@Cato I agree! Plenty of upside when the big generalist funds start to buy!
Please note, that some of these issues have been covered in previous notes, and that I try to keep my number of posts low and the comments try to be value adding, so if you really want to understand these things in more depth, go back through the previous posts - there's something for everyone!
I also often get asked where I get the short lending data from. I get it direct from the 3 main brokers who do this - UBS, Morgan Stanley and Credit Suisse. I don't give out individual details on any of these positions save for making a few general comments, and even then only if there's some new or worthwhile to say. At present, there's still hardly any availability of stock to lend and I suspect that if the shorts are covering a few hundred thousand shares they are probably paying to keep the option of reshorting, so that covered short stock isn't making its way back out to be available to lend to other shorters.
So, Cato, to answer your question, it should first be noted that, according to MSB's website, Insto, Mutual Fund and Insiders already own 83.3% of the company, leaving only 16.7% for retail holders:
Despite the already large commitment by insto's, mutual funds and insiders - most big generalist funds still don't own MSB. This note considers why this is the case, and whether it could change
Considerations for big funds
1. Rules and restrictions - eg profitability, cash flow, debt ratios, dividends, stock and sector limits etc
2. ASX200 Index inclusion
3. Liquidity
4.
What other funds are doing
5. Catalyst such as price performance, announcement
6. Investment "thesis" - reason for buying
1. Rules and Restrictions
Many big funds have limits built into their funds to avoid risky stocks and to limit volatility in their portfolios. That means they can't buy MSB yet, but as it matures, it means more of these funds will be able to buy in the future - supporting the share price for several years as profitability and dividends eventually arise.
Some exclude stocks which don't have a track record of paying dividends, some insist on a track record of never reducing their dividends. Obviously they won't be buying MSB for a while. It's inefficient for MSB to pay dividends without franking credits, and Australian profits and franking credits are some years away as prior year's tax losses are soaked up and as profits earned overseas don't attract franking credits.
The alternative is for MSB to pay off its debt (if the interest rate is above the cost of equity) and/or to do a buyback. They won't want the debt/(debt + equity) to go over say 20% at this stage of the company's development (ie pre-profits and pre-production/commercialisation of aGvHD). I previously said, when the price was only 9c above where it now,
that a further $US70m of debt could be justified, taking the potential total up to $US185m, which would be around 20% of total debt plus equity (at the current $US share price). Debt interest after US tax is below 12% which is below the cost of equity capital, so a limited share buyback would be more efficient for Aussie shareholders than paying an unfranked dividend.
So, I don't see MSB entering the "regular dividend payers" world for several years yet, and that will force some funds to stay away no matter good the technology looks.
Some funds will not allow companies which are unprofitable or are burning cash. Again, this means they can't buy MSB yet - maybe in 2021 or 2022.
Debt levels and interest payments are still quite low, so debt ratios shouldn't be a problem. EBIT/Interest cover ratios of at least 2x are common, as are the debt/(debt plus equity) ratio mentioned above. Obviously, MSB doesn't yet have a 2x Interest Cover Ratio, as it doesn't have EBIT and probably won't have enough EBIT relative to its interest bill until after the year starting June 2022 - so that means another chunk of the big funds can't consider MSB as an investment for another couple of years.
Stock and sector limits may be a constraint if they have large holdings in other health care stocks and don't want to sell them and realise taxable gains. That will depend on positions in individual funds.
There are often limits on the number of stocks you can own and liquidity limits and limits relative to index weight (most of which will be dealt with later). As an example, MSB is still tiny compared to CSL and a fund with a big position in CSL, RMD, COH etc may already be at its limit in number of stocks held and at a limit in the percentage of the fund in healthcare stocks. It therefore can't sell out of a CSL and replace it with MSB as big funds can't get the liquidity in MSB to replace CSL and you would be taking too big a risk.
On the other hand, if you only have a tiny holding in MSB, more in line with its sub-index position, the "gate-keepers" (asset consultants, fund researchers etc) would say you are distracted and wasting your time and research capability holding a stock which is less than, say, 0.25% of your fund and that you should be concentrating on your big positions. If you do this too often, they could recommend their clients sell your fund even if the small MSB position were to perform strongly.
So, those are a few reasons why insto's can be very slow to come into new stocks. However, once they start to become fashionable, the buying can last for years as these hurdles and Trumpian walls slowly melt away!
2. Theoretical considerations of entering the ASX200 Index
MSB is not yet in the ASX200. I think there's a reasonable chance they'll get there by March next year, but that requires averaging a price around $A2.35 over the 6 months from 1 Sep. Another partnering deal would push MSB well above this level, and the ongoing buying from the Grünenthal deal could well do it after digesting this first move up.
This ASX200 indexing is becoming more so as the industry continues to move into large industry funds such as Aussie Super, REST etc. I have detailed these trends previously. Boutiques are closing and being forced to sell their active equity positions, pushing down the stocks which are outside of the ASX200, and the money then moves to the big index funds who have little interest in buying outside the ASX200.
Why? Well you can get around 97% of the ASX300 by buying the ASX200, but you significantly reduce your transaction and management costs by buying 100 stocks less! Then if you benchmark to the ASX200, it doesn't matter if the extra small caps in the ASX300 perform better, they don't enter into your performance comparisons!
Australian Super's Ian Silk noted in June 2019 that he was "staggered" at the $A16 billion in cash inflows into the $A155 billion fund in the year to June. Their Balanced option holds just 22.8% in Australian shares, but that can vary between 10% to 45%. High growth holds 29.4% in Australian shares, Index Diversified" 32.1% and Stable is just 9.3%. Imagine that they decide to hold 22.5% in Aussie shares over time (although they have stated they will be reducing their Aussie weightings as they grow bigger) and that MSB's adjusted index cap is $A1 billion (at $A2.35, discounted by 15%) then MSB is around 0.056% of the ASX200. Aussie Super would then need to buy around 10 million MSB shares (or 2% of the company) for an index weight position. These are very rough figures and Aussie Super is much bigger than most other funds - but there are plenty of funds of a size 10% of Aussie Super and so most of them would need to each buy 1 million MSB shares for an Index weight position once it goes into the ASX200.
Can you imagine this amount of stock coming from retail holders, while shorters are trying to cover at the same time?
This is why you get big rises in share prices in the six months prior to stocks entering the ASX200 index.
Price considerations to enter the ASX200 Index
Note that the current rise post the Grünenthal announcement is similar to the rise in 2010 after the Cephalon deal. The current price rise is very different to any of the spikes in the past 3 years because this one is based on a big partnering deal, so a comparison with Cephalon is appropriate.
In the first month after Cephalon, the price rose from $3.30 to around $4.50 (after initially spiking as high as$ 5.34. A similar one-month percentage rise now would be close to $1.98 (close to where the price is currently trading).
The possible reasons for the similar price moves are that investors tend to act in a similar fashion to big announcement effects and that this current deal is almost as good as the Cephalon deal, but for a fraction of the global products being licensed (I have previously estimated that further deals could mean this set of deals are 2 to 3 times better than Cephalon in total).
In the first three months of the Cephalon rise, the 3 month (60 day average) share price rose from $A2.67 pre announcement to $A5.20; while the actual share price rose from $3.30 pre the deal's announcement to a $6.80 high over those first 3 months - on the way to its $9.95 high point.
See graph below of the 2010/2011 Cephalon period (the yellow line is the 60 day moving average; purple line is one month price period; red line is 3 month price period):
A similar 3 month percentage price rise now would see the 3 month average go from $A1.45 pre deal announcement to $A2.82 by the second week of December. That's not quite enough to get MSB in the December quarter ASX200 rebalance on 6-month average pricing (due to the previous 3 month average of on $1.45) - but would easily be enough to get it in the March 2020 rebalance, and the price could possibly even fall back to $A1.88 for the second 3 months and still get the 6 month average up to $2.35 by 28 Feb 2020, would be in the ballpark for qualifying for the ASX200 depending on price moves in other stocks.
An average price of $A2.35 gives a market cap (after the 15% ownership discount) of $A1 billion which would rank it around stock 179 and thus scrape into the ASX200 index. Once in the index, it would have to fall outside the top 220 in average price over 6 months to be forced out.
3. Liquidity Considerations:
MSB's liquidity is low due to the large insto and insider blocks of stock. Over the past year, average turnover is only 1.1m shares per day, and was only 388,000 per day for the 2 months from 11 July to just prior to the Grünenthal announcement on 10 Sep.
Insto's can't build a position with that sort of liquidity and they also can't get out if something goes wrong. So, for the big guys, their liquidity rules forbid them from buying no matter how good their valuation may be.
The recent increase in trading volumes will be a positive for future insto interest. Short covering will also eventually add to liquidity - and some of this can be forced as funds who want to take some profits recall their lent stock, forcing the shorts to buy back in the market as the big funds are selling. Then potentially the shorts may be able to reborrow from the new owners and reshort - create another round of trading in the market. So, shorts aren't all bad. In fact shorts are quite good in a rising market as they DO increase liquidity in those circumstances. The real problem with shorts is a falling market with a thinly traded stock - and then they can actually dry up liquidity by causing huge price drops on small numbers of shares - that's why shorts tend to put out "research" reports at the same time - which are effectively marketing beat ups gaining a lot of media attention and attracting new clients into their short funds while often spreading rumours on the stocks they're trying to beat down. I guess long funds go the opposite way, and the ASX and ASIC are potentially there to stop fake news, but it is much easier to cause a panic on a falling stock than to cause a price to rise dramatically on fake news.
Liquidity going forward - A bit of profit taking is natural after a first big rise, typically there's more to go - but where are new insto's going to find stock???
A 50% plus price rise post Grünenthal announcement will naturally attract some trading and profit taking ($1.455 to $2.23). It is slightly surprising that this rise and correction is so far outperforming the initial rise post the 2010 Cephalon deal, and appears to be well supported around $A2.00, only a 10% correction from the first rise.
At current prices around $A2.00 ($2.04 today), most holders who bought in the past 1, 3 and 5 years are in profit, so there may naturally be some more profit taking to digest before the price moves ahead - though in previous big runs that first correction period has only lasted around 4 weeks before the next big run starts. Also, the volumes have dropped off dramatically in the past few days, to be in line with the average volumes in the past 12 months - so profit taking seems to be already abating.
The volume weighted average price paid by investors over the past year is $A1.58; over 3 years is $A1.63; the past 5 years is $A1.86 and since MSB listed is $A3.07.
I took the average of the daily Open, High, Low and Close prices and multiplied that by the volume traded each day to get these figures. So, for those waiting for a profit before they sell, people buying in the past 5 years will be already taking advantage of the current rise. That's why most of the rises in the past few years have seen around a month of profit taking after the first spike higher, before the next upward spike happens.
The next move then depends on whether the good news continues (as in the case of Cephalon deal) or whether there is a capital raising/major placement or selldown of stock or a bad perception of how the technology or cash burn is going.
So, if we consider the insto, mutual fund and insider holders in the MSB website table as long-term supporters (and most instos and insiders have been in there for at least 5 years), then they are not likely to provide much selling and there just isn't much opportunity for other insto's to buy in, unless they push the price dramatically higher to try to shake some of these long-term holders out.
Most of the existing holders would have valuations around the US analyst average of $A3.90 per share (though those forecasts are being upgraded post Grünenthal) and some of the beliebers will be looking for more than $A5.00 per share if they follow valuations like Bell Potter's (just over $A5) and Cantor FitzGerald's $US23 per MESO ADR (or $A6.80 per MSB share).
Notice the TipRanks average price of 5 analysts below at $US12.50 per MESO ADR. Marketwatch.com is higher at $US13.05 (or $A3.90 per MSB share) using 8 analysts. The main point though is the big upgrades in the past month - of which more to come!
Furthermore, there is another 5.4% of the capital (or 26.9 million shares) in "frozen buying" which has been shorted. If the big holders don't sell, and there's no equity issue from MSB, then the only way they can cover that short is buying 32% of the total retail holdings. The shorts only covered 370,00 shares of their Net Short position in the big volume between the Grünenthal announcement and last Thursday, and the Gross Shorts have dropped off again since then - so we can conclude that virtually nothing has changed for the shorts since Grünenthal. The retail sellers and any loose insto holdings who were going to sell on the price spike have probably done that in 12 trading days since the announcement - in fact most of the volume was in the first 2 days (over 12m shares total in those 2 days combined). Volume in the past 3 trading days has averaged 1.147m per day, which is close to the average volume of the past year (1.13 million shares per day average past 12 months). Today was only 0.9m and that included unusually large buying on close of 179,000.
4. What are other funds doing?
Very few analysts and fund managers want to take a risky position in a stock after a big price rise unless most others are doing it - particularly in an illiquid, small cap, loss making stock which has been burning cash! Where's the upside? If it goes down, everyone says "you should've known better" and it doesn't even matter to your portfolio or the index - then you are in a politically dodgy position, with others after your job and your bonus. Very few analysts or portfolio managers at big conservative funds will take this sort of career or bonus risk on a stock like MSB - though they may in later years when it is no longer small, illiquid and loss making.
Even if a stock like that doubles or triples, if it isn't in the index it doesn't hurt your fund's relative performance if you don't own it. Of course, after it enters the index it's a different matter, and your performance can be significantly harmed if it continues to rise and you don't own it.
That's why the maximal pressure would be applied to funds if MSB just rose slowly from here and averaged around $2.35 until Feb 28 next year. If there's still the chance of it running to $5 or more after it enters the ASX200, if profitability is turning positive and market cap and liquidity improve then funds will be forced to buy or risk underperformance on a big mover.
5. Catalysts - price performance, announcements, etc
Well this has already happened and we've noticed the big step up in volume since the Grünenthal announcement. That will involve buying by some funds who are early movers and have rules such as "price momentum" in their investment process. This can be seen as a variant of "what are other funds doing" but is more mechanical.
We've had a few spurts of positive price momentum over the past 3 years, seeing the price move up to $3 in early March 2015, up from $1.15 (or up 160%) two weeks earlier! Or from $A1.06 in Nov 2016 to $A3.40 in late April 2017 - up 220% in less than six months!
The funds who look for catalysts:
These price rises of the past 3 years fizzled for two main reasons - capital raisings/share selldowns or technology disappointment (often stemming from over-expectation or people misreading the trial results). I have argued that the Grünenthal announcement makes this rise different to the rises and falls of the past 3 years, and is more like the Cephalon deal of 2010.
Those who need a "catalyst" as well as price momentum can take out the following - Grünenthal gives technology credibility on the Chronic Lower Back Pain product from Europe's no. 2 pain company; Grünenthal's cash payments strengthen balance sheet and mean capital raisings won't be necessary. So, that's why "this time is different"!!
The combination of catalyst and price momentum is bringing some funds in while others are clearly taking some profits. The insto profit taking may simply be that the price move has taken the percentage weighting in the fund above the recommended weighting - that's fine, it gives us liquidity. The retail profit taking is obviously heavily weighted to people who think this is just another short term spike that won't hold (obvious because I keep reading people saying this on HC!!).
6. Investment "thesis" - "thematic investors" - "story stocks"
Some insto investors' investment process calls for a "theme" or "thesis" - I would argue MSB has always had that - but many insto investors are obviously still waiting to see it proved.
This is also called a "story stock" - ie a stock with a great theme or "story" - obvious for everyone to see that it has a great new idea, has a great market position, is a key player in an excess growth market etc.
Obviously, solving the world's back pain crisis, or heart failure deaths and serious hospitalisations, rheumatoid arthritis, diabetes etc etc with global blockbuster products could be a major investment thesis, within the general theme of growing worldwide healthcare spend at rates above GDP, ie a great "story" stock!
However, the big funds need proof positive before they will move on these themes and theses for MSB (a bit like the big pharma to date). Grünenthal's endorsement is a strong first step, other big pharma deals and FDA approvals would open up the "thesis" floodgates - and that's potentially not far away given the aGvHD BLA should be fully lodged with the FDA in the next month or so, and hopefully approved in 6 months or less from then. Positive results from the Chronic Heart failure trial by the end of this year and Chronic Back Pain in the first half of 2020 should add to the required "thesis" for these instos.
This is the end point of up to 5 years in these phase 3 trials (on top of the previous phase 1 and 2 trials) - the prize is just a few months away and could add significantly to the insto buying.
Bottom line
Despite the fact that most of the MSB stock is already tied up with insto's, mutual funds and insiders, the big generalist funds have not bought in.
They are probably kept out by a variety of fund rules regarding everything from balance sheet to market liquidity to ASX200 Index exclusion. They also probably don't want to move before other big funds into such a stock before it can prove its technology and that it is financially stable.
As we know, the Grünenthal deal answers a lot of these questions, but we still have FDA approval, phase 3 trial results etc over the next few months, and these very conservative funds will probably want to tick those boxes before taking the risk on MSB.
So, I don't think it's a judgement on the valuation of MSB, which has stayed up near $A4.00 from the average of US analysts and is in the process of further upgrades since Grünenthal. In fact, I don't think these funds would even be aware of the recent deal. It will take a while to filter through.
The smaller, agile funds (those that are left!) are probably taking advantage of prices which don't reflect the recent partnership.
The big funds are slow to move - but when they do, they trigger price rises, market cap rises, liquidity rises, probable inclusion into the index, and then more insto buying in the 6 months prior to index inclusion. After that there could be more buying over the next couple of years and profitability arrives, Interest Cover ratios etc start to tick boxes and general fund requirements are met.
By that stage, the last of the big funds will be buying index weight positions, the shorts will have covered, and the price could be squeezing well above the 12-month target of $3.90 (or Bell Potter's $A5 which I think more likely) and after a few years, could be on the way to $A20 IF similar sized partnering deals (to the Grunenthal deal) are done on US Chronic Lower Back Pain, US and European Chronic Heart Failure and other milestones are received from Tasly on the Chinese market.
As @Cato implicitly asks of the big funds, what are they waiting for?
(20min delay)