A MSB Equity Issue Now Would Be A Ridiculous Idea
There's been some weird pondering about an equity raising, with some real misconceptions about MSB.
I can't help but feel some of the comments are a bit mischievous or being generated by people trying to support a short position.
Mesoblast won't issue equity in the foreseeable future, regardless of the recent share price rise, for the following reasons:
1. As disclosed today, c
ash on hand at the end of the quarter was US$81.3 million (A$116.1 million). That will last 12 months at the current $US20m per quarter burn rate. Over the next 12 months, Mesoblast may have access to an additional US$62.5 million (A$89.3 million) through existing financing facilities and strategic partnerships, giving another 3 quarters of cash burn out to Sep 2021 - see points 4 and 5 below.
2. They just raised $A75m ($US50m) in an equity placement less than 4 months ago
3. Their deal with Grünenthal in September 2019 guarantees $US45m in the first year ($US17.5m already received)
4. They have reduced their ongoing (ie adjusted for one-off partner payments) cash burn to less than $US20m per month. The cash flow statement today shows cash burn of $US19.648 excluding the money received from Grünenthal. Sure, the projected cash burn for next quarter is $US22.8m, but that doesn't include the $US2m royalties from JCR, nor interest receipts (which were $US240,000 last quarter, and could be a bit higher this quarter with the higher cash balance) - so cash burn could easily come in a little less than $US20m again next quarter. Note that the forecast cash burn for the current quarter was a burn of $US21.9m pre the $1.9m royalty receipts from TEMCELL in Japan - so the actual result was spot on.
4.
Up to an additional US$35.0 million is available to Mesoblast subject to achievement of certain milestones, under the financing arrangements with Hercules Capital and NovaQuest.
5. Additional future payments from Grünenthal may include milestones up to US$27.5 million within the first year comprising US$20.0 million on receiving regulatory approval to begin a confirmatory Phase 3 trial in Europe, and US$7.5 million on certain clinical and manufacturing outcomes.
6. The opportunistic equity raising at $A2.00 just after the Grünenthal deal, combined with rumours that Capital was likely to sell their 27m share holding ruined the share price run (which had hit a high of $A2.23) and forced the price down to $A1.65, which cruelled the chances of entering the ASX200 Index in March - pushing it back at least 3 months to June. It would be counterproductive to do this again before the end of May when the calculations for the June Index rebalance are done.
7. I argued against the equity raising in early October, and would've preferred a debt drawdown if they desperately needed cash - the price would've run up to $3 or more (propelled by short covering and the ASX200 inclusion, which would've happened in March). They could've then done an equity raising at a 50% higher price in March and they would've been in the ASX200 by then and the issue would've been easy to get away to index funds. They would've only had to issue 25m shares at $3 to raise the same amount, rather than 37.5m shares at $2.
8. The more shares MSB issue, the more The Prof is diluted - he was down to 12.62% of the issued capital in the Annual Report. He obviously doesn't need the stress of running down to the wire from a cash point of view, but it's time for a new mindset on cash if the company truly believes they are "in advanced negotiations" with partners - the cash flow statement today said:
"Mesoblast continues to be in active discussions with additional pharmaceutical companies with regard to further potential global and regional strategic partnerships."
9. That new mindset on cash should be active consideration of a big share buyback if a blockbuster partnering deal or two are done with at least $US100m in upfront payments. It should be done quickly before the price runs too hard and that means more shares are bought back for the same amount of money
10. On the question of cost of debt - it sounds high at a current rate of 9.7% for Hercules * ($US50m drawn so far and $US25m to go) and 16.3% for NovaQuest including the $0.4m loan admin fee ($US30 drawn, with $US10m to go) - however, these are pre-tax numbers and convert to 7.7% and 12.9% after tax.
So the current net cost of debt is 9.6% pa on $US80m and would be 9.48% on the full $US115m if drawn down.
Note the cash cost is less as the Nova debt only accrues interest until product sales ex Asia so it doesn't hit cash at present.
* variable with US prime rate
11. MSB currently has a weighted average cost of capital (WACC) of 15% to 21% according to most analysts. With debt at 9.6% on $US80m and a market Equity value of $US1,088m, that means the cost of equity is 15.4% to 21.8% to get to WACC of 15% to 21%.
Cost of equity is calculated as Risk Free Rate (1.7%) + Stock Beta (1.8) times [Return on Equity Market (9.1% to 12.4%) less Risk Free Rate (1.7%)]. ie If you use a required S&P500 market return of 9.3% then the cost of equity capital is 15.4%, if your required return on the market is 12.9% your cost of equity capital is 21.8% for a stock with a Beta of 1.8.
12. So cost of Equity capital is currently around 5.8% to 12.2% pa above the net cost of debt capital. That's hideously expensive equity capital and MSB would increase its valuation by replacing equity with debt. Due to the share price rise, debt is only currently 6.8% of debt + equity (at current $A3.00 share price) and the company can support more debt, especially if product sales for US aGvHD start later in 2020 as the company plans to do.
13. As I've said in the past, I believe that analysts are using a WACC which is way above reasonable levels. However, that's the rate they use to discount future cash flows and it horribly hits the long term NPV of Mesoblast. The company should do whatever it can to get this cost of capital down. An equity issue would push the cost of capital higher by increasing the equity mix and is against the company's interest, especially if a big partnering deal is about to occur. As long as MSB is confident of having enough cash, it is in shareholders' interests to buy back equity (and even using debt to do this).
14. There are nearly 27m options with exercise prices up to $A4.28 and 24.5m of them are currently in the money with a share price above $A2.80, plus 1.5m performance rights. That's a significant amount of potential profits, mainly to senior management and board directors (and 1.5m to KentGrove). These options don't have the right to participate in share issues - so any placements or issues are going to stunt the potential profits of these option holders by holding the share price down - there's a real incentive for board members to do everything they can to boost the share price. Back in September, when the share price was less than $A1.50, there were less than 11m of these options in the money, and less than 6m in the money at $A1.30 share price - so the recent share price rise should really have the attention of these influential option holders and I imagine they wouldn't want to see anything done to diminish their value.
15. Even though the debt interest payments are less than the cost of equity, they could probably be negotiated a little lower, as mentioned by a couple of the analysts in the past 6 months, maybe saving 1-2% on the average debt rate. At MSB's stage of development, debt is still expensive, but that could change over the course of this year if the FDA approves aGvHD and if there are good results from the Heart and Back Pain phase 3 trials. Funds like BioPharma Credit (BPCR) lends on a diverse portfolio of secured debt instruments for life science companies - their current loan portfolio has an average coupon rate of c 9% (of which c 50% is at a fixed rate) and I note that M&G is a major funder of BPCR.
16. Why raise money now at $3 (less a discount) now if the price is likely to keep rising and you are under no pressure to raise it - you'd be far better off raising it later at much higher prices closer to analysts' valuations, especially as some of the analysts (like Dawson James today) are upgrading their price targets and indicating they'll continue to upgrade if good clinical data emerges.
Bottom Line
There won't be an equity issue, even if the share price above $3 looks juicy issue now would make ASX200 Index inclusion much more difficult due to the drop in the share price; it would dilute The Prof's holding further; it would be against the interests of insiders holding options which are only recently in the money; it would play into the hands of the shorts and annoy instos who had recently stumped up for the last capital raising only 4 months ago; it would be an inefficient use of the balance sheet (especially if a partnering deal is close); it would increase the cost of capital and hurt the NPV calculations by analysts.
We have at least enough cash on hand to last through 2020 and will probably have enough to last until September 2021 if we meet requirements of partners and lenders. Meanwhile cash burn has dropped to $US20m per quarter and sales of aGvHD are a strong possibility of beginning by the end of this year, generating high gross margins and maybe around $US40m of sales in the first year of sales (2021), and thus extending the cash runway out to March 2022.
The really big opportunity for cash vs new equity debate is when the "advanced negotiations" will turn into a big partnering deal with at least $US100m cash in upfronts for each blockbuster product(Back Pain and Heart) in each geographic area (US and EU). We have more than enough cash to get us through the results of the phase 3 trials by June this year and to give The Prof plenty of time to conclude an attractive partnering deal.
Finally, I would note the upgrade in the MESO price target today by DawsonJames from $US14 to $US15 ($A4.44 MSB equivalent) after only recently starting coverage of Mesoblast. I have said in the past that I believe analysts over-discount MSB's long term cash flows and come out with an unjustifiably low NPV. Dawson James alludes to this assessment when they say
"We emphasize that good clinical data in DDD or HF becomes transformative for the company and as a result our probability of success metric would rise"
Here's their summary:
Mesoblast (MESO): Raising the Price Target from $14.00 to $15.00 - A Year of Catalysts Ahead
As Mesoblast approaches a year of pivotal data and other catalysts we believe the valuation can push higher. We make a few small adjustments in our model as we project out the next ten years. The result is our price target slightly adjusts higher from $14.00 to $15.00 per share. We emphasize that good clinical data in DDD or HF becomes transformative for the company and as aresult our probability of success metric would rise
Meanwhile, an update for the parabolic traders
I agree that all the geniuses on here who trade every twist and turn and manage to get their average price down and sell out at the high should keep doing what they are doing. You are certainly beating the odds which show that most traders lose money (or significantly underperform the index). I bet you win on the poker machines and Lotto as well - some people are just naturally lucky (though not many if the odds are against it).
My comments are really to reassure normal investors that it's OK to stay in a stock if the long-term valuation is well above the current share price and that you don't have to take the risk of trading out, paying the costs and paying tax and maybe risk not getting back in, or getting back in at the wrong price. Getting whipsawed really makes it hard to re-enter at a higher price than you sold out - many people wait until it drops back, but if that doesn't happen they really lose out by buying at the nest peak or just never get back in.
To get an idea of the long term value, I follow most of the major analysts who attempt to determine a valuation for MSB. These valuations are very uncertain, and heavily discounted, but they're the best we have. Most price targets are currently well above the share price - as noted earlier, Dawson James upgraded today to $A4.44 and Edison recently moved up to $A7.91 (or $A7.53 diluted for options).
So, calling the recent price move parabolic, and thinking that therefore the shares are a sell is short-term thinking. As I noted recently, even using the Parabolic SAR (Stop and Reverse) indicator, MSB is still a buy - see graph below, where the share price would have to fall to $2.60 at present to move out of the positive parabolic uptrend. Sometimes the hardest thing to do as an investor is to wait - we get nervous after a big rise and fret that someone else may sell, so some of us try to get out first - if you do that, you may feel good for a day or two if the price corrects a bit, but ultimately there's a lot of regret if it turns around and continues the uptrend. The insto buying is still strong, the cash flow statement today was solid (and a little better than I expected), analysts are still upgrading and the price is well below the average consensus 12-month price target. I'm happy to stay with it while these factors continue, and we'll all be rewarded if the phase 3 trial results replicate the earlier phase 2 studies and/or if a partnering deal is completed.
Here's the graph with the share price still well above the Parabolic SAR point (which I stress is only a trend following indicator for short-term traders):
(20min delay)