Here is the latest RBS analyst report on Chemgenex:ChemGenex...

Here is the latest RBS analyst report on Chemgenex:


ChemGenex Pharma
Target in sights

Cephalon Inc will provide CXS with up to A$15m in convertible note financing,
which if converted will give it a 9.6% stake. Separately, Cephalon has also
entered into an option agreement with two of CXS' major shareholders to acquire
a further 19.9% of stock. Removal of funding risk is positive. Back to Buy.

Funding risk removed as Cephalon Inc takes a strategic stake

In a surprise announcement, CXS has entered into an arrangement with Cephalon Inc
(CEPH:US, Nasdaq) which alleviates the short-term funding position that had been weighing
on the stock in recent times. Cephalon will provide CXS with A$15m (in two tranches) of
financing via a convertible note, which if converted, will give Cephalon an approximate 9.6%
stake in CXS. Separately, Cephalon has also entered into an option agreement with two of
CXS? largest shareholders, Stragen International NV and Merck Sant? SAS, to acquire an
additional 19.9% stake in CXS, at an exercise price of A$0.70 (details overleaf). In our view,
the removal of the short-term funding risk is positive for CXS, as is the interest of Cephalon
Inc. We now highlight the possibility that Cephalon is lining CXS up for a potential
acquisition. CXS concluded FY10 with A$12.8m in cash, which was sufficient until 1HCY11.

Key catalyst to watch
Major catalyst: EU approval, forecast for early CY11 and triggers a milestone payment from
Hospira Inc (RBSMe: US$15m). Any delay is a short-term risk, in our view.

Upgrade to Buy (from Hold) and A$0.70 target price
We have adjusted our forecasts, with changes detailed overleaf. Our DCF-based valuation
has fallen to A$1.44 (from A$1.46). We set our target price at A$0.70 (was A$0.45) ? at the
anticipated exercise price of the option ? and upgrade our recommendation to Buy (from
Hold). The key reason for this change of view is the removal of short-term funding risk and
the potential for corporate activity from Cephalon Inc. We see limited downside at the current
share price and believe the potential for Cephalon to acquire CXS for 70cps (A$219.3m
equity value) creates an opportunity for investors with a more aggressive risk appetite. We
think it is important to note, that while this presents an attractive outcome for shareholders
buying the stock today (potential c.30% gain), over the medium term, unless CXS is able to
secure a competitive bidder for the business, the upside may well have been capped.

Funding risk removed
CXS has finalised a convertible note subscription agreement with Cephalon (through its whollyowned
subsidiary Cephalon International Holdings, Inc.) under which Cephalon has agreed to
subscribe for up to A$15m of convertible notes. The notes are convertible at A$0.50 per share,
which when announced, represented a premium of 13% to the volume weighted average price of
CXS shares for the one month period to 15 October 2010. Shareholder approval is required.
Furthermore, Cephalon has separately entered into option agreements with two of CXS? major
shareholders, Stragen International NV and Merck Sant? SAS Under the option agreements,
Cephalon has the right to acquire up to 19.9% of their CXS shares. The key points are
summarised below.

Convertible notes
 The convertible notes facility comprises up to A$15m in two separate tranches; A$10m will be
drawn down immediately and a further A$5m can be drawn down on shareholder approval. If
shareholder approval is not obtained, Cephalon may redeem the notes.
 The convertible notes will bear interest at 10% per annum. If shareholder approval is obtained
by 31 December 2010, no interest will be payable on the notes. There are no fees associated
with the notes.
 As flagged in our research note, A mixed bag, published 8 October 2010, the US Food and
Drug Administration (FDA) has agreed that no further clinical trials are required to complete
the New Drug Application (NDA) submission for Omapro as a treatment for CML patients who
have failed two or more tyrosine kinase inhibitors (TKI). However, the FDA has advised CXS
that further data needs to be gathered from participating clinical centres, as part of the
submission. As part of the arrangement with Cephalon, if the data collection and analysis is
completed by 31 March 2011, Cepahlon will waive a charge it has taken over the assets of
CXS as security for its performance of CXS? obligations under the notes.
 We also note that Cephalon will be entitled to redeem the notes if the patient data collection
and analysis process is not completed in accordance with the pre-agreed milestone relating to
this data collection. We understand that these milestones relate to the mechanical elements of
collecting and analysing the data and not the interpretation or quality of the data.
 CXS expects the notes will be converted into ordinary shares in 1QCY11, post shareholder
approval. Each of Alta Partners, Stragen, Merck and GBS Venture Partners (which as of 22
October 2010 hold in aggregate a total of 44.4% of CXS shares) has indicated that it supports
the issue of convertible notes.
 Use of funds: CXS will use funding provided under the convertible notes to fund the operations
of the company into the next financial year, including its collection and analysis of patient data
which is necessary to progress the planned NDA submission to the FDA.

Option Agreement
 The options give Cephalon an immediate ?relevant interest? under the Corporations Act of
19.9% of CXS shares, notwithstanding that they may not be exercised. Accordingly, CXS will
seek shareholder approval to allow Cephalon to increase its relevant interest above 20% via
the conversion of the convertible notes.
 The options are exercisable by Cephalon at any time before the later of 31 March 2011 and
one week after the completion of the above-mentioned data collection and analysis.
 The option exercise price is A$0.70 per share.
 It should be noted, that Cephalon has not indicated an intention to exercise its options at this
point. Whether or not Cephalon exercises the options depends on the progress of the patient
data collection and analysis process which is necessary to progress the planned NDA
submission to the US FDA.
 Stragen and Merck have received no fee or other consideration from Cephalon for the grant of
these options, apart from an undertaking to pay an option fee of A$10.00.

RBS Morgans viewpoint
In our view, the arrangement with Cephalon overcomes the short-term funding concerns which
had been weighing on the stock. Assuming the collection and analysis of patient data proceeds as
planned and the NDA submission is made to the FDA, then one would think that Cephalon would
look favourably upon exercising its option to acquire an additional 19.9%, raising the possibility
that it will also ultimately acquire the company. Following a number of setbacks for CXS this year,
most notably the unfavourable outcome of the original NDA filing to the FDA (see our research
Out of left field published 23 March 2010), and the recent funding concerns weighing on the stock,
we view this as a positive outcome.
For new investors, the possibility that Cephalon Inc will acquire CXS, if it exercises its option
agreement, presents an opportunity, albeit, not without risk.
The next major catalyst for CXS is EU approval, forecast for 1QCY11 and will trigger a milestone
payment from Hospira Inc (we forecast US$15m). The timing of approvals from regulators is
difficult to predict and delays are common. Any delay in meeting this target increases the
importance of the relationship with Cephalon.

About Cephalon Inc
Cephalon Inc. is an international biopharmaceutical company engaged in the discovery,
development and commercialisation of products in four core therapeutic areas: central nervous
system (CNS), pain, oncology and inflammatory disease. In addition to conducting an active
research and development programme, it markets seven products in the United States and
numerous products in various countries throughout Europe and the world. Its principal product are
its wakefulness products, PROVIGIL (modafinil) Tablets [C-IV] and NUVIGIL (armodafinil) Tablets
[C-IV], which comprised 51% of its total consolidated net sales during the year-ended December
2009. During 2009, Cephalon acquired an exclusive, worldwide licence to the ImmuPharma
investigational compound, LUPUZOR, which is in Phase IIb development for the treatment of
systemic lupus erythematosus. In August 2009, Cephalon acquired Arana Therapeutics Limited.
In April 2010, the company acquired Mepha, a pharmaceutical company. (Source: Thomson
Reuters consensus estimates)

Investment view
We have adjusted our forecasts, with changes detailed below. As a result, our DCF-based
valuation has fallen to A$1.44 (from A$1.46). We set our target price at A$0.70, in-line with the
Cephalon ? Merck/Stragen option agreement (was A$0.45) and upgrade our recommendation to
Buy (from Hold). The key reason for this change of view is the removal of short-term funding risk
and the potential for corporate activity from Cephalon Inc. We see limited downside at the current
share price and believe the potential for Cephalon to acquire CXS for at least 70cps (A$219.3m
diluted equity value) creates an opportunity for investors with a more aggressive risk appetite. We
think it is important to note, that while this presents an attractive outcome for shareholders buying
the stock today (potential c.30% gain), over the medium term, unless CXS is able to secure a
competitive bidder for the business, the upside may well have been capped.

Downside risks include:
 Any delays in collecting the patient data required before CXS can file its new NDA with the
FDA, as well as any unexpected outcomes from the data analysis.
 Cephalon choosing not to exercise its option or any conditions surrounding the convertible
notes not being met.
 Any delay in the EU regulatory review process.