Equity Analyst
Authors can be reached at Analyst Feedback
Morningstar's Editorial Policies
Analyst Note 03/27/2015
The Japanese Patent Office has granted a patent covering the use of Mesoblast's proprietary adult mesenchymal precursor cells, or MPCs, for the formation and repair of blood vessels in ischemic tissues. The patent extends and broadens its patent position in Japan in the area of cardiovascular disease and represents another important step towards commercialisation. In October 2014, Japanese partner JCR Pharmaceuticals filed with the Japanese Pharmaceuticals and Medical Devices Agency, or PMDA, for approval of manufacturing, marketing, and product registration of the mesenchymal stem cell, or MSC, product JR-031 in Japan for the treatment of acute graft versus host disease, or aGVHD, in children and adults. If the filing is successful, JR-031 will be the first allogenic cell-based product approved in Japan and the first potential source of product-related revenue for Mesoblast. Nonetheless, and subject to regulatory approval and final pricing, we expect revenue to be modest.
Our fair value estimate for Mesoblast remains unchanged at AUD 7.00 per share which implies the stock is undervalued at current levels. We believe the market is underestimating the partnering prospects for Mesoblast given its late-stage pipeline and is overly focused on the 18-month cash runway. Our fair value estimate incorporates an assumed equity capital raising of approximately AUD 300 million in fiscal 2016. Our no-moat and very high fair value estimate uncertainty ratings remain intact.
Investment Thesis 03/23/2015
Mesoblast's investment case rests primarily with the validation of its proprietary mesenchymal precursor stem-cell, or MPC, technology platform. A multi-indication pipeline is targeting chronic diseases affecting large populations across the four key therapeutic areas of cardiovascular, spine disease, immunologic/inflammation and oncology. With nine clinical programs underway, including five phase III clinical trials, the company is rapidly approaching a defining moment in its history. A positive clinical outcome in any of the four key targeted areas would lay the foundation for a raft of high-value pharmaceutical products, and complement the culture-expanded mesenchymal stem-cell, or MSC, assets added through the acquisition of Osiris Therapeutics in October 2013. Positive clinical trial results from a 100-patient phase II trial of MPCs in patients with chronic moderate-to-severe discogenic lower back pain supported a move into phase III trials in 2014, increasing the total number of phase III trials to five. With the largest of these trials fully funded by co-development partner Teva, and cash reserves of AUD 149 million as at 31 December 2014, the odds are mounting of becoming the first to reach the market with an Food & Drug Administration, or FDA, approved stem-cell product.
The most advanced of Mesoblast's clinical trial programs are targeting cardiovascular, bone marrow replacement and orthopedic diseases. Mesoblast is also targeting other disease areas such as diabetes, Alzheimer's and macular degeneration.
Valuation of development-stage biotech companies is challenging, given the multiple sources of risk. Nonetheless, at current levels, a high probability of clinical success appears factored into the share price. Core patents provide protection until 2026, but generation of new IP should provide ongoing protection beyond then. Mesoblast's strategic alliance with Teva Pharmaceuticals is a key component to the company's investment case. The original deal in 2010 with U.S. biotech Cepahalon (subsequently acquired by Teva in 2011), was the most lucrative ever negotiated by an Australian biotech company. Under the agreement, clinical development in the cardiovascular indication of congestive heart failure is fully underwritten by Teva. The deal which gave the U.S. company a 19.9% stake in Mesoblast, materially derisked the stock and raised Mesoblast's profile internationally. Nonetheless, with no approved products on the market in the U.S., based on its proprietary MPC technology, and only conditional approval of Prochymal (the most advanced product acquired in Osiris deal) for treatment of children with acute graft versus host disease, or GcHD, we do not assign a moat to Mesoblast.
Economic Moat 03/23/2015
Mesoblast is a no-moat company, in our opinion. Notwithstanding its market size and leadership position in the area of stem cells, Mesoblast is a clinical trial stage pioneer with limited diversification and, therefore, highly exposed to the binary nature of event-driven risk in addition to the myriad risks typically associated with emerging biotech companies. Despite the potential of engineered stem-cell therapies to address major unmet needs, the technology is unproven and therefore exposed to considerable clinical and regulatory risk. The Food & Drug Administration, or FDA, is yet to approve such a treatment. Nonetheless, a solid patent portfolio underpinning its proprietary mesenchymal precursor stem-cell and mesenchymal stem-cell platforms could form the basis of a moat should clinical trials currently underway render positive data and lead to FDA approvals.
Our fair value estimate on Mesoblast is AUD 7.00 per share. Our valuation methodology incorporates risk-weighted net present value analysis of the company's drug development pipeline including the nine clinical trials now ongoing. A phase III trial in congestive heart failure partnered with TEVA is the most important of these being pursued with the MPC platform and represents the largest component of our valuation. Typically, we anticipate Mesoblast earning in the range of 30% to 50% of gross margin. The cost of equity applied is 13% with near-term revenue potentially commencing in 2016 from a launch of the MSC-100-IV candidate, subject to FDA approval.
Risk 03/23/2015
Mesoblast is subject to typical biotech company development risks, including unpredictable outcome of clinical trials, regulatory decisions, and commercial risks associated with the potential introduction of a new class of therapy. Near-term challenges include manufacturing scale-up of product for use in clinical trials and associated product quality issues.
Management 03/23/2015
We award Mesoblast a Standard stewardship rating. Mesoblast has emerged as the global leader in the area of stem-cell therapy development. The company has also raised AUD 379 million since listing on the Australian Securities Exchange in 2004. Notwithstanding the large clinical trial in congestive heart failure, which is currently underway and is being fully funded by co-development partner Teva, capital raised has been used to support multiple clinical programs and allowed for opportunistic acquisitions such as Osiris Therapeutics in 2013. In our opinion, capital has been well invested in terms of funding research and development and making appropriate strategic acquisitions which have proved to be complementary to the existing intellectual property portfolio. However, with clinical trials still ongoing, the company has yet to generate earnings from the original mesenchymal precursor cell platform.
Professor Itescu has been in the role of CEO since the company listed, after working as a physician scientist in the field of stem-cell biology, autoimmune diseases, organ transplantation, and heart failure. He is an active faculty member of Melbourne and Monash universities in Australia and was previously a faculty member of Columbia University in New York. His experience garnered in advisory roles for various international pharmaceutical companies, and biotechnology and health-care investor groups, underscore a series of transformational deals for the company, including strategic alliances and partnerships with Cephalon (now Teva) and Lonza.
The management team is well credentialed with a mix of commercial and medical expertise, and is led by CEO Professor Silviu Itescu. The six-member board, which includes the CEO, comprises largely independent members. Executive salaries appear reasonable and comprise base salary together with short- and long-term incentives. The CEO's salary includes a cash bonus linked to performance.
Overview
Profile:
Mesoblast is developing adult stem-cell therapies based on its proprietary mesenchymal precursor stem cell, or MPC, and culture-expanded mesenchymal stem-cell, or MSC, technology platforms. It has nine clinical trial programs across four major areas (cardiovascular, spine disease, immunologic/inflammatory and cancer) targeting chronic diseases affecting large populations.
MSB Price at posting:
$3.28 Sentiment: None Disclosure: Held
(20min delay)