Numinus Wellness: Sector Consolidation Underway (TSX:NUMI:CA)

Introduction

It’s still very early days for the psychedelics sector and so it should come as no surprise that a lot has changed since my first note on Numinus Wellness (TSX:NUMI:CA) in February 2022. News at the sector level has flowed thick and fast over recent months, and it hasn’t been a quiet period for Numinus either. In this note I’ll highlight recent interesting sector level updates and take a fresh look at the investment case for Numinus.

Sector News

My main focus in the psychedelics space is on psychedelic-assisted therapy ‘PAT’. I have less interest in organizations that are solely or primarily working on drug development /discovery; these entities are best regarded as bio-tech stocks.

Compass Pathways (CMPS) has a foot in both camps (therapy and also drug development/discovery). Compass is seeking to establish a new, patent-protected model of psilocybin-based therapy, utilizing their own proprietary formulation of synthetic psilocybin, COMP360. CMPS is arguably the leading listed player in terms of the race to obtain regulatory approval for PAT. On 12 October 2022, CMPS announced the launch of Phase 3 trials applying COMP360 psilocybin therapy to treatment resistant depression ‘TRD’. The company says that this will be the first Phase 3 trial for psilocybin-based PAT globally. The announcement represents a big and very important step for the psychedelics sector. The trial is expected to commence before the end of 2022 but investors will need to remain patient, as trial outcome data will not be available until mid-2025. Assuming that the trial is successful (which is far from certain), a best-case scenario for regulatory approval would be at some point in 2026. There are genuine question marks regarding the validity and ethics of certain aspects of the patent-driven strategy that CMPS is employing but I think that investors interested in the psychedelics sector will benefit from keeping a close eye on this stock.

The initial market excitement and hype regarding psychedelics resulted in a number of low-quality companies being able to attract capital. The combination of a long and uncertain timeframe for revenue generation with ongoing cash burn meant that the likelihood of early stage company failures was high. This ‘thinning out’ effect is already playing out, both in the listed and unlisted space and we are starting to see consolidation.

A couple of recent cases serve as examples of what is sure to be an ongoing sector theme. As recently as January 2022, VC-backed Eleusius Holdings was talking about a public listing, however it appears that an inability to raise capital has forced the company to seek a buy-out, with Beckley Psytech likely to step-up and add the operation to its portfolio. In late September, listed HAVN Life Sciences announced that it was “no longer a going concern”; US institutional investors who coughed up CA$2m in March 2022 must be feeling rather bruised.

The cases referenced above serve as examples of the point made in my initial note on Numinus, which continues to be relevant: ‘prudent investors should be mindful that as things stand today, all stocks in the psychedelics space should be considered high risk propositions’.

Broadly speaking, sector consolidation ought to be positive for the stronger players – such as Numinus – in the psychedelics space. However, it’s not all good news – for the Numinus Bioscience division, sector consolidation has effectively shut down external revenue generation due to a contraction in demand for laboratory analytics. Numinus Bioscience generated only CA$10,000 of revenue in 3Q22 (2Q22 CA$105,966) and we should not expect to see further laboratory related revenue until the industry demand profile recovers.

Given sector consolidation, the decreasing corporate client base for psychedelic substance analytical services and limited revenue generating opportunities, Numinus Bioscience intends to focus purely on proprietary research activities for the foreseeable future. The divisions’ analytical testing capabilities remain available for proprietary and on-request basis. The Company, however, has eliminated its business development/sales activities for these services to reduce expenses in this period of sector dislocation.

Source: Numinus 3Q22 MDA, page 5.

Numinus Acquires Novamind

In April 2022, Numinus made its own contribution to sector consolidation, announcing the acquisition of CSE-listed Novamind Inc. for a price tag of ~CA$26m. Numinus was attracted by Novamind’s US platform of eight established clinics (across Arizona and Utah) and complimentary clinical research facilities. The deal completed on 10 June 2022, creating a significantly expanded group – comprising thirteen operating clinics, four clinical research sites, and a psychedelics research laboratory. Cost synergies of CA$3m pa contribute positively and are expected to bring forward the timing of Numinus achieving profitability. In the 2Q22 results Q&A session, CFO John Fong referred to profitability being reached within 2-3 years of post-deal completion.

As a consequence of the acquisition, Numinus prudently applied the brakes to its previous plan to organically expand clinic outlets. In a sector with such a heavy focus on growth, it was comforting to hear a willingness to step away from the prior expansion plans in order to concentrate on a successful integration process. As well as expanding the group’s footprint and patient reach, Novamind brings some new capabilities to Numinus, including TMS (transcranial magnetic stimulation) and the ability to provide drug developers with contract research site management services.

In the market release announcing the Novamind deal completion, Numinus delivered some negative news regarding Chief Medical Officer, Dr. Evan Wood:

As a result of the increased medical and research expertise added to Numinus’ expanded executive team, Dr. Evan Wood, Chief Medical Officer, will now be able to continue in his role in a reduced capacity, in order to enable him to maintain his important advocacy, clinical and teaching work. Dr. Wood remains committed to Numinus over the long term and will continue as the Company’s Chief Medical Officer through the integration of Novamind, though with reduced office hours.

Source: Numinus news release 10 June 2022.

Reading between the lines, it appears that this is the first stage of Dr. Wood’s eventual departure from the operating business. Given Dr. Wood’s impressive credentials, this is a blow for Numinus. I am assuming that Dr. Wood will continue to be linked with Numinus, perhaps joining one of the group’s advisory boards. Concern regarding the loss of Dr. Wood is eased somewhat by the arrival of Novamind’s Dr. Reid Robison, adjunct professor at both the University of Utah and Brigham Young University. Dr. Robison has an extensive background in psychedelic related research and practice; he will take the role of Chief Clinical Officer at Numinus. I have listened to several interviews/podcasts with Dr. Robison and he strikes me as highly competent. Novamind’s Dr. Paul Thielking has been appointed as Chief Science Officer and he also adds positively to the team’s bench strength, particularly on the ketamine-assisted therapy side.

Downside Protection

The presentation pack for the Novamind acquisition states that the deal positions Numinus to be the “top revenue producing psychedelics company”. In contrast to most companies in the psychedelics space, Numinus is actually already generating revenue; as at the deal completion date, the pro-forma annual revenue generation of the combined group was CA$11.9m (the majority of which comes from Novamind). It is unlikely that much of this CA$11.9m relates directly to psychedelics (even throwing ketamine-assisted therapy into the psychedelics bucket) given that Numinus clinics also offer a range of traditional non-psychedelic mental health treatments; I therefore feel that there is an element of poetic license in the claim to be the top revenue producing psychedelics company – even though it may be technically true.

In terms of the investment case for Numinus, the fact that the group is generating revenue from the provision of non-psychedelic mental health services is a clear positive. Such services include: traditional talk therapy, group therapies, couple therapies, TMS and neurological care. I note that (according to the 2Q22 management speech) neurology-focused services are high margin and that the group’s Neurology Centre of Toronto is often fully booked.

The path to regulatory approval of PAT is extremely uncertain; current expectations of 2024 for MDMA-based treatments and 2026 for psilocybin-based treatments appear achievable but these timeframes could easily be extended. Companies in the psychedelics sector that lack the ability to generate revenue from non-psychedelic services are much more sensitive to delays in the regulatory approval process than Numinus. Taking this a step further, if regulators ultimately decide to deny regulatory approval for PAT, most companies in the psychedelics sector will fail, whereas Numinus appears to have a genuine chance of sustaining its operations.

Drug Discovery/Development

In my view, the investment appeal of Numinus relates to its strategy around delivering PAT and other mental health and wellbeing services. However, via Numinus Bioscience, the company is also active in drug discovery/development – an aspect that may appeal more to bio-tech investors. Let’s take a quick look at recent news from Numinus on this front.

In 2Q22, Numinus announced that Numinus Bioscience had discovered an additional drug product candidate, referred to as NBIO-03, and stated an intention to include NBIO-03 in the Phase 1 clinical trial alongside its other product candidate, NBIO-01. That sounded positive, however things quickly changed, and by 3Q22 the clinical trials had been postponed:

The Company is focusing on accelerating its timeline to profitability and will postpone its clinical trials of NBIO-01 and NBIO-03, given the high cost of clinical trials. Once the Company can observe a clear direction to regulatory approvals or has achieved profitability, the clinical trials for these drug candidates will commence.

Source: Numinus 3Q22 MDA, page 5.

This rapid turnaround highlights the need for investors to temper enthusiasm when reviewing announcements regarding new drug candidates.

On 22 June 2022, Numinus announced that Numinus Bioscience had filed a patent application with the World Intellectual Property Organization (WIPO) “for a rapid production process for Psilocybe and other fungi species containing psilocybin and other compounds”. The filing represents an international extension of an earlier June 2021 filing for US patent protection. It remains uncertain as to whether or not the patents will be granted. Further, if the patent applications are successful, a follow-on consideration would be around the financial materiality of having a slightly faster fungi production process.

On 05 October 2022, Numinus announced that Numinus Bioscience has developed a psilocybin-containing tea bag. This novel delivery system is currently intended for use in clinical research and could eventually be used in PAT settings. Numinus is seeking approval from Health Canada for the new tea bag to be included on the psilocybin supplier list for the federal Special Access Program. Delivery of psilocybin in this format has advantages for certain patients who have serious health conditions that prevent them from comfortably taking pills or consuming whole mushrooms. Numinus state that the product will be fully standardized (to deliver 25mg per dose) and that they have control over the entire tea bag production process – from growth of the basic Psilocybe cubensis ingredient, through to finished product manufacturing.

Whilst the psilocybin-containing tea bag is a positive and interesting development, I am doubtful that this is particularly significant in terms of investment value. Mushroom production is a relatively simple and low-cost activity, and the same can be said for tea bag manufacturing. Without patent protection – which appears extremely unlikely – I see limited opportunity for strong cash flow generation from the product.

Cash Burn

My previous Numinus Seeking Alpha note stated that coming up with a fundamental valuation for psychedelics stocks is total guesswork; as yet I see no reason to budge from that position given the high degree of uncertainty the sector faces (please feel free to comment below if you disagree – I am open to consider sensible valuation metrics). In the absence of a reliable valuation framework, the key investment issue for me with Numinus and other psychedelics stocks is whether the company can stay afloat long enough for PAT to receive regulatory approval, and in doing so, to also avoid shareholders running the risk of massive dilution from multiple discounted capital raisings.

As at 31 May 2022 (3Q22), Numinus had cash and equivalents of almost CA$41.8m. Operating cash flow for 1Q22 was -CA$5.15m with a similarly negative outcome in 2Q22. Operating cash flow losses increased materially to be -CA$6.1m in 3Q22. In my previous review I assumed that Numinus would want to keep a minimum cash balance of CA$20m to support future growth. Given the Novamind acquisition, it is logical to assume that the minimum cash balance will have increased – I will work with CA$25m. Assuming a quarterly operating cash flow of -$6.1m, Numinus only has sufficient cash to last until early 2023 before breaching the CA$25m level. If management are willing to run cash down to say ~CA$10m, then Numinus probably has sufficient balance sheet cash to last until late 2023. The Novamind acquisition brings in a small amount of additional balance sheet cash, but also brings Novamind’s cash burn effect (albeit partly offset by deal-related cost synergies).

In the 3Q22 results management speech, CEO Payton Nyquvest stated that the company had sufficient cash for “approximately two years”. I struggle to see the company making it through to 31 May 2024 without raising equity and suggest that investors take the CEO’s statement with a healthy pinch of salt.

The combination of an increased level of cash burn and a significantly weaker share price has increased the risk of material dilution for shareholders relative to my February 2022 Numinus review.

Conclusion

I remain hopeful that some form of PAT will eventually make it to market. Reducing human suffering and promoting wellbeing feels like something that deserves a positivity bias. However, when it comes to investing, it’s important to maintain a balanced view. Psychedelics are not miracle drugs and whilst evidence regarding the effectiveness of PAT to treat certain mental health conditions continues to build, there is still a lot of hype and over-stretch regarding the future potential for the sector. I recommend this August 2022 article from Wired as something of a reality check.

Interestingly, the Wired article provides support to my view that the assisted therapy aspect of PAT is where the real human benefit and value exists. It strikes me that the extensive therapeutic preparation and post-trip integration sessions are powerful tools for tackling conditions such as PTSD and depression. Numinus, for the most part, is focused on this vital assisted therapy aspect of the psychedelics space.

The stock’s low share price and increased rate of cash burn is concerning in regard to dilution risk. Taking a more positive view, Numinus is still sitting on a healthy cash balance and the company may be able to deploy this cash to acquire less well-funded groups that are forced to put themselves up for sale due to an inability to access capital funding in the current environment.

In February 2022 I landed at a ‘sticking-my-neck out’ HOLD rating for Numinus. For this review, I’m going to land at an oxymoronic rating of speculative HOLD. Picking winners (and it is possible that there may ultimately be none) in the psychedelics sector isn’t easy and I recommend that investors interested in this theme spread their bets over the better quality options – which would include Numinus.