Perspective: We're in the home stretch - look at the big...

Perspective: We're in the home stretch - look at the big picture!

The filing of the BLA (Biologic Licence Application) with the US FDA was announced only 2 days ago. This is the most significant event so far in the life of MSB's science.

My sincere congratulations to The Prof and the whole team for their dogged determination since at least 2004. There have been moments of exhilaration and despair along the way, not to mention the difficulty of self-funding years of hugely expensive trials and repelling attacks from those determined to sow doubt for the sole reason of profiting from the destruction of the company.

Mesoblast has built an asset base of over 1,000 patents, has successfully concluded its first phase 3 stem cell trial in paediatric Steroid Refractive acute Graft vs Host Disease, having met the primary and secondary endpoints agreed with the FDA (the world's first autologous stem cell company to achieve this outcome) and has also completed large and expensive phase 3 trials in heart failure and chronic lower back pain. If these "blockbuster" phase 3 trials return similar results to the successful phase 2 trials, there should be major partnering deals completed - and MSB tell us they are in "advanced negotiations".

MSB has also significantly strengthened its Board and management in the past year, and has built a sales team to be able to start selling in the US later in 2020. MSB entered into a strategic alliance for clinical and long-term production with world leading biologic manufacturer Lonza 4 months ago and Alberto Santagostino, SVP Head of Cell & Gene Technologies, Lonza said: “Mesoblast is a true trailblazer, leading the way in developing life-changing cell therapies and working hard to soon make them available to large numbers of patients."

MSB has also been wholeheartedly backed by leading global stem cell researchers and clinicians (notably Dr Joanne Kurzberg of Duke University, among several others) and by global specialist biotech lenders Hercules and NovaQuest.

The strength of the patent portfolio has already been shown by the licencing agreements with JCR Pharma in Japan and Takeda/TiGenix in Europe. Royalties are now running at a rate of $US8 million pa just from JCR selling TEMCELL in Japan.

The "surprise" partnering deal with Grünenthal in September last year was another major step forward in
recognition and credibility and combined with the last equity raising in early October to ensure MSB's balance sheet is strong through 2020. The Grünenthal deal could eventually be worth over $US1 billion in milestone payments plus royalties, and this could be just the first of several big deals in heart and back pain in the US, Europe and Asia - each possibly as big or bigger than Grünenthal.

While these achievements have been years in the making, most of the recognition has only come in the past 4 months, and the read-outs from the big trials are expected in the next 5 months. So, the current period has been exceptional for MSB.

That has been somewhat recognised with the share price move from a multi-year low of $1 just over a year ago to $3 now. However, major international analysts have 12-month share price targets up to $A7.91 per share ($A7.53 fully diluted for options) - the highest being Edison. The 4 US analysts

(excluding Edison)​

who have updated their forecasts since last October, when most of these changes had occurred have an average price target of$US15.25 per MESO ADR, or $A4.50 per MSB share. Bell Potter are very close to MSB in Australia and have a 12-month target price of $A5.15, saying "MSB remains one of key stock picks for the year".

Most of the analyst valuations have heavy probability discounts applied to product success and also discount future cash flows at swingeing rates of 21% to 30% - yet in some cases they still get valuations and 12-month price targets north of $A5 per share. So, it just is not correct to say (as one disclosed short-seller does) that "it's all in the price" - Rubbish!

If everything goes well, and the probability discounts are reduced and the discount rate in the NPV calculation comes in at a more reasonable level, the analyst valuations could jump to multiples of their current levels (as I have demonstrated several times in the past). So there is still very high potential upside and most of the upside possibilities are definitely NOT in the price (as the analysts point out in their valuations, explicitly telling us how many product candidates and global regions are NOT yet included in their valuations).

Short term share price considerations

Well, for all those (like Madam) who have been waiting for MSB to stop burning cash and become commercially sustainable etc etc, you've missed the first big move from $1 to $3 in just over a year. I know you think you'll have plenty of time to buy when the cash burn ends, but even if you buy now at $3, you'll need it to go to $9 just to match the 3-bagger you've just missed. The odds are that you probably actually won't be buying your first tranche until it is higher than $5.

As for those who are short, I'm mystified! It's a very dangerous game you play, with very limited upside (from a price fall - maybe $1 at the most) and almost unlimited downside (share price could easily go to $5, and maybe $10 or $20) - the risk/reward for shorts looks awful. Surely there are better shorts out there!

Maybe a very quick short opportunity existed when the price went "parabolic" above $3, but there have only been pennies in it and you had to be very quick to book a gain (which people don't seem to have done).

I'm frankly surprised that in all the panic of the Chinese Corona virus a stock which had risen as fast as MSB didn't have a bigger correction. A 61.8% correction of the breakout move from $2.40 in mid-January would have taken MSB's price back to $2.70 and traders could have also tried to force it into the gap in the mid-250's. I think this is what the shorters were aiming at - but, as usual, MSB refuses to play the game by normal traders' rules of thumb!

Interestingly, the US ADR price of MESO did a complete 61.8% retracement of the mid-January move (see the green line on the graph below for the rise from $US8.00 to $US10.88, and the red line for the retracement to $US9.10 (61.806% retracement!). Note also that there is no January gap in the US price:

I think the answer to the question of why MSB hasn't had a bigger pullback is the aggressive buying by at least one insto in the Australian market. In fact, the aggression of the buying marks it as either short covering ​

(unlikely, as the short position hasn't really moved), or a really big insto who needs huge volumes to make a difference in their portfolio, or a really aggressive medium-sized player (which is my best guess). Based on the number of shares bought, there is at least one really aggressive insto plus a few others building a position - if it were only one, they would've gone over 5% by now (and we may still get a substantial in the next day or so).

I think the recent pause in the price run and drop in volumes since January 24th is because the big buyer (or buyers) found a big seller and they have been negotiating a price where he was prepared to sell. So why keep buying in the market and supporting the price when there is a potential volume seller out there? Particularly when markets started panicking about the Corona virus. That allowed the buyers to negotiate a crossing price of $2.80 which was still above the Fibonacci retracement level and the mid-January gap.

The following speculation of who is buying and selling is guesswork, and could be wrong. Due to the number of shares sold and the timing and the price, I suspect the seller is Tasly. It could also be Alex Waislitz (unlikely), or LALP (Anthony Pratt - but he's a big believer and recently tweeted about the extraordinary prospects of MSB) or M&G (but they were recently prepared to buy more shares to support the company and seem rock solid) or The Prof (don't make me laugh). Nobody else has enough shares to cover the amounts crossed.

The bulk of Tuesday's crossing by Macquarie was a single line of 12m at $2.80, then a smaller line of 1.89m. I suspect that the seller was Tasly, who was recently able to sell for a profit (even after discounting the price by 5%) for the first time since they bought in. Tasly HK owned 14.46m shares and 13.89m were crossed in total. I suspect Tasly went into risk minimisation in the face of the Corona virus - who knows what other pressure they are under in China during this important health scare?

Tasly paid $US20m for its 14.464m shares at $US1.383 and whoever sold will receive $US1.88 - if it's Tasly then it is a profit of 36% in $US terms since 12 October 2018. Over the same period, the S&P500 is up 20% - so MSB has been a good investment for Tasly whether they sold or not. Tasly bought in at around $A1.95 and the AUDUSD is down about 5% over the same period - so the AUD price had to get to $A2.06 for them to break even. The price briefly got there in early Sep during the Grünenthal deal - it spiked briefly above $A2.20, then fell quickly back below $A2 in early Oct with the placement and then the long period of waiting for Capital to sell at $1.711. By late December, the price was back up to $A2.10, but Tasly would have to accept a discount of around 5% to get out, so would still book a small loss. Finally, in January the price rocketed up to a level where they could comfortably sell, and the Corona virus hit just at the time that Tasly would've been able to sell at a 5% discount and still book a profit - it looks like they took the conservative approach and grabbed a profit in the face of a "grave" Chinese health emergency (as declared by WHO and their own president). THIS IS ALL SPECULATION ON MY PART.

This is somewhat similar to when Capital panicked and sold at $A1.711 (a 5% discount to the then price) after US President Trump caused a three day 3% high-low fall in the US markets in December, saying that the US-China trade deal might not arrive before the 2020 Presidential Election and signing a pro-democracy bill in Hong Kong and also caused further uncertainty about a renewed tariff war with Latin America and Europe. These worries would've been very close to home for Capital, directly affecting American investors, just as Corona virus would've been very close to home for Tasly (affecting Chinese companies), and may have been the final straw to tip them over the edge and sell.

These are things which rattle markets in the short-term, yet have no possible impact on Mesoblast's long term cash flows or their discounted NPV. Whoever is stepping in and buying these lines of stock from panicky insto investors is very smart and obviously has a much higher valuation and big cojones (that's why I've got a pretty good idea who at least one of the buyers is!).

It looks like there were 2 buyers in the crossings by Macquarie this week - the aggressive guy took a neat 12m and someone else cleaned up the balance. It could've been another client, or it could've been Macquarie taking up the balance "as principal" - that would be unusual in a stock this small unless they had another buyer lined up or some sort of comfort that they could sell it again quickly (index inclusion? announcements due soon?), or that the shorts etc were out of the way. I'll let everyone put 2 and 2 together regarding aggressive fund managers and former links to Macquarie, I won't be regaling you with my suspicions, but there's a good chance it's someone who has been active in the stock in the past!

To see how the buyers were playing the game, the volume dropped off at the end of January to 1.2m and 1.3m shares, after 7 days in January of around 4m shares traded per day. Average volume in 2019 was 1.1m shares per day - so it looks like the big buyer(s) were buying around 3m shares per day, and he/they dropped right out on Jan 30 and Jan 31st. On Feb 3rd, at the peak of the Corona virus scare, the volume ticked up to 2.6m shares as the price fell to $2.81 - maybe the big seller started selling in the market that day (that's why the crossing may have been slightly below Tasly's total disclosed holding) - and then the seller was bid for and completed the big line the next day at $2.80 - they possibly felt it was a good deal to move such a big line only 1c below where they may have been selling the previous day. A line of 12m shares at a big discount to the recent high of $3.21 was also a coup for the buyer - especially as it possibly amounted to 4 days of heavy buying that would've undoubtedly driven the price higher. You've gotta dip your lid.

The very low range of closing prices since Jan 28 (when it appears the big buyer(s) started standing back) has been $2.94 to $3 over 7 trading days - which is a tiny range of 2% for a volatile stock like MSB, vs a range of 1.4% over the same period for the ASX200, especially during the Corona virus scare. In the previous 7 trading days, MSB rose from $2.40 on Jan 16 to $3.07 on Jan 24 (up 28%) vs ASX200 up 1.3%. Since Dec 31st, MSB is up 42.3% vs ASX200 up 4.4%.

The lack of a pullback in the MSB price is truly remarkable after such a strong short-term rise, and with the major buyer apparently dropping out for a few days, and during a period of global panic. It must have the shorts totally bamboozled.

There may be an announcement eventually if Tasly has sold out, and the shorts will try to beat it up into another reason to sell. Tasly are/were less than 5% of the company (only 2.7%) so they don't have to lodge a substantial, but we'll see if it was them in the next Top 20 Shareholders list. It was never a major holding for Tasly and they had not increased their holding when the price was low, so I was not thinking that the shareholding was a major component of their relationship with MSB. I had disputed with Madam that Tasly would sell at a big loss when their stock came out of escrow last year because I thought why lose face and take a loss, especially if you have long term plans to partner with this company. Those plans appear to be moving very slowly, with hardly any information released about planning for trials in China etc - however MSB did reference China in the recent Ryoncil BLA submission announcement, saying MSB "...has established commercial partnerships in Europe and China for certain Phase 3 assets" - so MSB still thinks China is worth mentioning.

A reality check for the shorts who may try to jump on this - have a look at the analysts' valuations of MSB - nobody has anything in their valuations for China anyway, it isn't guaranteed that Tasly was the seller (just my speculation based on the number of shares and the public pronouncements of other major holders) and even if Tasly sell their small equity stake it doesn't mean they can't still work together with MSB to develop the Chinese market (they still have a partnering agreement under which they have paid MSB an initial $US20m, with a lot more to come subject to the 6 milestones in the agreement).


Bottom Line

1. The BLA announcement is a spectacular milestone in MSB's advancement to commerciality. It provides credibility in the science and the manufacturing processes. The FDA would not have let MSB get to this stage and MSB wouldn't have bothered submitting if they couldn't meet the requirements. The FDA have been receiving the rolling BLA for months and have had several opportunities to talk to MSB and review what is being submitted along the way. This last module is mainly administrative and tying up any loose ends. MSB's Board and management are experienced in this type of process, even if the whole stem cell approach is new to the FDA.

2. The recent share price performance shows very strong institutional support. Most of the profit taking as the price rose strongly and the "Corona virus" related selling appears to have been retail as CBA was the major broker involved (prior to the 2 crossings on Tuesday). Instos appear to have significantly increased their holdings during this share price rise at the expense of retail holders, and the buying by instos was obviously still strong right up until yesterday.

3. It is quite possible that Tasly was the seller on Tuesday, possibly provoked by taking profits which had just become possible right at the time that the Corona virus was casing a mini-panic globally and a huge concern in China. Tasly's holding was a small 2.7% of the company, Tasly had never shown any interest in increasing that holding and it does not have appeared to mattered much to them. They can now sell at a profit and avoid losing face. While there has been very little said about the China relationship, it appears to be ongoing and was recently referenced by MSB. Even if it stops, it isn't in any of the analysts' valuations of MSB's long term prospects, so should not affect NPVs or the long-term expectations of the share price.

4. Recent aggressive insto buying should become evident once a new Top 20 list comes out. Someone could also announce a substantial shareholding in the next day or so - the 12m share line from Tasly was 2.23%. If they also bought a large chunk of the Capital selldown of 27m shares, and were responsible for multiple big volume days in January, they could easily be close to 5% (or through 5%). So, with the 37.5m share placement and the Capital line of 27m shares, it appears there has probably been more than 1 big buyer, but at least one of them has been very aggressive!

5. In response to people asking how you can value a company with no current revenues and which is burning cash, I'll give a very brief response as I don't think it is a sensible query, rather it is meant to stir people up. The whole of finance theory is built on time value of money - money which can be forecast to be received in the future has a value today - a promissory note for an amount in 1, 2, 10 or 100 years has a discounted value today. The Net Present Value (today) of future discounted cash flows depends on how far out the cash flows are and the discount rate you use. Analysts have valued MSB's estimated future cash flows and come up with values mentioned above in this note. The US analyst average (of the 4 who have updated valuations since October) is $A4.50 per MSB share. Bell Potter is $A5.15 and Edison is at the high end at $A7.92 ($A7.53 diluted for options). Those analysts have predicted peak sales on the blockbuster indications (or product candidates) of $US3 billion to almost $10 billion. Then they heavily "probability discount" the profit streams to account for the risk that these products may not succeed, then they apply very heavy NPV discount rates on long term cash flows, which reduces them dramatically. Yet they STILL come up with valuations around $A5.00!!!

6.

If/when everything goes well, and the probability discounts are reduced and the discount rate in the NPV calculation comes in at a more reasonable level, the analyst valuations could jump to multiples of their current levels (as I have demonstrated several times in the past) and as the recent research notes by the analysts have started pointing out. So there is still very high potential upside and most of the upside possibilities are definitely NOT in the price (as the analysts point out in their valuations, explicitly telling us how many product candidates and global regions are NOT yet included in their valuations). Downside may be limited to around $A2 where Edison recently said the share price could be supported by aGvHD indication alone - even if all the other blockbusters fail. So, the risk/reward trade-off remains highly skewed in MSB's favour.​

7. There are still several large potential announcements due in the next 6 months. These include the phase 3 trial results in blockbuster back pain and heart failure indications. They include the possible acceptance by the FDA of the BLA and then the possible approval of the BLA (I'd say probable given the FDA process so far and trial results). They also include possible partnering deals of the blockbusters back pain in the US and heart failure in the US and Europe - all of these should generate upfront fees of at least $US100m each, with longer term milestone payments which could exceed $US1 billion each (as in the recent Grünenthal deal).

8. Sure, small pullbacks in the price are possible and nothing (not even CSL) goes up in a straight line - but (in my view) the easiest way to play this one is to stay long until the price is well above the analyst valuations (because those valuations are likely to rise as milestones are met and as the share price rises - the analysts are already signalling this!). There will always be a few traders who make a few pennies on selling and buying back or shorting etc - but as we've seen in the past year, the big money has been made by those who just held on!

So, as I said at the start,

Perspective: We're in the home stretch - look at the big picture!​