2018E FCF.

AcelRx Pharmaceuticals
Downside Scenario - Only European Royalty Revenue + Net Cash

			2018E
European Revenue			$24.2
Royalty Rate			18.5%
Cost Of Goods			$0.0
Research & Development			$1.0
Other Operating Expenses			$5.0

EBIT			$18.2
Taxes @		35.0%	$6.4
Net Income			$11.8

Depreciation			1.5
Option Expense			1.0
Capex			-
Change in WC			-

Unlevered Free Cash Flow			$14.31

Discount Rate				12.5%
Forward Multiple Of Terminal Year FCF				12.0
2017 Terminal Value				$171.7
Discounted Terminal Value					$113.7
Development Milestone Payments				$215.0
Discounted Milestone Payments					$169.9
Discounted Market Cap					$283.6
Current Net Cash					$71.8
Discounted Enterprise Value					$355.4
Per Share Value					$8.17
Current Stock Price					$10.04
	Downside To Current Stock Price				-18.6%

Approval Is Highly Likely Given That The Active Ingredient Is A Generic And Not Novel – The difficult FDA review is for drugs and biologics, where the approval rate in some years is substantially below 50% for novel molecules. What’s different with Zalviso is that Sufentanil is a generic that has been around for decades with a strong record of safety and efficacy. As opioids go, Sufentanil, when compared against morphine (in studies done by ACRX and by third parties literally decades ago) demonstrate clear statistically significant efficacy and safety over morphine, the main opioid used in IV PCA, the current standard of care. Therefore, the biggest uncertainty around the approval of Zalviso is the device. However, typical Class II medical devices have a much higher approval rate (80% in 2012), given they generally are seen as much lower safety concerns. Devices have a different path through the FDA via the Center for Devices and Radiological Health (CDRH). In the case of Zalviso, as a compound product, the CDRH does its own separate review, allowing the drug side of the FDA, CDER, to take lead. This designation of CDER as the lead on the compound product demonstrates that the bigger concern is around the drug, which in this instance is a long standing generic, so Zalviso is not a difficult product to review for the FDA.

Sufentanil Has An Extremely High Therapeutic Index – The Therapeutic Index is defined as the median lethal dose divided by the lowest median effective dose. The Index therefore provides a very clear ratio of safety and efficacy (the FDA’s two major hot buttons) in a single number. Sufentanil has a score of 26,716. The other major opioids are much lower with morphine at 71, hydromorhpine at 232 and fentanyl at 277. Those are not typos, Sfentanil is literally 376x better than morphine on the most widely used safety-to-efficacy ratio. This speaks well to the FDA looking favorably upon Zalviso and helps drives a very high probability of approval on the PDUFA date.

Extension Of ACRX’s PDUFA Equals Approval – The best outcome from our perspective is that the FDA requires an additional 3 months to review some aspect of the NDA. The reason this is a great scenario is that the stock probably only goes up a small amount, which would provide bulls the chance to buy heavily knowing that the odds of approval have just gone up significantly, from an already very high level. The FDA almost never asks for a 3 month extension to then provide ACRX with a complete response letter (how the FDA turns down a drug). Hence, the stock will likely go up on an extension as there are many investors that will increase position size and shorts will begin to cover.

Enough Cash To Hit Breakeven – Prior to July’s $5 million milestone payment from Grunenthal, ACRX had enough cash to make it to breakeven, so long as an approval is achieved on July 27th or October 27th (if there is a 3 month extension to the PDUFA date). With the $5 million ACRX is in even a better position. In Q1 2014, ACRX spent about $11.5 million in cash, which should increase by $2 million in Q3 as half the salesforce is hired. This would mean that ACRX has over 6 quarters of cash available (starting with pro forma cash at end of Q2 2014) if there is a PDUFA extension or requirement to refile the NDA (even carrying the increased cost of the salesforce). This is important as it will solidify ACRX’s ability to trade higher post PDUFA, as there have been instances where underfunded companies had an approval and traded down, knowing that a big equity raise would occur.

Pacira Is A Prime Example Of A Great Product Approval Leading To A Falling Stock - This is the case with Pacira, the other new pain drug company, where it fell significantly post approval as it was forced to raise a new equity round that was 47% dilutive to share count, followed by yet another sale of equity several months later that was an additional 27% dilutive. Pacira is now a $3B market cap company even after all of this dilution, trading at $85 a share or 8x greater than where it was after the approval of its drug Exparel.
Pacira Timeline

-          Oct 31, 2011 – Exparel approval (PCRX Open $10.94; Closed at $9.78)

-          Nov 16, 2011 – Priced 7 million shares at $6.50 (plus another 1.05 million overallotment)

** shares out as of 9/30/11 was only 17.2 million so the additional 8 million was a 47% increase

-          Jan 2012 – Announced they were having delays in producing / manufacturing

-          April 9, 2012 – Launched Exparel commercially (eventually reports $2.3m for this first quarter of sales)

-          April 11, 2012 – Sold another 6 million shares at $9.75 (plus another 0.9 million overallotment)

Current Standard Of Care For Post-Operative Pain Treatment Has Many Issues - IV PCA technology has limitations and challenges, which will allow Zalviso, once approved, to take significant share. The major issues for IV PCA include:

- (i) potential for programming and medication errors as nurses are needed to enter the right amounts (not an issue for Zalviso);

- (ii) frequent monitoring required, especially for patients at risk for respiratory depression (something Zalviso greatly minimizes, as Sufentanil is 1,000x more powerful than morphine, so needs significantly less drug to be administered for the same level of pain relief);

- (iii) pump failures or malfunctions that can lead to overdoses (not an issue for Zalviso as any failure in the device leads to an inability to dispense drug);

- (iv) time consuming set up and programming (again, not relevant for Zalviso);

- (v) restricted patient mobility with potential impact on length of stay (Not applicable to Zalviso);

- (vi) variable and considerable cost impact to hospitals (Zalviso is much cheaper on total cost of care, as improving patient mobility shortly after surgery has been proven to cut down on length of stay, which adds greater costs and correlates to increased chance of acute pain becoming chronic pain);

- (vii) risk of IV site infection (clearly not applicable to Zalviso); and

- (viii) delay in pain relief given time of setup and delay in morphine making their way to the brain (Zalviso peaks in under 7 minutes vs 15 minutes for IV PCA to be 80% effective and 90 minutes to hit peak – Sufentanil also provides greater relief of pain after the first four hours of use).

- Zalviso Minimizes The Main Risk Of Opioids - The most significant issue with IV PCA out of all the issues listed above is the fact that morphine has a high rate of respiratory depression. Respiratory depression results in patient discomfort and possibly death if opioid use is not stopped. This leads to decreased doses, thereby significantly limiting pain control in these patients. Needless to say, there are enough problems and cost with IV PCA and significant improvements from using Zalviso over IV PCA that AcelRx should be able to have a successful commercial launch and take substantial market share over the first five years. In fact, doctor checks for high pain, high rehab need type operations such as orthopedic surgeries, suggests market share could go well over 50% for many doctors.

Large Opportunity – The US has over 12 million surgical procedures a year that result in moderate-to-severe pain and Europe has even more. There is an additional 7.5 million hospital inpatients in the US that also suffer from moderate-to-severe pain. Even assuming relatively minor market share gains, it is easy to see that Zalviso has the potential to generate hundreds of millions in US sales alone. This is significant given that the enterprise value for ACRX is roughly $350 million today. Since most patients complain of inadequate pain relief in post-operative situations, there is certainly room for new products such as Zalviso that offer faster and longer lasting pain treatment in the post-operative setting. Simply put, if Zalviso captures just 10% share of postoperative and inpatient scrips to treat moderate-to-severe pain, with a $200 price, results in $360 million in revenue with a gross margin over 90%. Europe has more volume than the US, but will have a lower price, so the market sizes will be roughly the same.

High Short Interest Will Accelerate Closing Of Gap To Intrinsic Value Post Approval – There are approximately 6.8 million shares shorted in ACRX, representing about 16% of shares outstanding and 27% of free float (ie excluding shares held by the VCs). The main short thesis is that Zalviso is not approved or faces serious delays (ie over a year). In this case, yes, the shares will go down, but again, we see this as a small possibility. The secondary short thesis is that other products like the pain patch from Medicines Company (this also has serious delay in providing pain relief – up to 45+ min for some patients besides the fact it was recalled years ago in Europe, so is not marketed in the US) and Pacira’s Exparel will limit the commercial opportunity for Zalviso. However, post approval, this stock is going higher, so to be short on this secondary thesis will be exceedingly painful if the FDA approves the NDA. Since we think that Zalviso will have a strong commercial launch given its superior efficacy and safety data versus current standard of care treatments, analyst estimates will need to trend higher as well. The secondary thesis on additional competition from Pacira and Medicine Company’s, to the point of crowding out any real opportunity for Zalviso, also doesn’t hold water. Pain treatment will continue to be multi-modal (ie several types of drugs used in combination – approximately 60% of all surgeries use multi-modal pain treatment) and so, Zalviso can grow rapidly and coexist with Exparel, Pacira’s foam matrix injection, as it is for local analgesia and only given while patients are still in the operating theater. The patch from Medicine Company does not seem viable in the post-operative environment where quick and secure pain treatment is required, and it still faces regulatory hurdles. Additionally, analysts are using “risked” numbers for ACRX which discount sales levels to better approximate the uncertainty with approval, but post approval, these discounts will drop significantly and estimates will go higher as analysts fine tune their models for launch.

Conservative Commercialization Forecast Leads To Substantial Upside – Even our Conservative Case which only has ACRX gaining 10% share of the addressable universe of patients by 2023 still leads to big upside in the stock. In this case the DCF value for AcelRx, using highly discounted US and European sales expectations and a 15% discount rate points to a fair value of approximately $27.03. Obviously this is highly dependent upon a lot of assumptions that go out many years, but our belief is that the actual outcome is likely to be a lot better so long as Zalviso is approved by the FDA. With survey data pointing to market share gains by some docs in the 75-80%, 10% market share overall in 9 years seems very likely.

Quicker Than Expected Penetration Due To Pain Control Becoming A Major Driver For Hospital Reimbursement Rates – While several decades of use for IV PCA seemingly creates a significant incumbency dynamic and therefore a headwind for Zalviso’s product launch and penetration gains, the new post-operative patient survey should fully offset this. The survey is comprised of 20 questions, 2 of which are for pain. This survey will be used by payors to determine reimbursement rates for specific hospitals and doctors. This makes pain treatment a C suite issue. Given that Sufentanil offers significantly faster onset of pain relief with less side effects and greater patient mobility, it would be easy to understand how patients will react more positively when taking Zalviso than IV PCA (as demonstrated in ACRX’s comparator phase III study). Seriously, if you were in significant post-operative pain and a doctor offered you a choice between a drug that would provide pain relief in 7 minutes with less associated adverse events or another drug that would require poking you with a needle and take 45 minutes to provide similar pain relief, which would you choose? In the end, this survey and the lower all in cost for Zalviso should drive P&T applications leading to formulary adoptions beginning in 4Q14, and first commercial sales in 1Q15, and more rapid adoption thereafter.

ACRX Is Experiencing Unbelievable Success Recruiting Cadence Sales Reps - Cadence is another new pain treatment company which was bought by Mallinckrodt last year. Cadence had a successful launch of its acetaminophen injection product for the acute pain settings, so their sales reps are highly experienced and know hospitals and docs that will be early adopters and will be able to ensure the best launch possible. ACRX has hired some Cadence sales reps already and have others on contingency deals, with them coming over to ACRX post approval. Helping ACRX is that Mallinckrodt has a poor pay and benefits package and a big bureaucratic culture. One Cadence sales rep thinks that ACRX could be successful in recruiting upwards of 25 Cadence reps.

High Gross Margins Even With A Low Price Tag For Zalviso – Because Sufitenal is a generic drug, the compound is very cheap to procure. AcelRx should be able to achieve a 90%+ gross margin, even though its average one day prescription cost should be around $100/day. The device is also very inexpensive, especially compared to IV PCA pumps. AcelRx will sell the device at near cost and Zalviso will become a razor razorblade model, where AcelRx makes very high margins with stable revenue by selling nanotabs.

IV PCA Is Not Cheap – AcelRx’s recent study of the cost of various IV PCA treatments over thousands of surgeries concluded that the treatment will cost between $196 to $243 for a 2 day prescription and associated device and other costs. This figure does not include the labor costs for the nurses required to setup, monitor and maintain the IV pump. Medicines Company did a similar study of the IV PCA cost and came up with numbers, including labor, that was even higher. The labor cost for AcelRx will be substantially less, as setup time is just a couple of minutes and there is virtually no monitoring required.

Low Operating Expenses – Besides the high gross margin, the opex for AcelRx should also be very low. With Zalviso only being marketed to hospitals and acute care facilities, ACRX can get away with having fewer than 75 sales representatives and cover the entire country. At $250,000 salaries, even with a sales team as large as 75 (ACRX aiming for 65 to cover the first 1,400 hospitals that represent 80% of all relevant procedures), the sales cost will be about $18.75 million. Then throw in $20 million of R&D (probably growing to $40 million over time as sales ramp) and the typical costs associated with being a public company, EBIT margins should be substantial, with limited to no capex.

Significant Leverage To Higher Pricing – Our conservative DCF value goes up 21% with a price increase of just 15%. Since this would represent a 2 day all in cost for Zalviso of only $230 and the cost of IV PCA is still well north of this all in, this is not farfetched. Moreover, as Zalviso gains share, AcelRx can use the standard big pharma tactic of raising price as doctors embrace the new treatment. There is no reason that Zalviso should not be priced at a premium to IV PCA over time, as most new and improved drugs are priced at a premium.

Strong IP With Significant Opportunity To Extend Patent Life – ACRX’s main patents extend through 2027. However, given that AcelRx will likely improve upon the device and nanotab over the course of time and that the Company will have these new drug/device combinations approved by the FDA, the life of using pain medications delivered sublingually through a patient controlled device is likely to be extended even longer. This should help the Company to maintain their dominance in this segment of the post-operative pain market for at least the next few decades.

Grunenthal Relationship Provides Further Upside Potential From European Sales – Grünenthal, a German specialty pharma company, signed an agreement last year to distribute Zalviso in Europe and providing ACRX a $30 million upfront payment, with $220 million of additional milestone payments, and a royalty between 16-20%. Grünenthal brings its pain-focused organizational capability to support a successful launch of Zalviso in the EU and Australia. Grünenthal is the number two pain company in Europe, so has all the necessary relationships to drive sales. Zalviso’s success is strategically relevant for Grünenthal and fits well with their pain treatment portfolio. Most sellside models do not put any European or Australian sales into their models, even though Europe has even more procedures resulting in moderate-to-severe pain (19 million) than in the US (12 million). Even though AcelRx will only get a royalty, it will have 100% EBIT margin as there will be no associated costs.

ACRX Is No One Hit Wonder – Many pre-approval biotechs usually only have one real drug in their pipeline, which makes them less a company and more just a product with a corporate shell. AcelRx is different for an early stage biotech, as it has a strong pipeline with a second product probably 18 months away from an NDA in ARX-04. AcelRx received a grant from the US Army Medical Research and Materiel Command (USAMRMC) for $5.6M to help develop the drug, as the Army sees it as a replacement for morphine syringes, one of the few standard issue pieces of equipment for a combat medic. The problem is that when a soldier gets a serious wound, say being hit by an IED, a medic will inject the soldier with a syringe of morphine, but there is no immediate onset of pain relief given the delay in morphine hitting the brain as it is only water soluble (not lipid-soluble like Sufentanil). This sometimes leads to multiple injections (“dose stacking”) as the pain continues, then leading to an overdose. Behind AXR-04 and several years out are two additional pain drugs, both of which are promising and have good data early on.

AcelRx Is A Prime Takeover Candidate – There are several firms with pain franchises that likely would find AcelRx a great acquisition. Mallinckrodt is the most likely given its desire build into a higher growth specialty pharma company. Zalviso also fits well with the drug, Ofirmev, obtained in the acquisition of Cadence. This MNK deal valued Cadence at $1.3 billion and Cadence only had $110 million of trailing revenue. Perrigo can launch in 2020 a generic form of Ofirmev and that means MNK has a short window to capitalize on Cadence and a need to build around their existing salesforce more products with longer patent protection. MNK is also the supplier of Sufentanil to ACRX, which means the operations are already well known and that the two can work together well.

- Furthermore, to the odds of ACRX being sold, the current board members of AcelRx in aggregate have sold over 10 companies and for attractive premiums.

- Other potential buyers would be companies with strong hospital salesforces that could cut the entire SG&A line out in synergies, such as Hospira or the IV PCA pump manufacturers. Zalviso would be a great fit strategically with Pacira, but the Pacira CEO does not want to diversify its product offering in pain, so this combination is unlikely currently.

- Based on the valuation that Mallinckrodt bought Cadence, AcelRx is worth $26.87 today using a 12.5% discount rate in the Base Case, if a deal is completed two years from now.

AcelRx Pharmaceuticals
Acquisition Multiple Future Valuation

	Cadance 2014E Sales @ Time Of Deal Announcement	$173.0
	PCRX Enterprise Value	$1,276.3
	PCRX Multiple	7.4
			2017E
	ACRX 2017E Sales - Conservative Case (4.5% US & 3.5% EU '17 market share)		$219.9
	PCRX Multiple Discount			15.0%
	ACRX Forward EV/Sales Multiple			6.3
	ACRX 2016E Market Cap			$1,378.8
	Pro Forma Q2 2014 Net Cash			$71.8
	Cummulative Free Cash Flow Q2 2014 - Q4 2016E			$118.3
	Estimated Year End 2016 Enterprise Value			$1,568.9
	Discount Rate			12.5%
	NPV of 2016E EV to Today			$26.87
	% Upside From Current Stock Price			168%

Few FDA Approved Drugs Creates Scarcity Value – There are very few NDA approvals each year, making AcelRx a scarce commodity if Zalviso is approved, as one of the few small companies with an approved drug. In 2013 the FDA’s Center for Drug Evaluation and Research only approved 27 new molecular entities. The old rule of thumb is that few companies with a new approved drug is worth less than a billion, as there are many companies facing patent cliffs and with large sales forces that need to feed the machine. While not something to fully hang one’s hat on, it does illustrate that the value of ACRX is probably going to be a lot higher post approval, if it happens as we expect.

Valuation And Projections

Today, if Zalviso is approved sometime over the next 3 months, AcelRx, in the Blue Sky Case where Zalviso gains 25%+ share in the first five years using a 10% discount rate is worth $65/share today. In the Conservative Case ACRX is worth $27.03/share today (DCF valuation – 15% discount rate) and in three years $31.12/share (12x forward FCF) and with a Base Case valuation of $41.07/share today (DCF valuation – 15% discount rate) and in three years $55.44/share (15x forward FCF). These Base Case numbers are based on the following set of projections and DCF:

AcelRx Pharmaceuticals - Base Case
Revenue Assumptions & Discounted Cash Flow Analysis

REVENUE MODEL				2014E	2015E	2016E	2017E	2018E	2019E	2020E	2021E	2022E	2023E	2024E	2025E

US Surgeries Resulting In Moderate-To-Severe Pain				12,485	12,734	12,989	13,249	13,514	13,784	14,060	14,341	14,628	14,920	15,219	15,523
	% Suitable For Zalviso				95.0%	95.0%	95.0%	95.0%	95.0%	95.0%	95.0%	95.0%	95.0%	95.0%	95.0%
	Growth Rate				2.0%	2.0%	2.0%	2.0%	2.0%	2.0%	2.0%	2.0%	2.0%	2.0%	2.0%
	Market Share				1.0%	3.6%	5.6%	8.7%	11.1%	13.5%	15.8%	16.7%	17.4%	18.0%	18.6%
US Pricing					$200.00	$203.00	$206.05	$209.14	$212.27	$214.40	$216.54	$218.70	$220.89	$223.10	$223.10
	Price Inflation					1.5%	1.5%	1.5%	1.5%	1.0%	1.0%	1.0%	1.0%	1.0%	0.0%
US Non- Surgery Inpatients Resulting In Moderate-To-Severe Pain				7,624	7,738	7,854	7,972	8,091	8,213	8,336	8,461	8,588	8,717	8,848	8,980
	% Suitable For Zalviso				75.0%	75.0%	75.0%	75.0%	75.0%	75.0%	75.0%	75.0%	75.0%	75.0%	75.0%
	Growth Rate				2.0%	1.5%	1.5%	1.5%	1.5%	1.5%	1.5%	1.5%	1.5%	1.5%	1.5%
	Market Share				0.9%	3.3%	4.7%	5.6%	6.6%	7.5%	8.5%	9.4%	9.9%	10.3%	10.8%
Europe Surgeries Resulting In Moderate-To-Severe Pain				19,250	19,491	19,734	19,981	20,231	20,484	20,740	20,999	21,261	21,527	21,796	22,069
	% Suitable For Zalviso				95.0%	95.0%	95.0%	95.0%	95.0%	95.0%	95.0%	95.0%	95.0%	95.0%	95.0%
	Growth Rate				1.25%	1.25%	1.25%	1.25%	1.25%	1.25%	1.25%	1.25%	1.25%	1.25%	1.25%
	Market Share					1.0%	3.5%	5.0%	7.0%	10.0%	10.5%	11.0%	11.5%	12.0%	12.5%
Europe Pricing					$130.00	$131.95	$133.93	$135.94	$137.98	$139.36	$140.75	$142.16	$143.58	$145.02	$145.02
	Price Inflation					1.5%	1.5%	1.5%	1.5%	1.0%	1.0%	1.0%	1.0%	1.0%	0.0%
European Royalty Rate						18.5%	18.5%	18.5%	18.5%	18.5%	18.5%	18.5%	18.5%	18.5%	18.5%


IS & CF ($ in Millions)				2014E	2015E	2016E	2017E	2018E	2019E	2020E	2021E	2022E	2023E	2024E	2025E

US Revenue				$6.1	$34.8	$129.9	$203.4	$305.5	$394.3	$486.4	$581.7	$640.0	$686.1	$734.3	$774.9
European Revenue						4.8	16.5	24.2	34.8	50.8	54.5	58.4	62.5	66.7	70.3
Total Revenue				$6.1	$34.8	$134.7	$219.9	$329.7	$429.1	$537.2	$636.2	$698.4	$748.6	$801.0	$845.2

Cost Of Goods				0.0	7.8	18.2	22.4	30.6	39.4	48.6	58.2	64.0	68.6	73.4	77.5
	% Of US Revenue			- -	22.5%	14.0%	11.0%	10.0%	10.0%	10.0%	10.0%	10.0%	10.0%	10.0%	10.0%

Research & Development				20.5	23.6	27.1	31.2	33.5	36.0	38.7	41.6	44.8	48.1	51.7	55.6
Other Operating Expenses				17.0	41.3	43.8	45.7	47.8	49.9	51.2	52.5	53.8	55.1	56.5	57.9


EBIT				($31.4)	($37.9)	$45.7	$120.6	$217.9	$303.7	$398.7	$484.0	$535.9	$576.7	$619.4	$654.2
Taxes @		35.0%			0.0	0.0	0.0	76.2	106.3	139.5	169.4	187.6	201.9	216.8	229.0
Net Income					(37.9)	45.7	120.6	141.6	197.4	259.1	314.6	348.3	374.9	402.6	425.2

Depreciation				1.1	1.3	1.5	1.5	1.5	1.5	1.5	1.5	1.5	1.5	1.5	1.5
Option Expense				2.5	3.0	3.5	4.0	4.5	5.0	5.5	6.0	6.0	6.0	6.5	6.5
Capex				0.0	0.0	(0.1)	(0.1)	(0.1)	(0.1)	(0.1)	(0.1)	(0.1)	(0.1)	(0.1)	(0.1)
Change in WC				(0.5)	(0.7)	(0.9)	(1.1)	(1.3)	(1.5)	(1.7)	(1.9)	(2.1)	(2.3)	(2.5)	(2.7)

Unlevered Free Cash Flow					($34.3)	$49.7	$124.9	$146.2	$202.3	$264.3	$320.1	$353.6	$380.0	$408.0	$430.4

Period					0.5	1.5	2.5	3.5	4.5	5.5	6.5	7.5	8.5	9.5	10.5
Discount Rate			15.0%
Discounted Cash Flows					($32.0)	$40.3	$88.1	$89.6	$107.9	$122.5	$129.0	$124.0	$115.8	$108.1	$99.2

Sum Of Discount Cash Flows			$992.6
Shares			43.50
Terminal Year FCF			$430.4
Multiple Of Terminal Year FCF			8.0
2025 Terminal Value			$3,443.4
Discounted Terminal Value			$793.7
DCF Enterprise Value			$1,786.3
	Per Share Value		$41.07
	% Upside From Current Price		309.0%
Current Share Price			$10.04
Current Enterprise Value			$358.4

Catalysts

- Approval for Zalviso on July 27^th

- First analyst day in early fall 2014

- Latin American distribution agreement for Zalviso (likely with an upfront payment)

- Pricing study and guidelines (early fall)

- P&T Committee approvals at leading hospitals (throughout the fall and early winter)

- First sales of Zalviso (Q1 2015)

- Approval for Zalviso in Europe in Summer 2015

- Phase III data on ARX-04 in H2 2015

Risks

Receiving A Complete Response Letter (“CRL”) On July 27^th With No Recommendation Of Actions - A complete response letter stating Zalviso is not approved and with no recommendation of actions for approval is the worst case scenario, but a scenario with almost no chance of happening in our view. The most likely reason for this would be that the FDA uses the Zalviso NDA as the driver for reviewing all opioid compounds. This seems unlikely because (i) the FDA has become incrementally more comfortable with opioids given the recent fast-track approval of a take home opioid antagonist called Evzio, an auto-injectable device containing a single dose of naloxone (decreases chances of an overdoese), (ii) the fact that Zalviso is strictly for the acute-care setting which is significantly more secure than opioids used outside the hospital setting, and (iii) the significant issues with the current standard of care with IV PCA, which would only allow the continuation of less safe opioid treatments to continue and further accidental deaths.

- Of the many possible reasons for an NDA to receive a CRL over the last 5 years, the two most common reasons cited for receiving a CRL (there can be more than one reason often times) are roughly 50% of due to deficiencies in chemistry, manufacturing and controls (“CMC”) and 50% due to deficiencies in labeling. While ACRX management had not indicated an issue with either of these, there clearly can be no certainty that the FDA doesn’t find issues that cannot be addressed simply with a three month extension.

- However, since Sufentanil has been around forever and is the safest major opioid and that it will be manufactured by Mallincrkodt, CDER is unlikely to have issue approving Zalviso. On the other side of the FDA review process, CDRH, the threshold for approving a Class II device is very low. Between 1999 and 2010, the average annual 510(k) approvals for Class II devices had been approximately 3,200. Yes, that’s in the thousands of approvals per year. 510(k) is not an NDA, BLA or PMA where there are only a handful of approvals and with very high rates of non-approval. The Class II devices that are turned down tend to also be due to a shody application.

Receiving A Complete Response Letter On July 27^th With Recommendation Of Actions - A complete response letter stating inadequate data and allowing for eventual resubmission, resulting in ACRX needing to fund an incremental study to provide more information on particular points that the FDA is concerned about. This likely means 12 months before another PDUFA date and possibly requires, but still probably doesn’t result in additional capital being raised. On average, a CRL with recommended actions will delay a product’s market entry for 14 months. However, there are situations historically where a relatively benign CRL, such as with Navidea’s drug Lymphoseek, can be much faster:

Navidea Timeline

- Aug 10, 2012 - Navidea Biopharmaceuticals filed NDA for Lymphoseek injection;

- Sep 10, 2012 - FDA issued a CRL citing labeling and facility deficiencies, and requested safety data;

- Oct 30, 2012 - The company resolved all the issues raised in the CRL and resubmitted the NDA;

- Mar 13, 2013 - FDA granted approval to Lymphoseek.

Cowen Research Report Which States Post Approval Returns 21% Negative For Biotechs – The basic claim that the Cowen biotech team makes is that looking over a large number of material PDUFA dates, the average small biotech trades up 84% in the year before, which sets up for a 21% average loss post PDUFA as commercialization starts up. In Barrons, this Cowen analyst even mentioned AcelRx as a company that would trade lower. Why he states this is a mystery for most investors, as ACRX has actually traded down 20% over the past 12 months, so AcelRx simply doesn’t fit the massively oversimplified trading pattern. Also, a good deal of the stocks in the Cowen research had to raise capital post PDUFA to commercialize their product. Again, ACRX could carry the full salesforce for 6 quarters with zero revenue coming in, so a capital raise and big dilution to valuation is exceedingly unlikely for ACRX so long Zalviso is approved. This is a just a weak analysis on part of a small firm trying to get noticed, with no substantive backup to their claims. Its important to note that even Cowen thinks there is a very high probability of approval for Zalviso.

IV PCA Has Been Around For Decades, So Docs Won’t Switch – This is the other most commonly cited bear argument, next to the Cowen study. The problem with this is that IV PCA morphine is not a great product and that it accidently kills people all the time (eg broken pump, nurse error in programming). First, directly relating to this incumbency issue is that Sufentanil has also been around for decades and many docs also prescribe it. In China, it’s the main analgesic. Second, Sufentanil has shown for decades to be faster and longer lasting than morphine, so it’s far more efficacious. It historically has been hard to administer given how peaky it is, but Zalviso fixes that and allows for the fast acting relief which morphine is not able to provide given that it is only water soluble. Third, Zalviso has far fewer adverse events and those events are far less serious. In a comparator phase III study against IV PCA morphine, Zalviso had 30% less patients with oxygen desaturation of < 95%. Fourth, the amount of nurse time required to administer an IV PCA pump is significant. It requires two nurses to program the pump in the attempt to avoid programming errors and it constantly has alarms going off, requiring further nurse time. Finally, in AcelRx’s hospital survey to determine penetration speed and market share, even the most doubtful subgroup (representing 19% of the total) stated that Zalviso on average could achieve a 29% market share and these specialists would test it for 7.4 months, while the eager users (representing 21% of the total) stated that Zalviso on average could achieve a 47% market share and they would test it for 3 months. Obviously, even the low end of market share is multiples higher than our Base Case. Altogether, while there are going to be some docs that refuse to change, the efficacy, safety and total cost data are overwhelmingly in favor of Zalviso and that will result in substantial market share gains over time and our checks with doctors would substantiate that point as well.

- Using The Low End Share From The ACRX Leads To Significant Upside - 29% Market share in Year 5 for Zalviso would result in a fair value today on a 15% discount rate and 10x forward FCF multiple of $37.71/share.

FDA Extends The PDUFA Date - The FDA states that they need more time to review the data and application and require an additional three months. It is wholly possible the stock trades up on this news, as it usually indicates the FDA will ultimately approve a drug, but there are other occasions where a 3 month delay leads to a selloff in a stock. The only reason for ACRX to potentially selloff on the news of an extension is if the Company in its press release states the reason for the extension is something very negative, like the FDA has “serious” concerns around the efficacy data in the comparative phase III study.

Commercialization Is Perceived To Undershoot Expectations – Bears will point out that being short small company commercial launches for hospital drugs has been an attractive strategy. However, the pain launches by Pacira and Cadence have both gone very well. While they were good shorts for a period of time post PDUFA (Pacira due to needing to raise substantial capital and Cadence due to ligation around the validity of their patents) both of them were highly successful in launching their products and growing sales. The fact that ACRX will have sales reps from both companies to aid in the Company’s launch of Zalviso will only make this risk decrease in probability.

Greater Than Anticipated Competition – Bears on ACRX would state that much greater cannibalization of IV PCA by Pacira’s injectable local analgesic called Exparel, will result in the total addressable market size for Zalviso to be smaller than expected. Additionally, down the road one of several experimental pain treatments could be approved and experience fast adoption, cutting into Zalviso’s market penetration as well. However, given penetration expectations by the sellside are exceedingly low to begin with and already don’t include Europe which is an even bigger market than the US, there is little chance that the Zalviso commercial launch will underwhelm, even with the bears being partially correct on a shrinking size of IV PCA. Furthermore, Pacira does not even state that Exparel eliminates the use of opioids in patients, it just minimizes the use in certain circumstances.

- Pain Is Complex And Needs To Be Treated With Multiple Drugs - At least ten independent neurobiological mechanisms may initiate or sustain pain. Each mechanism involves many targets, some unique, some shared. That is why pain specialists have come to determine that pain must be treated with a multi-modal regime of drugs that complement each other. This is why the majority of patients with moderate-to-severe pain are provided more than one analgesic.

One scientific paper abstract sums up the situation very well and why more and more, multiple pain drugs will be utilized: “Persistent postoperative pain can cause long-term disability. It is the result of complex neurohormonal effects that can be prevented using preemptive analgesic therapy. Multimodal pain therapy can result in additive or synergistic analgesic effects and minimize adverse drug effects. Limitations of systemic opioid analgesics given by patient-controlled analgesia include adverse effects, a short duration of action, and nocturnal hypoxemia. Limitations of local anesthetics include unwanted motor blockade, which can interfere with postoperative mobilization and rehabilitation efforts. Inadvertent administration of analgesics into subarachnoid, subdural, or vascular spaces is a potential problem with the epidural route. Use of this route may be limited by the perioperative use of prophylactic anticoagulation.” So if you believe this, it basically states that the best means of treating most postoperative pain is through the use of several different pain control medications acting together. Zalviso will gain share, the question is how much and how fast.

Non-approval in Europe - Though this seems highly unlikely as the bar for approval in Europe is even lower as the approval will focus more squarely on the drug component of Zalviso, Sufentanil, which is also a well-established generic in Europe. This is why Grunenthal felt very comfortable making a $30 million upfront payment to gain exclusivity for the European distribution rights and was willing to put in another $5 million for just filing the application for Zalviso in the EU.

We currently own stock in AcelRx, along with certain friends, advisors, affiliates and peers and actively trade the stock and the corresponding options. This is a very fluid situation and one needs to do significant amounts of their own due diligence before they either buy or short ACRX.

(note: multiples in the box at top of page above the write up reference 2016 and 2017 respectively, not 2014 and 2015).

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Approval for Zalviso on July 27^th.
First analyst day in early fall 2014
Latin American distribution agreement for Zalviso (likely with an upfront payment)
Pricing study and guidelines (early fall)
P&T Committee approvals at leading hospitals (throughout the fall and early winter)
First sales of Zalviso (Q1 2015)
Approval for Zalviso in Europe in Summer 2015
Phase III data on ARX-04 in H2 2015

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			2014	2015
Price:	10.04	EPS	$1.21	$3.21
Shares Out. (in M):	44	P/E	7.6x	3.1x
Market Cap (in $M):	437	P/FCF	5.9x	2.5x
Net Debt (in $M):	-78	EBIT	58	140
TEV (in $M):	358	TEV/EBIT	6.2x	2.6x