April 6, 1999     RECOMMENDATION:  BUY

Megabios Corp. (Valentis, Inc.) (nasdaq: mbio)

"Merger of Megabios and GeneMedicine Creates the Leader in Plasmid-Based Gene Therapy; Initiating Coverage with BUY Recommendation"

Exchange Symbol.....................MBIO (NASDAQ)
Price of Common Stock (4/5/99)............$4.62
30-Day Average Trading Volume.............26,000
Shares Outstanding.........................22.1 mm
52-Week High/Low......................$9.25/$2.87

Address.....................863A Mitten Road
..............................Burlingame, CA  94010
Telephone............................650-697-1900
President and CEO..................Benjamin F. McGraw, III
Chief Financial Officer........Bennet L. Weintraub

Summary Investment Considerations

Following the approval of the shareholders of both Megabios and GeneMedicine on March 18, we are initiating coverage of the merged company with a BUY recommendation. The new company intends to operate under the new name of Valentis, Inc., in the near future. We believe this merger was synergistic from a number of perspectives, and the resulting company is the clear leader in plasmid-based gene therapy using lipids as the means of gene delivery. Valentis has seven potential products in Phase I/II clinical trials, and 24 therapeutic genes in research or pre-clinical development, significant collaborative partnerships with Glaxo Wellcome, Eli Lilly, Roche and DSM Biologics, a combined intellectual property portfolio that should strengthen the new company’s ability to compete in the gene therapy field, and a stronger balance sheet. Together, we feel Valentis has all the key technological components–gene delivery, gene expression and gene medicine production–to successfully develop and commercialize gene therapy and other products. We believe the company is significantly undervalued relative to comparable companies participating in the gene therapy field and are recommending purchase of the stock for those investors tolerant of the risks associated with small-cap, developmental-stage companies.

I.  Impressive Clinical Product Portfolio -- Seven Products in Clinical Trials

• Cancer Gene Medicines: Valentis has clinical trials ongoing with Interleukin-2 (IL-2), IL-2 in combination with superantigen B, and Interferon-alpha (IFN-a ) for treatment of head, neck and lung cancers. Preclinical trials are also ongoing on the BRCA1 gene to treat breast and ovarian cancer and on an IL-12 gene medicine.
• Pulmonary Gene Medicines: Valentis has two clinical trials underway currently–one to treat cystic fibrosis (CF) and one that uses the alpha-1 antitrypsin (AAT) gene that is being developed to treat AAT deficiency, a significant contributor to the development of emphysema.
• Cardiovascular: Two clinical trials are ongoing in Finland using Valentis technology to develop vascular endothelium growth factor (VEGF) gene medicines. VEGF has been shown to induce angiogenesis, and is being evaluated for use in the prevention of reclosure of vessels in patients undergoing angioplasty.

• Valentis has multiple, strong corporate partnerships to help defray the high costs of drug development and spread the risk over multiple programs in various therapeutic areas. Partners include Glaxo Wellcome, Eli Lilly, Roche and DSM Biologics, a leader in the manufacture and supply of biologics.
• We are impressed with management’s vision to leverage its expertise in gene delivery and create a company with a more general focus on biologics delivery. This should serve to broaden the Company’s technology base and product pipeline, diversify risk, and possibly shorten the timetable to product revenues (should products be acquired or licensed further along in the clinical process).

III. Compelling Valuation -- Moving Forward from a Position of Strength

• As of the date of the merger, the combined company had cash and cash equivalents of $50 million; management has expressed its goal to reduce its burn rate to under $15 million per year during 1999 as a result of the integration of the two companies.

• With several years of cash available, we believe Valentis to be in a position of great financial strength, a unique characteristic of a development-stage biotechnology company. In addition, versus its peer group, we believe Valentis to be significantly undervalued based on the breadth and depth of its product and technology portfolios.

Merger Overview & Rationale

On March 18, 1999, shareholders of Megabios Corp. ("MBIO") and GeneMedicine, Inc. ("GMED") agreed to merge the two companies. As a result of the merger, GMED shareholders received 0.571 shares of MBIO for each GMED share. MBIO issued 9.1 million new shares to GMED shareholders, and the combined company has approximately 22 million shares outstanding. We believe the merger is good for shareholders, and indicative of the type of strategically driven consolidation that has been anticipated in the biotech sector for some time.

• Complementary core technologies, and a strong intellectual property portfolio
• Improved financial resources and significant operational synergies
• Diversified clinical product program with seven products in Phase I/II trials
• Enhanced ability to attract new corporate partners to augment current alliances

The synergies between the two companies is striking–both companies are involved in plasmid-based gene therapies using proprietary cationic lipid technology, and both focus on cancer, cardiovascular disease, DNA vaccines, rheumatology, neuromuscular disorders, and pulmonary diseases. Both predecessor companies had broad intellectual property portfolios, strong balance sheets and impressive corporate collaborations. Additionally, GMED brought to the table proprietary protein- and polymer-based gene delivery technology and a patented "GeneSwitch" technology, whereby oral small molecules can be used to turn "on" and "off" the delivered genes, while MBIO brought targeted gene delivery technology for use in rheumatoid arthritis, osteoarthritis, and ischemia, as well as licensed technology for certain cardiovascular applications.

Company Description

Valentis is a leader in the development of gene-based therapeutics using proprietary gene delivery, gene expression and gene medicine production technologies. Partnered with many major global pharmaceutical companies, Valentis has seven clinical programs ongoing and a broad preclinical pipeline as well. We believe the Company’s strength lies in the breadth of its patents pertaining to cationic, or positively-charged, lipid-based gene delivery systems. These systems allow for improved gene delivery to specific tissue types, which should reduce the incidence of unwanted side effects, while allowing for the flexibility to apply the technology to a large number of therapeutically relevant genes. In addition, the Company has its GeneSwitch technology that should allow for the control of gene expression using an oral small-molecule drug. With all of these technologies, a broad clinical program and a vision to expand the Company’s portfolio through licensing and acquisition, we see Valentis as a unique investment opportunity at this time.

Gene Therapy Overview

Before we get into a detailed discussion of Valentis and its technologies, we thought it might be helpful to introduce the concept and terms used to describe gene therapy.

Put most simply, gene therapy involves the use of DNA to treat disease. DNA is made up of genes, or defined segments of DNA, that contain the code necessary for the cell to produce certain proteins. Proteins are involved in the most cellular functions–enzymes, hormones, cellular receptors and signaling molecules are all proteins. It is now well accepted that the majority of diseases have genetic bases, that is, they result from the malfunctioning of genes. What gene therapy attempts to do is introduce corrected genes into the body’s cells. This DNA can be modified to do many things, the most useful of which is the production of measurable and clinically beneficial levels of therapeutic proteins. "Gene expression" is the term most often used to describe the process by which a gene’s information is translated into a protein.

It is estimated that there are approximately 100,000 genes in the human genome. The Human Genome Project and other private ventures are attempting to fully map and sequence all of these genes and provide these sequences to the public. Although only approximately 5-10% of these genes has been fully characterized, the pace is accelerating and experts believe all the genes could be identified in the next one to three years. As these statistics imply, the number of genes currently available for use in gene therapy is limited, but should accelerate as the Human Genome Project progresses.

There are several different approached to gene therapy; each having its own advantages and disadvantages. A brief discussion of these approaches is presented below.

In-Vivo and Ex-Vivo Approaches: The in vivo, or within the body, approach involves the direct administration of genes into patients, often through injection or inhalation. There are advantages to the ease of administration, and the potential to treat both localized and widespread diseases, but the in vivo approach requires an efficient vehicle, or delivery system, to deliver the genes to the cells. The ex vivo, or outside the body, approach to gene therapy involves the extraction of cells from the body, the insertion of genes into those cells, and then the re-insertion of those cells back into the body. The advantages of this approach include the ease of targeting specific tissues types and ease of inserting DNA into the cells, while the disadvantages include the inability to treat non-localized diseases, the extra effort required to extract and process the cells and the subsequent higher associated costs.

Viral Gene Delivery Systems: Viral therapies, which may be used in vivo or ex vivo, are based on the incorporation of a therapeutic gene into a disabled virus. Once the virus is delivered to the body, it then inserts the DNA into cells. Viral therapies frequently offer the benefit of efficient delivery and expression of the therapeutic gene. This efficiency is balanced therapeutically by concerns that the virus itself, although inactivated, causes an immune response in the body and that their ability to be used repeatedly for chronic conditions could therefore be limited. Viral systems may also induce genomic disruption by virtue of their potential to be permanently integrated in the chromosomes of the cell. Issues also exist concerning the manufacture, storage and characterization of viral-based gene therapy products.

Non-Viral (Plasmid-Based) Gene-Delivery Systems -- the Valentis Approach: Non-viral systems, also known as plasmid-based systems, use DNA sequences that contain the gene of therapeutic interest along with the necessary information to provide for the controlled expression of the gene and its delivery elements. Plasmids are pieces of circular DNA that contains multiple genetic elements that direct the cell in how to handle the therapeutic gene. Getting the plasmid into the nucleus requires the use of delivery agents that protect the plasmid from degradation, control the distribution to the target tissues or cells, enhance its transport across the outer membrane of the cell, and facilitate the intracellular movement of the plasmid to penetrate the nuclear membrane to reach the nucleus. Once in the nucleus, the various elements of the plasmid direct the production of protein from the therapeutic gene. Depending on the genetic elements incorporated into the plasmid, it is possible to control in what cell types the protein will be produced (e.g., in muscle but not liver) and whether the protein will be secreted from the cell, displayed on the cell surface, or retained within the cell. A plasmid-based system offers many opportunities to control the selectivity and specificity of gene-based therapeutics. Non-viral systems offer the benefit of being well characterized, able to be repeatedly administered, reproducibility and efficiency of manufacture.

Valentis Technology Platform

Effective gene therapy necessitates the integration of multiple components–the gene itself, the delivery system used to incorporate the gene into the cells, and the gene expression system that can control the location, level and duration of expression of the gene and can control the ultimate location of the resultant protein. Working with genes already identified to be of therapeutic interest, both MBIO and GMED had developed proprietary systems that have already resulted in gene therapy products currently in clinical trials. We believe the combined strength of the merged technologies creates a powerhouse in all of these areas.

In Vivo, Plasmid Delivery Systems: Both MBIO and GMED have been developing plasmid delivery systems, designed to overcome the limitations of viral and ex vivo delivery systems discussed above. Valentis’ proprietary gene delivery systems consist of two components: (1) DNA plasmids that contain and control the proper expression of a therapeutic gene, and (2) lipids and other agents (such as polymers and peptides) that facilitate the delivery of the DNA plasmid into target cells.

Gene Delivery Systems: Valentis develops gene delivery systems based on lipids, polymers and peptides, all of which are designed to improve the specificity of cell targeting and the delivery of the genes through the cell membrane and into the nucleus:

Gene Expression Systems: Valentis is engaged in the development of gene expression systems to control the targeting, activation, level and duration of gene expression that produces therapeutic proteins to selected sites within the body.

Products in Development

The combined company has seven different potential products in Phase I/II clinical trials, and 24 therapeutic genes in research or pre-clinical development. This is an impressive clinical product profile, with candidates in a number of disease areas of significant market potential. We mention below a number of the programs as described by the two predecessor companies, and will revisit the product strategy and clinical program following further discussions with the development teams (as the merger integration progresses).

Cancer Products: Valentis is developing an Interleukin-2 (IL-2) gene medicine for the treatment of head and neck cancers. Recombinant IL-2 protein has already been approved by the FDA for the treatment of renal cell carcinoma, however, this product has demonstrated an extremely short half life in the body and has exhibited toxic side effects. Valentis’ IL-2 gene medicine is designed to be injected directly into a tumor, with minimal systemic exposure, and is intended to be used in conjunction with conventional surgery and radiotherapy. The therapeutic strategy is to create an immune response to the tumor and its sites of metastasis. Over 40,000 patients in the US and 75,000 patients in Europe are diagnosed each year with head and neck cancer. There is a 30% mortality rate associated with this disease.

In early animal studies, Valentis’ IL-2 gene medicine was shown to slow the rate of tumor progression and increase survival. In August 1997, Valentis commenced Phase I clinical trials in the US and Germany for IL-2 for the treatment of head and neck cancer, which were concluded with positive results in June of 1998. The clinical trial data showed the IL-2 gene medicine to be safe and well tolerated at all dose levels studied. The trials were conducted at John Hopkins University and in Germany in collaboration with the Company’s corporate partner Boehringer Mannheim, now part of Roche. Phase II clinical trials are expected to commence in mid-1999.

Valentis is also developing gene medicines for the treatment of cancer using the genes for the cytokines Interleukin-12 (IL-12) and Interferon-alpha (IFN-a). As a result of Valentis’ expanded alliance with Roche, these gene medicines include proprietary Roche technology related to these genes. In June 1998, Valentis disclosed its progress on these two projects:

Also in the cytokine area, Valentis is working on a cytokine/superantigen gene combination product. Superantigens are antigens that simultaneously activate large numbers of T Cells, or immune response cells. Clinical trials began in June 1998, sponsored by the NCI using superantigen B and IL-2 genes. Initially targeting melanoma and hoping to expand to other solid tumors (breast, prostate and ovarian), this gene medicine is intended to help the body build an immune response to cancer cells by having the superantigen B produced within the tumor. The response is then amplified by production of IL-2, a white blood cell growth factor, also within the tumor.

Through its collaboration with Eli Lilly, Valentis is working with the BRCA1 gene, a gene identified to be a tumor suppressor. Defects in this gene are thought to promote breast, ovarian and prostate cancers. Initially, Valentis is studying direct injection of the BRCA1 gene medicine for treatment of breast and ovarian cancers. Combined, these markets are over $1.0 billion, with over 26,000 cases of ovarian and over 180,000 cases of breast cancer per year in the US.

Originally part of a collaboration with Pfizer that was concluded in May 1998, Valentis is pursuing an anti-angiogenesis application of its gene medicines. Angiogenesis is the process by which masses, mostly tumors, create blood vessels that supply blood and oxygen to the mass allowing it to survive and prosper. Valentis has developed an anti-angiogenic gene medicine, delivered intramuscularly (IM injection). In several preclinical mouse studies, the anti-angiogenic gene medicine has demonstrated an ability to slow the growth of tumors in a lung cancer model. It has also been demonstrated that uptake of Valentis’ lipid:DNA complex is 33 times greater in tumor angiogenic endothelial cells than normal cells. The initial focus of the product will be in non-small cell lung carcinoma, a market of over $1.0 billion.

Cardiovascular Gene Medicines: Valentis is currently developing multiple therapeutics for the treatment of cardiovascular diseases. Specifically, Valentis is developing products for therapeutic angiogenesis to enhance circulation in patients with inadequate blood flow, to prevent restenosis (reclosing of blood vessels) following balloon angioplasty or bypass surgery, and to prevent organ rejection following heart transplant. Two Phase II clinical trials are ongoing using Valentis’ proprietary cationic lipid gene delivery system for non-viral delivery of the human vascular endothelial growth factor (VEGF) gene. VEGF has been shown to induce angiogenesis, the process of forming new blood vessels, and restore blood flow to ischemic tissue. Additional products could enter clinical trials in 1999 and 2000.

Pulmonary Gene Medicines: Through its collaboration with Glaxo Wellcome, Valentis is developing gene-based therapeutics for the treatment of cystic fibrosis (CF). CF results from a defect in a gene called CFTR, resulting in the patient’s inability to break down mucus in the lung. This defect causes infection, loss of lung function and premature death. In early preclinical studies, primates receiving the CFTR gene medicine by inhalation were shown to successfully express the human CFTR gene. In addition, there was no evidence of inflammation and 20% of the target cells were still producing the protein 6 weeks after administration. In October 1998, Valentis reported that in a small Phase I/II human clinical trial, the CFTR gene medicine revealed no evidence of inflammation and was found to be safe by all trial measurements.

Also in October, Valentis announced the receipt of a Phase II Small Business Innovation (SBIR) Grant from the NIH to investigate further uses of its alpha-1 antitrypsin (AAT) gene medicine. This follows the successful completion of a Phase I human clinical trial for AAT deficiency conducted at Vanderbilt University, the results of which were announced this past May. In this trial, the AAT gene medicine was shown to be safe, to produce elevated AAT protein levels in patients for at least a week and demonstrated anti-inflammatory properties. These results proved to be better than results achieved using the protein alone. AAT deficiency affects an estimated 160,000 patients in the US, and is a significant contributor to the development of emphysema. The SBIR grant will be used to look at alternative uses for the AAT gene medicine, including conducting preclinical work on the preventative effects on respiratory syncytial virus (RSV) infections. RSV is a common respiratory disease that can cause life-threatening conditions, particularly in the elderly.

Rheumatology Gene Medicines: Valentis currently has several pre-clinical programs underway involving plasmid-based products to treat a range of rheumatological diseases including rheumatoid arthritis (RA) and osteoarthritis (OA). Valentis has exclusive access to broad patent portfolios from the University of Pittsburgh and Baylor College of Medicine related to gene therapy, both viral and non-viral, in vivo and ex vivo, for joint diseases. Phase I/II trials have been conducted that demonstrated the safety and feasibility of treating RA through an ex-vivo gene therapy approach. This was the first gene therapy clinical trial conducted on a non-lethal disease and the first on RA. Valentis is looking to license these viral technologies.

Nucleic Acid Vaccines: Valentis is also engaged in the research and development of nucleic acid vaccines, which have the potential to provide immunization against diseases, where no vaccine currently exists, with costs and compliance better than traditional vaccine approaches. The prospective advantages of nucleic acid vaccines include more precise control of expression of antigens, greater specificity of the immune system towards the pathogen (disease-causing agent), the ability to express several antigens for protection from the same disease or multiple diseases, and longer antigenic memory with better control of the response from the immune system. Valentis is currently collaborating in preclinical studies of lipid and PINC™ genetic vaccines for the prophylaxis and treatment of H. pylori infections.

Valentis has announced the acceleration of its genetic vaccine program targeting dendritic cells. The Company announced that it had received several proprietary peptide sequences from the University of Texas Southwestern Medical Center at Dallas, that the Company believes, when combined with Valentis’ proprietary gene delivery systems, could be key to designing novel genetic vaccines that could treat or prevent infectious diseases and possibly cancer.

Corporate Partnerships

Valentis intends to develop its products through alliances with biotechnology and pharmaceutical partners. The Valentis strategy is to focus on discovering, developing and optimizing core technology platforms, and then collaborating with a corporate partner to develop candidate gene therapy products through preclinical and clinical testing. As a result of the merger, the combined companies have an impressive list of corporate collaborations. We also believe the combined company will be able to leverage its collective scientific expertise, intellectual property and product development efforts into additional collaborative partnerships.

Eli Lilly: Valentis entered into a 2-year collaboration with Eli Lilly in May 1997 focused on the identification of gene-based therapeutics using the BRCA1 gene. As a result of the agreement, Lilly agreed to provide at least $7.0 million in R&D funding during the first 2 years of the collaboration, which may be extended from May 1999. Lilly originally purchased 286,000 shares of MBIO at $10.00 per share. Upon completion of certain pre-clinical and clinical milestones the Company could receive an additional $27.5 million and would receive royalties on sales of any products resulting from the collaboration.

Glaxo Wellcome: In April 1994, Valentis entered into a partnership with Glaxo Wellcome to develop gene-based therapeutics for the treatment of cystic fibrosis (CF). Under the agreement, Glaxo Wellcome is responsible for conducting clinical trials, large-scale clinical and commercial manufacturing and sales and marketing of any gene-based therapeutics emerging from the partnership. As of April 1997, Glaxo Wellcome’s funding obligations ended, having provided Valentis with $5.3 million. Valentis would receive a milestone at the commencement of Phase III trials and would receive royalties on sales.

Roche: Valentis and Corange (now Roche) in 1995 originally entered into a five-year collaboration to develop gene therapy products to treat head and neck cancer and melanoma, with a three-year option to extend to other cancer indications. In August of 1998, the alliance was extended two more years to February 2002. Valentis currently has a gene-specific alliance with Roche in the field of non-viral gene therapy for human cancer focused on IL-2, IFN-a , and IL-12. In April 1994, Valentis entered into a 3-year research program with Syntex Inc. (also now part of Roche) for the development of products for inflammatory and immunological disorders. The alliance ended in April 1997, but as a result, Valentis obtained a worldwide co-exclusive license to Syntex’ cationic lipid gene delivery technology (DOTMA).

DSM Biologics: In September 1998, Valentis announced a three-year strategic partnership with DSM Biologics to manufacture and supply DNA plasmids and lipid:DNA complexes to the gene therapy industry. The partnership uses Valentis’ proprietary methods for manufacturing DNA plasmid and complexes creates the first contract manufacturing facility designed to produce plasmid-based therapeutics up to a commercial scale. Under the agreement, Valentis has licensed its technology to DSM who will pay license and milestone fees to Valentis. Both companies will share in the sales profits. With more than 75 gene therapy clinical trials ongoing in 1999, the potential market for these plasmids and complexes could be significant.

Others: In December 1997, Valentis entered into a feasibility agreement with Merck to evaluate Valentis technology for use in two potential therapeutic applications. In November 1998, this collaboration was expanded to evaluate Valentis’ GeneSwitch™ technology for use with Merck’s vector system and to include three therapeutic targets. Valentis has also entered into a feasibility agreement with Heska Corporation, a leading animal health products company, to evaluate Valentis’ lipid- and polymer-based gene delivery for certain immunotherapeutic applications in companion animal health.

Management Team & Board of Directors

The following team will be managing the combined entity, post-merger.

Benjamin F. McGraw, III, Pharm.D., joined MBIO as President, Chief Executive Officer and Director in September 1994. In February 1997, he became Chairman of the Board of Directors. From April 1993 to September 1994, Dr. McGraw was Corporate Vice President for Corporate Development for Allergan, Inc. He served as President of MedTech Trends, Inc., an investment advisory company from November 1990 to April 1993. From November 1991 to April 1993, Dr. McGraw was President of Carerra Capital Management, Inc., an investment company where he was the fund manager for a limited partnership that invested in health care companies. From July 1989 to November 1990, Dr. McGraw was Vice President, Development at Marion Merrell Dow, Inc., and from November 1987 to July 1989, he was Vice President, Development at Marion Laboratories, Inc. Dr. McGraw received his Doctor of Pharmacy from the University of Tennessee Center for the Health Sciences.

Kenneth R. Lynn joined the Company as Sr. Vice President, Business Development and Legal Affairs in January 1999. Previously from 1993, Mr. Lynn was employed by Cortech, Inc. a biopharmaceutical company, where he served as Chairman and CEO from 1997, President and CEO from 1995 to 1997, Sr. Vice President of Business Development from 1993 to 1995 and General Counsel. Prior to Cortech, Mr. Lynn was employed as General Counsel and Corporate Secretary for US Biosciences, Inc. a biopharmaceutical company, from 1991 to 1993. He served in various capacities in the legal departments of Marion Merrill Dow, a pharmaceutical company, from 1984 to 1991, United Telecom Computer Group, a service provider to the computer industry, from 1982 to 1984, and Mangan, Dalton and Trenkle Chartered, a law firm, from 1981 to 1982. Mr. Lynn received his MBA from Rockhurst College and his Juris Doctor from University of Kansas.

Rodney Pearlman Ph.D., has served as MBIO’s Senior Vice President, Research and Development since July 1998. From January 1995 until the time of this appointment, Dr. Pearlman served as Vice President, Research and Development. From January 1988 to December 1994 Dr. Pearlman was Director of Pharmaceutical Research Development at Genentech, Inc. At Genentech, he was a Project Team Leader for the Human Growth Hormone from March 1992 to June 1994. From September 1987 to December 1994, Dr. Pearlman was a senior scientist at Genentech, having joined the company as a scientist in September 1984. Prior to joining Genentech, he was an Assistant Professor of Pharmaceutics at the University of Texas at Austin. From 1978 1981, Dr. Pearlman was a Senior Scientist at Lilly. Dr. Pearlman received his Ph.D. in Pharmaceutical Chemistry from the University of Kansas.

Bennet L. Weintraub, has served as MBIO’s Chief Financial Officer and Vice President Finance since May 1998. From March 1996 to May 1998, Mr. Weintraub was Chief financial Officer and Vice President Finance and Administration for Technology Modeling Associates, a software company. From September 1993 to March 1996, he was employed as Director of Finance by Metra Biosystems, a bone diagnostics company, and from September 1987 to September 1993, he was Controller at Advanced Polymer Systems, a drug delivery company. Mr. Weintraub received his MBA from Harvard Business School and his BA from Pomona College, and is a CPA in California.

Under the terms of the reorganization agreement, Valentis will increase its number of authorized directors to eight. Five of the directors on the new board will be former directors of MBIO, and three will be former directors of GMED.

Financial Information and Valuation Discussion

Valuation of biotechnology companies like Valentis is very difficult. Like most gene therapy companies, the size and timing of Valentis’ product revenues and earnings are extremely difficult to predict. Traditional discounted cash flow models are rendered even less precise than usual, due to the significant number of years in the future that sales and earnings are predicted. Given the considerable clinical, regulatory and market risk associated with drug candidates in an unproven sector, analysts and investors can argue indefinitely on the appropriate discount rates and terminal value multiples.

Perhaps a more useful methodology is concept of relative valuation. Prior to the merger, the market was assigning a very low valuation to both MBIO and GMED relative to their peer group. We believe this may have been due to significant uncertainty relating to potential conflicts in the MBIO and GMED patent portfolios. In our opinion, the merger should eliminate these concerns and this "valuation penalty" should now be removed from the stock. We have also analyzed the relative "technology value" of Valentis versus several other publicly traded comparable gene therapy companies. (Technology value is defined as the market capitalization plus debt (the "market’s" value of the company), less the cash.) Valentis trades at a large technology value discount to the comparable set. As such, we feel the combined company is significantly undervalued relative to comparable gene therapy companies and recommend purchase for those investors tolerant of the risks associated with small-cap companies.

Below is selected, unaudited balance sheet data as of September 30, 1998, taken from the proposed merger documents. The data give effect to the merger of MBIO and GMED as if it occurred on that date, and reflects the planned accounting treatment for allocation of purchase price, including in-process R&D, liabilities assumed, and adjustments related to severance liabilities of approximately $2.3 million.

According to Valentis management, the combined Company had approximately $50 million in cash and equivalents as of the date of the merger, net all merger-related expenses. As a result of the synergies and the integration of the two companies, management is expecting its cash burn rate to be reduced significantly, to less than $15 million per year. With several years of cash available, we believe Valentis to be in a position of great financial strength, a unique characteristic of a development-stage biotechnology company.

Risk Considerations

This section of the document is provided to remind potential investors to undertake a prudent level of due diligence prior to making an investment in the securities of MBIO. For a complete description of risks and uncertainties to the Companies’ businesses, see the "Risk Factors" section in the Companies’ SEC’s filings, which can be accessed directly from the SEC Edgar filings at www.SEC.gov on the internet. Other potential risks include:

• Market risk: Investors should consider technical risks common to many small-cap or micro-cap stock investments, including liquidity levels, small float, risk of dilution, dependence upon key personnel, dependence upon single products or technologies, and the strength of competitors that may be larger, better capitalized and hold dominant market positions.
• Business risk: Valentis is developing unproven products. The field of gene therapy has significant potential value, but is very new and rapidly evolving. The Company expects to incur operating losses over the next few years, and there is no assurance that the Company will ever achieve profitability. The Company is dependent upon collaborations with partners, and there is no assurance that the Company will enter into favorable partnering terms, if at all.
• Regulatory risk: There are no gene therapy products approved by the FDA in the market, and there is limited data on the safety and efficacy obtained from clinical trials. There is no guarantee that Valentis will ever develop a viable product, and even if successfully developed, there is no assurance that it will be accepted by the FDA, or be commercially successful.
• Competitive risk: There is no assurance that Valentis’ product will have better efficacy than other drugs on the market, if they get to the market. The gene therapy industry is changing very rapidly, and more competition will inevitable come as the industry gets larger.

Sources for Additional Information

The following are website addresses offering related information, and links to other sources of information.

www.Valentis.com  Valentis’ Home Page

www.SmallCapsOnline.com SmallCaps Online’s site for company information and research

www.nih.gov  National Institutes of Health

www.nhgri.nih.gov  National Human Genome Research Institute

www.FDA.gov  US Food and Drug Administration homepage

www.SEC.gov  U.S. Securities and Exchange Commission, with links to EDGAR filings

The information in this report has been obtained from sources that we believe to be reliable, but we do not guarantee its accuracy or completeness. Neither the information nor any opinion expressed constitutes a solicitation by SmallCaps Online LLC for the purchase or sale of any securities. SmallCaps Online LLC has performed investment banking, consulting or other services for or may solicit investment banking, consulting or other business from, any company mentioned in this report. SmallCaps Online LLC or persons associated with SmallCaps Online LLC may at anytime be long or short any of the securities referred to herein and may make purchases or sales thereof while this report is in circulation or posted on the SmallCaps Online LLC website at www.SmallCapsOnline.com. This material, or any portion thereof, may not be reproduced without prior permission from SmallCaps Online LLC. SmallCaps Online LLC is not responsible for the contents of this document that is intended for electronic transmission and could be thus subjected to tampering or alteration. Copyright © 1999 by SmallCaps Online LLC. All rights reserved.