We are initiating coverage of DARA BioSciences (DARA) with an Outperform rating and price target of $1.60 per share. We believe that DARA is poised to deliver meaningful news flow on the pipeline over the next several quarters — something the company has been lacking over the past year due to funding constraints.

DARA has been slowly rebuilding its business over the past two years following the failure and discontinuation of phase III advanced non-small cell lung cancer drug talabostat in mid-2007. Headcount is down to only 5 employees, and the company has spent the last year rebuilding the Board and refocusing the pipeline. Meanwhile, the stock languished in 2008 with little to no clinical news flow.

Richard Franco rejoined the company as CEO and Chairman in January 2009. He had two key objectives for 2009: secure funding for future operations and advance the pipeline forward. Over the last quarter the company has secured just shy of $5.0 million through private placements and secondary offerings, and in May 2009 phase II neuropathic pain candidate, KRN5500, offered up some very encouraging data.

It has been a successful past several months, and we think the steady news flow should continue into 2010. Besides KRN5500, DARA possess several interesting preclinical candidates, with DB959, a unique first-in-class dual peroxisome proliferator-activated receptor (PPAR) delta / gamma agonist with potential activity in controlling blood sugar levels, cholesterol and triglycerides.

In our view, the company teetering on the brink of bankruptcy throughout 2008 and early in 2009 has created an attractive opportunity now that we can finally see the light at the end of the tunnel. The valuation is extremely attractive, the financial position has significantly improved, and clinical milestones are now squarely in-sight. The intellectual property is also strong, with the rights to 70 patents and 59 pending applications worldwide.

The stock is well-supported at this level and we believe has meaningful upside over the next year as the early-stage pipeline begins to reach monetization points. DARA’s goal is to take its clinical candidates through proof-of-concept and then partner for upfront cash and backend milestone and royalty consideration.

The company possesses an enormous preclinical library with candidates for potential metabolic and inflammatory conditions, and we believe that as the most advanced candidates in KRN5500 and DB959 are monetized, new preclinical candidates can be brought to proof-of-concept for the next wave of licensing.  It’s a turnaround story with significant legs, in our view. We encourage investors to take a look at the stock at this level.

Target is $1.60

Based on our analysis of the pipeline, we see DARA fairly valued at $1.60 per share. Our assumptions assume that DARA takes both KRN5500 and DB959 through phase IIb proof-of-concept and then out-licenses to a mid- to large-cap pharmaceutical company. Post-phase II products have been commanding upfront payments in the area of $25 million, followed by NDA filing and approval milestones north of $50 million, with another potential $200 – 300 million in backend sales related milestones and royalties in the mid-teens.

CIPN candidate KRN5500 should be ready for a partnership post-phase IIb, around the middle of 2010. Potential blockbuster type-2 diabetes candidate, DB959, is roughly one year behind, meaning that another lucrative partnership could follow in 2011.

Plus, DARA is sitting with an estimated $4.5 million in cash on hand as of October 2009. And we expect the company will secure some additional funding to push forward with KRN5500 in the next few months.

The company is currently trading at only 47 cents per share. KRN5500 alone is worth more than the entire market value, in our view. DB959 and several interesting preclinical candidates for metabolic and inflammatory disease round-out an impressive pipeline from which DARA should be able to extract value over the next several years. Upside is significant for this under-followed / under-valued story.
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