mesoblast price target raised to $14 from $12 , page-2

Mesoblast Limited Buy
(OTC: MBLTY-5 ADR AUX – $5.57)
Understanding the Mesoblast Acquisition of Prochymal; Raising our Price Target to $14.00, from $12.00
? We spent time last week with Mesoblast CEO, Professor Silviu Itescu. After delving into many issues, we left our meeting with much greater clarity as to the strategy behind the acquisition of Prochymal, the clinical path forward in GvHD and Crohn’s disease, and the company’s manufacturing and commercial dynamics. We conclude that Prochymal represents a long-term accretive acquisition while creating a lot of near-term strategic value for Mesoblast as the true leader in the cell therapy space.
? Prochymal in GvHD. Data from prior Osiris (OSIR - $18.12 - NR) pivotal trials suggest that Prochymal significantly improved overall response rates in a subset of patients with liver and gut GvHD and also improved survival. It may be possible for Mesoblast to pursue U.S. approval based on existing data, with a small supportive target study in this patient population (gut and liver GvHD). We have now included Prochymal—R&D, SG&A, and revenues (GvHD only)—in our model, and the impact is accretive by year 2 of revenues (GvHD), based on our assumptions.
? Manufacturing. It is our understanding that there is ample supply of Prochymal (many thousands of doses) cryopreserved [manufactured by Lonza (LZGAF - $80.10 - NR)] in a robust, validated commercial production process. Over time, we do expect Mesoblast to shift manufacturing to its Singapore facility and migrate the process to a 3D (vs. current 2D) process. After our conversation with management, we want to dispel any notion that Osiris has or had a manufacturing problem. Mesoblast was emphatic that the process is in fact, “robust.”
? The original deal terms between Osiris and Genzyme (acquired by Sanofi (SNY - $50.10 - NR)): Genzyme made a $130 million up-front payment to Osiris, ($75 million paid initially and $55 million six months later, July 2009). The deal terms also positioned Osiris with the potential to receive up to $1.25 billion in milestone payments. Given these terms from almost six years ago compared to the current terms, we believe Mesoblast struck a great deal.
? Valuation. We have included Prochymal in our model, and the impact raises our valuation to $14.00, from $12.00. Our 12-month price target for Mesoblast Limited is based on a triangulation of our three metrics, all equally weighted—free cash flow (FCF), discounted EPS, and sum of the parts (SOP) models—which point to a $14.00 price target.
Biotechnology10/15/2013Closing Price (10/14/2013)$5.5712-Month Target Price:$14.0052-Week Range:$4.87-$7.72Market Cap (M):$1,593Shares O/S (MM):286 Float (MM):257Avg. Vol. (000)879Debt (M)Dividend/Yield:$0.00/0.00%Risk Profile:FYE: DecemberEPSP/E2011A($0.17)nm2012A($0.31)nm2013E($0.26)nmMesoblast (MBLTY-5)Source: Thosmson Reuters as of 10/14/2013Jason Kolbert(212) [email protected]$0$10$20$30$40$50$6005/11/201107/11/201109/11/201111/11/201101/11/201203/11/201205/11/201207/11/201209/11/201211/11/201201/11/201303/11/201305/11/201307/11/201309/11/2013
Mesoblast Limited (AUX Exchange – MSB, OTC: ADR MBLTY-5)
Maxim Group LLC 2
Exhibit 1. A Masterful Manufacturing Process: Donors undergo extensive screening and quality checks and are monitored for up to five years after donation. The most viable cells are then isolated from the donor samples and put into the Osiris-Lonza manufacturing process, where they are expanded. The cells are then cryo-preserved and packaged with additional quality checks along the way.
The Original Deal Terms with Genzyme: Under the original Genzyme-Osiris terms of the agreement, Genzyme made a $130 million up-front payment to Osiris ($75 million paid initially and $55 million six months later in July 2009). The deal terms also positioned Osiris with the potential to receive up to $1.25 billion in milestone payments from Genzyme as follows:
Osiris was eligible to receive up to $500 million in development and regulatory milestone payments for Prochymal related to GvHD, Crohn's disease, and other potential additional indications that the companies developed together. Genzyme could commercialize the companies; two lead products (Prochymal and Chondrogen) outside the U.S. and Canada and excluding Japan (Prochymal was licensed to JCR Pharmaceuticals, where Osiris would receive milestones and royalties). Additionally Osiris paid 40% (Genzyme 60%) off all R&D and clinical programs in phase III or later.
Prochymal: Based on sales in Genzyme territories, Osiris was eligible to receive up to $250 million in sales milestones for Prochymal as follows:
o $100 million payable when annual sales reached $500 million and $150 million payable when annual sales reached $1 billion.
o Osiris was eligible to receive up to $500 million in development and regulatory milestone payments and up to $250 million in sales-based milestone payments, as follows:
o Total development milestones related to GvHD of up to $50 million, with $25 million payable upon marketing approval from the United States Food & Drug Administration (FDA), and $25.0 million payable upon marketing approval from the European Medicines Agency (EMEA).
o Total development milestones of up to $180 million related to Crohn’s disease and ulcerative colitis, with $50 million payable upon achieving statistically significant endpoint(s) in a Phase III clinical trial for Crohn’s disease, $100 million payable upon marketing approval by the EMEA for Crohn’s disease, $10 million payable upon achieving statistically significant endpoint(s) in a phase II or phase III clinical trial for ulcerative colitis, and $20 million payable upon achieving marketing approval for ulcerative colitis by the EMEA.
o Total development milestones of up to $270 million related to the development of follow-on indications for Prochymal, with $20 million payable upon each success in a phase II clinical trial for acute myocardial infarction, type 1 diabetes, or other follow-on indications, and $40 million payable upon receipt of each marketing approval by the EMEA for Prochymal for chronic obstructive pulmonary disease (COPD), acute myocardial infarction, type 1 diabetes mellitus, or other follow-on indications.
Mesoblast Limited (AUX Exchange – MSB, OTC: ADR MBLTY-5)
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In comparison, Mesoblast’s recent terms: Approximately $20 million in cash and $15 million in stock (upon transfer of the assets) and an additional $50 million (stock), contingent on certain U.S. and EU regulatory milestones being achieved with an additional royalty (single digits to a maximum of 10%) on revenues north of $750 million for an approved product (Canada and New Zealand) and a strategy for a near-term U.S. approval in GvHD. We believe this is attractive.
What is Graft vs. Host Disease (GvHD)? It is a life threatening autoimmune condition that occurs when donor cells (as a result of a bone marrow transplant) attack the recipient’s organs and tissues. It is considered to be a common complication of allogeneic bone marrow transplant. GvHD tends to be more severe in patients receiving mismatched transplants from family members or unrelated donors. GvHD can be thought of as two diseases: acute GvHD and chronic GvHD. Patients may develop one, both, or neither. Acute and chronic GvHD differ in their symptoms, clinical signs, and time of onset. Acute GvHD usually occurs during the first three months versus chronic GvHD, which usually develops after the third month post-transplant. The mechanisms are different. In acute GvHD, it is believed that T-cells present in the donor's bone marrow from the time of transplant identify the patient’s own cells as "non-self” and attack the skin, liver, stomach, and intestines. The earliest sign of acute GVHD is often a skin rash that usually first appears on the patient's hands and feet. This differs from chronic GVHD, in which newly produced T-cells are the causative agent, according to opinion leaders. Chronic GvHD patients typically experience skin problems that include a dry itching rash, a change in skin color, and tautness or tightening of the skin. Partial hair loss or premature graying may also occur. Both acute and chronic are debilitating and life threatening. Current treatments use immunosuppressive medications on average from one to three years. In steroid refractory GvHD, mortality rates approach 80%.
Exhibit 2. Prochymal – Acute Graft versus Host Disease (GvHD): Acute graft versus host disease (GvHD) can be a life threatening complication that arises in approximately 50% of all patients who receive a hematopoietic stem cell transplant (HSCT). Allogeneic HSCT are used for the treatment of diseases including hematological malignancies, certain forms of anemia, and immunological deficiencies. The transplant is derived from donated bone marrow, cord blood, or peripheral blood. GvHD occurs when immune cells in the donated cell population attack the recipient cells because the recipient cells are seen as “foreign.” Organs that are mainly affected by the immunological attack are the gastrointestinal (GI) tract, skin, and liver. As stated, GvHD occurs in up to 50% of patients, and symptoms generally appear within 100 days of transplant. GvHD may affect the patients’ organs and tissues including the digestive system (GI tract), skin and liver. Mesoblast believes by focusing on GI and liver alone (based on results and post-hoc analysis of existing data) that efficacy is present.
Colon Endoscopy’s of GvHD patient before (left) and after, (right), post two weeks, treatment with Prochymal, Source: Osiris
Endoscopy results comparing colon health from a GvHD patient prior to (left) and two weeks following Prochymal treatment (right). At the time of Prochymal infusion, this patient was unresponsive to all other modes of intervention. The circled area in the left panel marks an ulcerative lesion.
Mesoblast Limited (AUX Exchange – MSB, OTC: ADR MBLTY-5)
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Exhibit 3. Interaction of factors involved in GvHD process: Cytokines such as IL-1, IL-2, Tumor Necrosis Factor – alpha and gamma Interferon play a role in the initiation and propagation of GvHD
Source:eMedicine.medscape.com (http://emedicine.medscape.com/article/429037-media)
What does Prochymal Do? GvHD is a T-cell mediated inflammatory process that results in high levels of pro-inflammatory chemical signals called cytokines. These cytokines cause the unbalanced activation of certain immune cells that result in tissue damage. Delivered intravenously, Prochymal is able to target areas of active inflammation. Published data indicates that Prochymal is able to down-regulate the production of pro-inflammatory cytokines, including tumor necrosis factor-alpha or TNF-alpha and interferon-gamma. Additionally, Prochymal up-regulates the production of beneficial anti-inflammatory cytokines, specifically interleukin-10 and interleukin-4. When the stem cells found in Prochymal are delivered into an inflammatory environment, they appear to change the course of the disease by altering the cytokine secretion profile of the dendritic and T cell subsets, thereby resulting in a shift from a pro-inflammatory to an anti-inflammatory state and arresting disease progression. Furthermore, data indicates Prochymal may also promote the regeneration of tissue structures damaged by GvHD.
Background on Prochymal: The approval of Prochymal for GvHD in Canada and New Zealand marks a positive milestone for companies active in the cell therapy space. Previously, Prochymal had failed to receive approval for GvHD in the United States. However, we believe it is important for investors to understand that the U.S. trial failures may have shown utility in the most severe patients opening the door for a new Mesoblast driven strategy in the subset of acute GvHD patients. Investors should also note that Prochymal was used to treat, not prevent, GvHD. In certain GvHD sub-populations, Prochymal as we mentioned did show efficacy, which in part led to the approval in Canada and New Zealand.
What has the prior data shown? In May 2012, Health Canada approved Prochymal for the treatment of acute GvHD in children who fail steroids, affording eight and a half years of market exclusivity. The approval was based on the opinion of an expert panel that reviewed phase III data, showing that 61-64% of Prochymal patients experienced a clinically meaningful response at day 28 and a survival benefit in children over historical controls (p=0.028).
Phase III Steroid-Refractory Acute GvHD Trial (Protocol 280): The phase III trial evaluated the safety and efficacy of Prochymal in conjunction with standard of care for treatment of patients who had failed to respond to corticosteroid treatment for acute GvHD. The clinical trial was a double-blinded, placebo-controlled study. Patients were randomized to receive Prochymal or placebo at a 2:1 ratio in addition to standard of care. GvHD assessments were performed according to the International Bone Marrow Transplant Registry (IBMTR) grading scale. The trial enrolled 260 patients and treated 244 patients from 72 leading bone-marrow transplant centers across the United States, Canada, Europe and Australia.
Mesoblast Limited (AUX Exchange – MSB, OTC: ADR MBLTY-5)
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In February 2010, the data was presented by Paul Martin, M.D., of the Fred Hutchinson Cancer Research Center and Paul Szabolcs, M.D., of Duke University Medical Center at the 2010 BMT Tandem Meeting.
“Refractory GvHD is a devastating disease for which there have been no well-controlled studies demonstrating the safety and effectiveness of any therapeutic agent beyond steroids,” said Paul Martin, M.D. of the Fred Hutchinson Cancer Research Center, Professor of Medicine at the University of Washington and principal investigator for the steroid-refractory GvHD trial. “This rigorous study shows significant improvements in gut and liver GvHD above and beyond standard of care, and without additive toxicity. We now have clear evidence demonstrating the benefits of mesenchymal stem cell therapy in
the two most deadly and difficult-to-treat forms of the disease.”
Steroid-Refractory Gastrointestinal and Liver GvHD: Dr. Martin’s presentation entitled, “Prochymal Improves Response Rates in Patients with Steroid-Refractory Acute Graft versus Host Disease (SR-GvHD) Involving the Liver and Gut: Results of a Randomized, Placebo-Controlled, Multicenter Phase III trial in GvHD
Exhibit 4. Highlights from the abstract and presentation include:
Prochymal significantly improved response in steroid-refractory liver (76% vs. 47%, p=0.03) and gastrointestinal GvHD (82% vs. 68%, p=0.03).
In the sickest patients—those with GvHD affecting all three organs (skin, liver, and gastrointestinal tract), treatment with Prochymal resulted in a 63% overall response rate, while none of the placebo-treated patients responded (p<0.05).
Patients treated with Prochymal had significantly less progression of liver GvHD compared to placebo (37% vs. 65%, p=0.05).
Prochymal demonstrated a positive safety profile relative to placebo for key safety outcomes of interest, including recurrent malignancy (8% vs. 10%), infusional toxicity (2% vs. 2%) and discontinuation of study due to an adverse event (1% vs. 5%).
Source: Biology of Blood and Marrow Transplantation.
What is the market opportunity? Generally speaking, there are approximately 10,000 allogeneic stem cell transplants in the United States annually; that figure is rising, and the numbers in Europe are comparable.
Exhibit 5. GvHD market model: We assume a U.S. approval based on existing data sets may be possible in 2014. We also assume that approximately one-third of the market is GI, and liver GvHD and will be the target market for rescue therapy. We have not yet included Canada and New Zealand, nor have we modeled Europe or Asia (Japan), where Mesoblast now has an active partner. These geographies represent additional upside to our model with only incremental increase in cost (R&D and SG&A).
GI & Liver involved acute GVHD US20142015201620172018201910,000 US Allogenic stem cell transplants 10,137 10,501 10,863 11,223 11,580 11,934 Market Size Growth (Annual)0.9%3.6%3.4%3.3%3.2%3.1%% of GvHD Market: GI & Liver (30%)35.0%35.0%35.0%35.0%35.0%35.0%Target Market Prevention GI GVHD3,4233,6753,8023,9284,0534,177Market Share Penetration13.8%61.8%62.0%67.2%65.3%66.0%Number of Patients Procedures2791,2462,3592,6412,6452,757Cost of Therapy 175,000$ 175,000 175,000$ 175,000 175,000$ 175,000$ Price Growth0%0%0%0%U.S. Annual Sales49$ 218$ 413$ 462$ 463$ 482$ % Growth (qtrly)0%4%Source: Maxim estimates
Mesoblast Limited (AUX Exchange – MSB, OTC: ADR MBLTY-5)
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VALUATION
Our valuation metrics for Mesoblast are “mechanically” based on free cash flow (FCF), discounted EPS, and sum-of-the-parts (SOP) models. We assume a 30% straight royalty net of COGS from partner Teva (TEVA - $40.36 - Buy), we understand this could be low). In our income statement model, we now include revenues from Prochymal, but only for U.S. GvHD. We also model increases in R&D and SG&A costs. Approvals in Europe or in Japan represent only a small incremental rise in spending but substantial increase in revenues; because of this, we believe our assumptions are modest. We have not included Crohn’s disease (revenues), and, again, only an incremental rise in costs would be associated. For the cardiac products (Revascor), we model Revascor (beginning in 2017). In orthopedics, we include back pain (only); if we added in spinal fusion, the numbers would be substantially higher (for conservatism, we exclude it)—as we also exclude the $1.7 billion in milestones that are part of the agreement with Teva.
Our discount rate is set at 30%, which is typical for a company with phase III and multiple phase II products. In order to compensate for the binary risk associated with trial results, we apply a “probability of success” to our revenue models (60% for P3; 50% for P2). If we don’t apply a risk adjustment, given the size of the markets, the revenue and subsequent valuation numbers become too high to be credible. While we can model market size and opportunity and apply risk calculations, we must heavily weigh all the data to have a feel for the opportunity. This is our most important metric, but not one that can be easily quantified.
Our analysis suggests that the current trial data, the partner commitments, the science, its credibility, and the weight of supporting scientific published reports support our belief that this technology can work. Selecting cells via STRO-1 marker, which is only expressed on the earliest precursor mesenchymal cells, is itself unique. These cells appear to have a mechanism of action that is both anti-fibrotic and anti-inflammatory/immune modulatory (via shutting down specific T-cell subsets driving autoimmunity). The tropic factors may be much more potent than MSCs found later down the line. This is the engine of the Mesoblast story.
We believe that investors view the valuation for Mesoblast as high at a ~$1.6 billion dollar market, even though it’s down from its peak of $3 billion. We encourage investors to consider the market opportunity for Prochymal in GvHD and Crohn’s disease and Revascor in CHF—not to mention AMI, CMI, and others. Add in spine (back pain and fusion), diabetes, and macular degeneration, and you can begin to understand the complexities of the company. Couple this with several years of operating capital and a financially secure global partner in Teva, which is paying for the cardiac trials. In our model, the cardiac indications include only the EU and United States, and we add in the spine (back pain—U.S. only). We do not factor in any other indications or territories, even though we know Teva is looking at this product globally.
We then apply this to derive out-year EPS of $6.66 in 2020. We then apply this to a discounted EPS model, a free-cash-flow model, and a sum-of-the-parts model. These metrics are equally weighted and averaged to derive a price target of $14. Our models (FCF and EPS) assume a 30% discount factor and, for EPS, a low multiple (10x) of earnings, both in the year 2020................. Cheers Vin