MPCs as a commodity. Bleeding obvious., page-3

Hey Ben, I loved your post and it got me thinking.

I think it's even better than that! You have described beautifully what is happening out there, I'd just characterise it differently to a commodity.

I wouldn't call a highly specialised and highly regulated product a commodity. Especially when it is patent protected and it is not in general use yet. It also has very high barriers to entry (research and cost of trials) and has further protections because once it becomes the standard of care, competitors would have to have a step change in efficacy for the FDA to grant approval to them - and that is going to be very difficult given how high MSB's efficacy already is. This gives MSB a huge first mover advantage. Given these barriers to entry, Mesoblast can charge a much higher price and earn much higher margins than a typical commodity producer.


It's not a commodity like coal or iron ore which can be dug up and shipped anywhere in the world and the winner is the guy who processes it cheaper than anyone else (and even these products have premium prices for premium grades). It could be more akin to a company developing a much lower cost or more efficient patented production process which is then licensed to commodity producers and they sit back and reap the benefits, with licence payments tied to the volume or value of production - "clipping the ticket" as you say.

So is it more like a franchisor operating with very high margins and supplying the "special sauce" or the "11 different herbs and spices" or the "syrup" (in the case of Coca-Cola) - yes, it has some aspects of a franchise operation - with geographical limits on where franchisees can operate and so it is very attractive for early franchisees to get in now and tie up as much area as they can. With MSB the "area" comprises both geography and type of indication - so they can make sure their franchisees are specialists with the expertise to service each individual market, thus maximising the value of the partner company's experience and sales force. But it's better than that too, as normal franchisors still have to compete in an area with products that may be close substitutes, so limiting their profits and thus limiting the amount the franchisor can charge them. MSB has no close substitute for most of its indications. I think that this will result in a scramble for franchises once big pharma realise the game has started. The Prof has been negotiating hard so far, and the big pharma have been reluctant to pay his price before seeing phase 3 results for the big indications - but Tasly have broken the seal, and more are likely to follow suit once one has moved - if you don't grab the geography when it comes available (see Jack Cowin as an example), you are frozen out of what could become one of the biggest growth areas of the global pharma market.

I thought a bit more and realised that it is even better than that, because the products being produced with MSB cells are also not commodities, but are patent protected themselves, and they aren't like normal franchises because they often have close substitutes. It's much better than setting up a KFC in Lakemba, when someone else can set up in Wiley Park or Campsie and someone else can buy a MacDonalds franchise nearby - there are no near substitutes in stem cell land.

So is it a monopoly, which is capable of generating monopoly profits? Yes! And the profit forecasts, analyst 12-month price targets and NPV calculations reflect that (in a big way – see my calculations below). Eventually, like most monopolies, the patents will run out and profitability will revert to more normal levels, but we're only just reaching the starting line, so there's plenty to go yet. Monopolies earn monopoly rents - and the time to be in them is when they are starting out (think Andrew Carnegie or J Paul Getty)- especially when the market hasn't priced in their enormous potential upside.

But what I really think that MSB is like is if the guy who invented the circular wheel had patented it, then licensed it to a range of enterprises, each of which had a specialised use for it in a limited region. It has no close substitute. It is a completely new technology, it will put other technologies (like the triangular and square wheel) out of business, making them too expensive to compete and it will be much more efficient and effective.

Mesoblast is on another level – it is curing diseases rather than just masking symptoms. It fills a pre-existing need which can't currently be met - they don't have to create a market, they don't even really have to advertise it - people will flock to it (they already have a 50% market share in Japan for steroid refractory aGvHD)- parents with children dying of steroid refractory aGvHD, adults dying of heart disease, people with debilitating chronic lower back pain who don't want to become opioid addicts, people crippled with rheumatoid arthritis, and the list goes on.

We are probably only scratching the surface with our current forecasts of how revolutionary Mesoblast's cells may become. All analysts are too conservative to put their “unadjusted” forecasts for cash flows and valuations into their price targets as the numbers look ridiculously large - so they apply probability of success factors of only 30-40% on some of the bigger, longer term indications and then discount the cash flows by 15-30% pa (depending on the analyst). That sort of adjustment could mean a payment of $1m in 10 years time is worth as little as $21,761 in a Net Present Value calculation (e.g. if you are using a 30% probability of success and a 30% NPV discount rate).

I have done some sensitivity analysis on the actual analysts’ cash flow valuations of MSB. I'd argue that high discount rates and probability adjustments are a way to pull mind-boggling numbers down to more “acceptable” levels. In one example, a probability adjusted after tax profit stream from 2020-2030 is discounted at 15% to give an NPV of $US2.3bn. I found that if you just lower the discount rate to 10%, the NPV rises to $US3.47bn. If you don’t apply a probability adjustment and use a lower discount rate of 10%, the NPV rises to $US9.0bn – and these figures are all before including anything for this week’s China licence. Just as an aside, these cash flows would give an $A 12-month target share price range of $A6.45 to $A25.25 before taking China into account. It really is mind-boggling!

These figures show the huge differences you can get in an NPV valuation depending on the probability adjustment and discount rate used. All the underlying assumptions on market share, royalty rates, costs, etc are kept the same – yet we can get a range of $US2.3bn to $US 9.0bn. And as Madam has shown in his calculations on Friday, it can be pretty easy to be out by a factor of 1,000x! (Just a bit embarrassing when you repeat it, emphasize it, asterisk [*] it, bold it and point out that “it’s not a typographical error”).

So, we've invented the wheel, and we're patent protected and we're just starting to franchise it out in a controlled manner to the people with the best ideas on how to capitalise on it (we may even make and sell a few specialist products ourselves). There will be a land-grabbing scramble when others realise what's going on and they fear being shut out. How's that square wheel going for you at G**** & Shad Industries? We’re in the driver’s seat, we own the wheel and everyone else needs it – they just may not realise it…yet. Let's enjoy the ride!!