Time to Leverage Up: The Nexalis (ASX: NX1) Story

Retail investors don’t like to see debt in a company.

Particularly, early-stage biotech companies that are not generating any cash flow.

For better or worse, the old “convertible note” can be a death spiral, where it's a pattern of…

Convert. 20% discount. Sell. Repeat.

But this really depends on whether the note is in the hands of a friendly shareholder (such as a director) or a professional debt-financing company.

But not all debt is bad.

And there is one company on the ASX that has structured its company almost entirely with debt.

Not like the sharky convertible debt that you usually see.

But this is more like debt as leverage…

Specifically to run a clinical trial.

The company I’m talking about, the next in my Biotech 165 Challenge, is Nexalis Therapeutics (ASX: NX1), formerly known as InhaleRx (ASX: IRX).

It has a market cap of just ~$5M, but $52.3M in a debt facility.

This debt has only just been drawn, and is in place to fund a Phase 2 clinical trial for a THC-based pain medication.

The company also has two other programs (also funded by the debt), one for panic disorder (immediate pain relief), and a third oral ketamine-based product.

So that’s three programs.

Fully funded.

But all with debt.

Just like a mortgage on a house… if that house were a clinical trial.

It is, genuinely, one of the more interesting structures I've looked at on the ASX.

Let’s dive in.

Nexalis Therapeutics (ASX: NX1) is a clinical-stage drug development company with three key programs:

All three programs funded.

All with debt.

The debt facility can be drawn and disbursed only for expenses incurred on clinical trials.

So, NX1 does need capital for operational overheads…

But everything related to the trial (the most expensive part of running the business) is covered.

So what does a leveraged clinical trial actually look like?

Right now, NX1 has a market cap of ~$5M, and ~$50M in debt. 

What that really means is that the equity is highly leveraged to the clinical trial's outcome.

The concept of leverage means borrowing money to achieve an outsized return on a positive outcome with limited capital input.

Just like a mortgage on a house.

Take a simple (and completely hypothetical) scenario. 

Say NX1 delivers strong Phase 2 results and gets acquired for $100M. 

(Pick whatever number you want - the maths works the same way).

In that outcome, the debt gets paid first. 

Which means ~$50M to pay off the debt, and the remaining $50M flows to equity. 

In other words, you’ve turned $5M in equity into $50M. Roughly a 10x return.

(In reality, the loan balance won’t be exactly $50M. Slightly higher from 15% interest compounding monthly, and offset by 43% from the R&D tax rebate. 

But ignoring these nuances for the moment…)

It’s the same basic dynamic you see in housing. 

If a $1M house doubles to $2M, but you only put down $100K, then your equity has effectively increased tenfold. Leverage amplifies the outcome.

That’s the core idea here. 

Now, these numbers are incredibly rough and are just for illustrative purposes; don’t rely on them to make any decisions.

But it does illustrate how leverage can increase equity in the upside case.

The leveraged bet.

Because debt ranks ahead in the capital structure, small changes in total enterprise value can translate into very large changes in equity value.

Of course, this clean math only holds if nothing else changes along the way. 

In reality, the company still needs to pay for the salaries and ASX fees. None of that is covered by the facility. 

That comes out of equity raises.

So while a small equity base sitting under a large debt load can create outsized upside if things go right… 

If things go wrong, it can just as easily go to zero.

(and it's a giant risk from the debt holders because, unlike a house, there is limited underlying value for the company if the trials don’t work)

So that’s the risk/reward with the leveraged clinical trial bet.

Let’s take a look at some of the other terms of the debt, because I think they are important:

Just to double click on that last dot point (because I think it’s interesting).

The 20% options dilution has already been agreed. 

But the strategy is to price the shares high enough that the proceeds from the options are sufficient to repay the loan in full.

This is what the company said:

It’s a bold strategy, and very dependent on two things.

FIRST, the company's ability to communicate this creative capital structure to the market.

SECOND, the results of the trial.

So here's the bet… 

A sub-$6M equity stub that sits in front of a $52m secured loan, where the only way you win is if at least one clinical trial reads out well enough to rerate the share price into territory that lets warrants pay off the debt.

Free money if it works. Zero if it doesn't.

That's the nature of the bet. 

Now let's talk about the actual drugs. 

Because the structure of the bet doesn't matter if the drugs don't work.

Nexalis has two inhaled cannabis programs, both using the same pressurised metered-dose inhaler (pMDI) platform, the Medihale device, with different active ingredients.

Breakthrough cancer pain is the nasty, acute pain spike that hits cancer patients who are already on around-the-clock opioid therapy. 

It comes fast, it peaks in minutes, and by the time a standard oral painkiller kicks in, the episode is over. You need something that works as fast as the pain arrives.

The gold standard was fentanyl sublingual spray onset of 5 minutes, approved by the FDA in 2012.

But late last year, Trump designated Fentanyl as a “weapon of mass destruction.”

This order targets trafficking, not prescription fentanyl (Subsys and the rest are still legal), but the political direction of travel is crystal clear. 

No drug developer in their right mind is launching a new fentanyl-based breakthrough cancer pain product into that environment. 

The regulatory and reputational risk is now too high.

This left a gap in the market, and there is currently no FDA-approved, non-opioid, inhaled therapy for breakthrough cancer pain on the US market.

So, if NX1 can show a product that matches or beats fentanyl on pain relief onset and duration, that is a meaningful product. 

The Phase 2 trial commenced on Monday with the first patient screened.

Part A is an open-label, 156 patients, and Part B is a double-blind, placebo-controlled trial with 78 patients.

Pain trials are notoriously difficult to demonstrate superiority over placebo (because pain, at the end of the day, is subjective). 

Just something to keep in mind.

So if it does work, big tick.

Different drug, same idea. Panic disorder is characterised by sudden, intense episodes of acute anxiety that peak within minutes. 

Racing heart, shortness of breath, imminent doom feeling. 

Currently, the standard of care is oral benzodiazepines like Xanax, which work fine but take 30+ minutes to kick in.

So if NX1’s product can work just as well, but onset much faster, that becomes interesting.

Phase 1 is a randomised, double-blind, placebo-controlled, single ascending-dose study in up to 24 healthy volunteers across three cohorts. 

Cohort 1 has completed dosing with no safety concerns, and Cohort 2 is starting soon. 

Overnight, the US Justice Department reclassified FDA-approved cannabis products to Schedule 3.

I wrote about this previously, but I said that the big winners would be companies that are actually developing cannabis as a medicine.

(Just like NX1)

Read the full take: Trump floats new cannabis rules: Weeding out the good from the bad

What this reclassification does is effectively recognise cannabis as having acceptable medical uses.

This makes cannabinoid-based medical products investible by both US institutions and Big Pharma.

Two groups that like clarity and certainty.

Accessing capital from US investors should become easier with federal support for the industry.

AND, medical cannabis developers are becoming more attractive M&A targets because acquirers now have a clearer framework for understanding the industry's guardrails.

I think that from the ASX-listed cannabis stocks, NX1 is in a very good position to take advantage of these new rules, particularly as it runs its clinical trials with an FDA approval in mind.

NX1 has an oral ketamine product for the target in treatment of treatment-resistant depression.

Another macro tailwind from the US for this one.

Trump signed an executive order accelerating the FDA review of psychedelic therapies for mental health conditions.

Treatment-resistant depression is specifically called out. 

There is actually a ketamine based product on the market.

Johnson & Johnson's Spravato (nasal spray ketamine product), the first and dominant TRD therapy.

Over 140,000 patients treated worldwide. 

US$1.4B per year.

But Spravato has a big catch: patients have to be dosed in a REMS-certified healthcare setting, monitored for two hours post-administration, because of the sedation and dissociation risk. 

List price: US$590-885 per two-dose session. Not exactly accessible.

The pitch for NX1’s product is that it uses the same active compound (esketamine) but delivers it orally.

One that patients can take at home.

No REMS requirement, no clinical supervision, no $800 bill.

The competitive landscape is, however, crowded for oral ketamine products for treatment-resistant depression:

The most advanced oral ketamine player by a long stretch is Tasman Therapeutics / Douglas Pharma with R-107, an oral extended-release racemic ketamine tablet. 

So NX1 will need to show why its product is differentiated from the rest of the market.

So it's an interesting one.

The macro tailwinds are there for the company.

But a “leveraged” clinical trial bet is just so… strange.

I have this saying…

People like to invest in what they understand. 

And this one is hard to get your head around.

While the debt structure positions the company to fund its clinical trials, investors need to be convinced that the structure works.

For those who believe in the product and the clinical trials, this is a way to leverage the bet.

Higher upside. Higher risk. 

A big thank you to CEO Darryl Davies for sharing the NX1 story with me.

See you all next week,

The Armchair Analyst.

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