Mesoblast (MSB)
Financing uncertainty removed, MSB to be prudent on CHF trial spend
Recommendation
Buy (unchanged)
Price
$1.24
Valuation
$3.27 (previously $3.39)
Risk
Speculative
Analyst
Tanushree Jain 612 8224 2849
Authorisation
John Hester 612 8224 2871
GICS Sector
Pharmaceuticals & Biotechnology
Expected Return
Capital growth 163.7%
Dividend yield 0.0%
Total expected return 163.7%
Company Data & Ratios
Enterprise value $365.6m
Market cap $472.9m
Issued capital 381.37m
Free float 66.9%
Avg. daily val. (52wk) $1.99m 12 month price range $1.01- $4.06
Price Performance
BELL POTTER SECURITIES LIMITED
Speculative
CHF Programme to yield key data on futility in 1Q17
The second interim read out on futility and possible overwhelming efficacy from the CHF trial will be released in 1QCY17. A positive recommendation by the DMC to continue the trial as per protocol or affirmation that it meets the test of overwhelming efficacy, at that point, will strengthen the partnering prospects of this asset and guide MSB’s decision to continue to invest in this program. MSB has committed at this stage up to US$13m being funded from its existing cash reserves of US$80m towards the CHF programme through to 1QCY17. MSB has also secured a standby equity finance facility with Melbourne based Kentgrove Capital of up to A$120m available for drawdown at their discretion over next 3 years. MSB will also implement further cash management initiative which will extend cash runway for 12-15 months.
Strategy gives breathing space to deliver on milestones
We believe that MSB’s announced plan is a prudent, de-risked strategy to preserve cash while still allowing them to reach the next inflection point on each of their Tier 1 programmes. It also gives them some more time to conclude a strategic partnering deal which in many ways could be truly transformative for the company. Having a standby equity facility also removes the uncertainty around availability of financing should they need it and its discretionary nature and minimum issue price/discounts being fixed to an extent controls the dilution that would occur from any such equity placement. Overall, we welcome the transparency after the scant details provided last month and now look forward to the company delivering on its announced clinical and commercial milestones, as well as a potentially transformative strategic deal over the next 6 -9 months.
Maintain Buy, Valuation marginally reduced to $3.27
Revision to our model has led to a change in our NPAT est. as follows +30% FY16,
+2% FY17 and +27% FY18. Our valuation for MSB has marginally reduced to A$3.27/sh (was A$3.39/sh), driven primarily by the dilution from the assumed equity placement which has offset the short term reduction in Net Loss. We retain our Buy recommendation. Key catalyst: Phase II Rheumatoid Arthritis Trial results in 3QCY16.
Note: Revenue includes R&D tax incentive, deferred upfront received from cephalon and commercial milestone and royalty revenue from launch of TEMCELL GvHD product in Japan SOURCE: BELL POTTER SECURITIES
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Mesoblast (MSB) 4 July 2016
Financing uncertainty removed, MSB to be prudent on CHF trial spend
In the aftermath of Teva handing back the rights to the cardiovascular programme including the ongoing Phase III congestive heart failure (CHF) trial, Mesoblast (MSB) has provided an update on its cash management plans, its strategy for the CHF programme and details on the anticipated cash burn related to it and the much awaited details on the equity financing facility it alluded to last month.
CHF Programme to yield key data on futility in 1Q17
• Key futility interim analysis from CHF Phase III trial will be released in 1QCY17:
The second interim read out on futility and possible overwhelming efficacy from the CHF trial will be released in 1QCY17. Since the trial is blinded, the independent data monitoring committee (DMC) will look at the data on primary end point of the trial and provide their recommendation to MSB based on pre-specified thresholds. A positive recommendation to continue the trial as per protocol or that it meets the test of overwhelming efficacy at that point will strengthen the partnering prospects of this asset and also allow MSB to make a more prudent decision around continuing to make significant investment in this program.
• CHF trial up to 1Q17 interim analysis to cost US$13m: MSB estimates that between now and the futility interim analysis point in 1QCY17, they will spend ~US$13m on the CHF programme. Further investment on the trial will only be decided based on the interim results. In our view, this is a prudent, de-risked strategy to limit the investment required to reach the next inflection point on the program.
• Trial will continue to recruit across currently active sites in US and Canada: We note that the CHF Phase III trial is currently recruiting across multiple clinical sites in the US and Canada. The trial is around 40% recruited (240 of 600 patients). The trial is expected to be fully recruited by end of CY17. The US$13m up to 1QCY17 is likely to be spent on follow up of the 240 patients already recruited in the trial and on continuing to recruit at a modest pace more patients in the trial. We expect that the interim analysis will be based on 12 month follow up of the majority of the 240 patients already recruited in the trial. Based on the cost guidance, we believe MSB will not add any new clinical sites to the trial until 1QCY17. We expect the trial will recruit across the ~42 sites currently recruiting across US and Canada and the planned European sites will not be activated until next year after the interim results are available and MSB can implement the new Carto 3 catheter (use allowed recently by the FDA) from Johnson and Johnson in its trial.
Cash management to reduce cash burn
• Cash management to reduce cash burn: In the aftermath of Teva handing back the rights to the cardiovascular programme, the key question for the company was managing its cash burn. The company has announced that it will reduce its annualised cash burn in FY17 through further cost reductions via operational streamlining and strategic re-prioritisation of core assets. Details on the cost saving areas will be provided by MSB at the time of FY16 results.
• Annualised cash burn per quarter to reduce to US$16-US$20m/quarter: MSB has guided that its existing cash reserves of ~US$80m (in line with BPe FY16 ending balance of US$79.4m) provides cash runway for 12-15 months (June 2017-Sep 2017). This includes the planned US$13m spend between now and 1QCY17 on the Phase III
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Mesoblast (MSB) 4 July 2016
CHF trial as well as continued spend on the ongoing Tier 1 programs – Phase III US paediatric GvHD trial, Phase III chronic discogenic lower back pain trial and the ongoing Phase II Rheumatoid Arthritis programme.
• Strategic Partnership opportunities will be pursued: The company will continue to engage in partnering discussions to source a potentially non-dilutive source of funding during the time.
Standby Equity Financing Facility up to A$120m secured
• MSB has released details around its standby equity financing facility. The facility is being provided by Melbourne based Kentgrove Capital.
• Under the Agreement, Kentgrove Capital may provide the company with up to A$60 million of equity capital via placements over the next 18 months. MSB also has the option to increase the facility to A$120m (US$90m) over 36 months.
• It is a standby facility, which means MSB has the facility available to draw down as needed over the next 18-36 months.
KEY TERMS OF THE EQUITY FINANCING FACILITY ARRANGEMENT
• For each placement, Mesoblast determines when the placement occurs, the placement period, the maximum amount of the placement, and the minimum share issue price.
• For each placement, Mesoblast will receive funds from Kentgrove Capital via the issue of shares at a volume weighted average price (VWAP) based on the sale of Mesoblast shares by Kentgrove Capital over the placement period less 4.5%, which cannot be less than the minimum issue price determined by Mesoblast.
• The issuance of shares under the facility will be made in compliance with Mesoblast’s available placement capacity.
• Kentgrove Capital will be granted 1,500,000 incentive rights with a three year exercise period at an exercise price (A$2.22) equivalent to 200% of the average daily VWAP of Mesoblast shares sold on-market on ASX during the 10 trading days before the date of the facility. In our view, this is the facility fee paid by MSB for the facility in the form of options.
• Mesoblast may terminate the facility on 14 days’ notice. Kentgrove Capital may only terminate the facility in certain limited circumstances, such as a material breach of the facility by Mesoblast which is not remedied.
• Kentgrove Capital is an investment management firm focused on small and micro-caps with a particular focus on investing in stocks they believe are undervalued. As far as we are aware, previously, they have provided a similar type of standby facility to an Australian molecular diagnostics company called Genetic Technologies (ASX:GTG). The managing director and founder of the firm recently joined the Board of Australian biotech Alchemia (ASX:ACL) after the firm became a substantial shareholder in that company.
Our comments
• In effect MSB has committed at this stage up to US$13m being funded from its existing cash reserves towards the CHF programme up to 1QCY17. This is sufficient to get the program to reach its next inflection point where the company based on interim results can decide the best course of action for the programme forward.
• 3 things can happen at the interim analysis point a) the trial does not meet the futility threshold and the company decides to discontinue the trial; b) the trial meets futility thresholds and DMC recommends it should continue as per protocol. The company would have a strong case to partner the asset at that stage with a
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Mesoblast (MSB) 4 July 2016
cardiovascular focused company or alternatively decide to use the equity financing facility and self-fund the remaining part of the trial through to completion; c) the trial performs better than expected, showing overwhelming efficacy in which event MSB could engage with FDA regarding potential faster path to market (Breakthrough therapy designation/early stoppage of trial/potential approval based only on Trial 1). This would also make a strong case for partnering the asset at that stage with a company with an existing and established cardiovascular sales force. We note that Key players in this space include AstraZeneca, Sanofi, Novartis, Amgen and Pfizer. In Japan Takeda, Astellas, Daiichi Sankyo all have cardiovascular products.
• Cash reserves of US$80m provide cash runway up to June 2017/ Sep 2017. This will allow MSB to reach the next inflection point on CHF, lower back pain, Graft vs Host Disease (GvHD) and biologic refractory Rheumatoid Arthritis assets.
• Standby Equity Facility is available for use, but MSB can drawdown as per its discretion. At this stage we assume a drawdown in 4QCY16 of US$45m (A$60m). If in the meanwhile, MSB does manage to partner any of its pipeline assets, it may extend the timing of drawdown further. MSB can also control to an extent the dilution from this facility as its discretionary and they have control over the timing, amount of placement, minimum issue price etc. The placement price is also to an extent fixed at 4.5% discount to VWAP over placement time period.
• The best case scenario would be that MSB does not end up using the facility in which case the dilution is related to the 3 year 1.5mn incentive rights issued as facility fee with exercise price of ~A$2.22. In our view, for this scenario to come to pass, it would necessitate the company doing a partnering deal over the next 4-6 months on their pipeline (global lower back pain deal or CHF for Japan are more near term possibilities) and partner CHF asset based on positive second interim analysis results so that a partner funds the rest of that programme.
• If not, then we are looking at further dilution of up to A$60m in FY17 and potentially another A$60m in FY18 from the use of this facility. We note that during this time there are several catalysts expected which could inject cash in the company from other sources. Apart from potential partnering prospects, these include increasing royalty revenues from Temcell GvHD product from Japan and revenues from GvHD paediatric product by end of CY17 following potential launch in the US.
In summary, we believe that MSB’s plan is a prudent, de-risked strategy to preserve cash while still allowing them to reach the next inflection point on each of their Tier 1 programmes. It also gives them some more time to conclude a strategic partnering deal which in many ways could be truly transformative for the company. Having a standby equity facility also removes the uncertainty around availability of financing should they need it and its discretionary nature and minimum issue price/discounts being fixed to an extent controls the dilution that would occur from any such equity placement.
Overall, we welcome the transparency after the scant details provided last month and now look forward to the company delivering on its announced clinical and commercial milestones, as well as a potentially transformative strategic deal over the next 6 -9 months.
Earnings and Valuation Changes
We have revisited our assumptions for Mesoblast following this latest update provided by the company.
Key changes to our modelling assumptions
• MSB has guided that its existing cash reserves of ~US$80m (in line with BPe FY16 ending balance of US$79.4m) provides cash runway for 12-15 months. This implies a annualised cash burn of US$16m-US$20m a quarter. We expect details on the cost saving areas will be provided at the time of the FY16 results. In our view, the savings are likely to be in manufacturing commercialisation and G&A. As such, we have reduced our opex forecasts for both FY17 and FY18. For FY17 we expect the burn will be higher in 1QFY17, dropping thereafter and expect the burn in 4QFY17 to be the lowest. Overall we expect MSB to burn US$75m in FY17.
• Following Teva’s exit, we have now brought forward the amortisation of deferred revenue from FY17/18 to 4QFY16. This has led to an increase in our revenue forecasts for FY16, with decreases for both FY17 and FY18.
• We have reduced our estimated R&D tax incentive forecasts by ~US$1m for FY17 and FY18, following reduced burn.
• We now assume that MSB uses the equity financing facility to raise US$45m in 2QFY17 and another US$45m in 1HFY18. We also assume that MSB raises another US$52m gross in 2HFY18 through other sources. We note that we had previously assumed a US$177m raising in 2HFY17, however at much higher prices than we now forecast for the placements in FY17/18 for a total of US$142m. The reduced raising amount assumption was more than offset by the lower raising prices assumptions.
• We have included the 1.5m options issued to Kentgrove Capital as facility fee, exercisable at A$2.22 in our diluted shares calculations.
• We have removed all cash injection forecasts through exercise of options from our
FY17/18 forecasts.
Revision to our model has led to a change in our NPAT est. as follows +30% FY16, +2%
FY17 and +27% FY18. Our valuation for MSB has marginally reduced to A$3.27/sh (was A$3.39/sh), driven primarily by the dilution from the assumed capital raising which has offset the short term reduction in Net Loss. We retain our Buy recommendation.........................
Key Near-term Catalysts
• Increase in royalties from TEMCELL in Japan: JCR Pharmaceuticals launched its acute GvHD product TEMCELL on 24th Feb’ 16. MSB has received in 4QCY15 US$3.5m in pre-commercial milestones triggered by the approval of TEMCELL. Under the deal sales milestones (BPe ~US$4m) as well as royalties in the mid 20% range are also payable by JCR. MSB recorded US$99,000 in first royalty revenues in 3QFY16. We assume that at peak penetration (peak sales of US$110m), MSB will receive ~US$28m in annual royalty revenues from TEMCELL.
• Results from ongoing Phase II Rheumatoid Arthritis Trial: MSB has completed enrolment of the first dose cohort of its Phase II rheumatoid arthritis trial. Enrolment of the second cohort is ongoing. Top-line results from the trial (cohort 1 and cohort 2) are expected to be released in 3QCY16.
• Second interim analysis from Phase III CHF Trial: The second interim analysis for futility and possible overwhelming efficacy will be released in 1QCY17. Since the trial is blinded, the DMC will look at the data on primary end point of the trial and provide their recommendation based on pre-specified thresholds. A positive recommendation to continue the trial as per protocol or that it meets the test of overwhelming efficacy, at that point will strengthen the partnering prospects of this asset and also allow MSB to make a prudent decision on continuing to make significant investment in this program.
• Submission to the FDA for approval of MSC-100-IV for paediatric GvHD in US by end of CY16/early CY17. Following discussions with the FDA, MSB is running a 60 patient Phase III trial in paediatric GvHD patients. The trial is currently enrolling. Interim results are expected in 3QCY16, with Top-line results expected in 4QCY16. MSB expects to file for approval in the US by end of CY16/early CY17, positioning it for FDA approval in 3QCY17/4QCY17. We estimate that the product could launch in the US by end of CY17.
• Interim results from ongoing Phase III MPC-06-ID trial in chronic discogenic lower back pain (CLBP): MSB expects to complete enrolment in the first Phase III trial for CLBP in 4QCY16. Interim analysis from this trial are expected in 4QCY17, with possibility of an earlier interim analysis as well.
• Results from Phase IIb trial in end stage Heart Failure patients requiring LVAD with MPC-150-IM: The US National Institutes of Health (NIH) run and funded Phase IIb end stage HF trial is expected to yield results in 3QCY17.
• Potential partnering deal for MSB’s chronic discogenic lower back pain product: MSB continues to be is in advanced partnering discussions with major companies for its chronic discogenic lower back pain product. The potential partners include companies with existing presence and distribution capabilities in this space. We remain optimistic of a deal materialising in CY16.
• Potential partnering deal for any of MSB’s products for Japanese Market: We expect to see licensing interest building towards MSB’s products for the Japanese market. Our belief is based on the growing interest of pharma companies in Japan towards regenerative medicine, the pro-regulatory environment allowing an expedited path to commercialization and nearer term revenues, the size of the market and high demand for treatments for diseases applicable to an ageing population. MSB’s MPC-150-IM CHF product and MPC-300-IV product targeting inflammatory indications
including Rheumatoid Arthritis and Diabetic Nephropathy is likely a lead candidate for partnering in Japan. Ideally MSB would look to partner with a single company for a suite of its advanced products that may be approvable under the conditional pathway in
Japan.....................V
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