Valuations vs Price Targets…Or What Would You Pay For a Dollar...

Valuations vs Price Targets…Or What Would You Pay For a Dollar In The Future?
@col69 @Halime

Base case valuation for Ryoncil $A2 to $A3

There have been valid questions regarding my comment that the valuation downside for aGvHD was $A2-$3 per share. They point out that SR-aGvHD could ultimately be worth a lot more to the MSB share price – and I don’t disagree.

The $A2-$A3 base case was basically to answer the question "what valuation support is there if only paediatric SR-aGvHD gets approved by the FDA".

I am talking about a valuation NOW, based on a discounted Net Present Value (NPV) of future cash flows. In the future, it should be worth much more to the future price than this.

This is similar to when I say that MSB could sell for $200 (or more) per share in the future – that’s a potential price target at that time, and based on everything going right for Covid19-ARDS as a MSB blockbuster – it is not an NPV now.

The following valuations are just for Ryoncil as a standalone product – they are NOT valuations of MSB. If you want to assume that nothing else works, then the company’s value would be Ryoncil less the value of the ongoing corporate charges, interest bills and R&D costs of running MSB – however I presume that R&D costs would be reduced dramatically if nothing else were likely to work, and a much lower interest bill would be negotiated for a company which should then be cash flow positive. There are so many different combinations possible that I’ll leave you to do your own calculations.

At present, the forecasts are for a paediatric market in the US worth around $US120m pa – around 400 kids under 18 at $US300,000 per treatment. The assumption was that it would take a year or two to get to 50% of the market – ie growing from $US60m pa in the first year or two, then maybe building up to $US120m pa in the years after that. If the gross margin is 60%, then that’s a gross profit of $US36m, and let’s assume direct marketing costs of $2m pa and US taxes at 21%, leaving a net profit on this product of $US27m pa in the early days.

Put that on a P/E of 30x and you get a bottom-end product valuation for half market share of $US810m or $A1.17bn = $A2.01 per share. A PE of 30x isn’t unreasonable on a product which could double its market penetration in a couple of years – as we’re only using a half market share.

How does it look if it can get to $120m of sales in 4 years? That could be a net profit of $US55m and let’s say a lower more conservative P/E of 25x (which is around the current average of Australian industrial shares ex financials – though admittedly that’s a record high!). There could still be plenty of growth for Ryoncil going into EU and adult markets after hitting $US120m in sales, so potentially way above the industrial market average growth, so 25x is quite conservative in my view. A net profit of $A80m at 25x is $A2 billion or $A3.40 IN FOUR YEARS. Discounting that back at 15% pa (high discount rate to take risk into account) and you get a Net Present Value of around $A2.00, or just under. That doesn’t mean it can’t be worth more than $A3.40 in 4 years, just that the NPV now is around $A2 for US paediatric aGvHD.

Admittedly, the PE could be lower in either of the above cases, but I think it is reasonable over the course of the economic cycle and I think it’s a reasonable downside scenario given that it only covers the market for kids in the US, ie ignores kids in Europe and adults in both EU and US. Given the runaway success of this product in Japan, and the horrible side effects from alternatives (including death in most severe cases) it’s hard to imagine the Europeans wouldn’t want to save their kids too. It also doesn’t include anything for any other label extensions such as Crohn’s or most other inflammation based diseases. So it’s a reasonable base case NPV for TODAY.

Furthermore, let’s assume the Remestemcel-L gross margin eventually increases from 60% to 80% based on the new manufacturing upgrades (which could be announced on Monday in the Lonza podcast) and due to 3-D bioreactors and serum-free media. That would increase the base valuation from $A2.00 to $A2.70, or $A2.60 based on $US120m sales in 4 years.

These figures so far are my basis for saying that an approval for US paediatric SR-aGvHD in September gives us a current NPV of $A2 to $A3 per share from this product. It is a base figure which could obviously move higher once European aGvHD approval is granted and if it extends to adult aGvHD and eventually beyond. These figures are just for the aGvHD product and are not a total company valuation - to do that you would have to assume the current cash burn from R&D, trials etc is shut down and not forget to take into account fixed costs including interest and admin expenses. That is, I am just trying to estimate the contribution the first stage of aGvHD makes. You can make your own assumptions re ongoing costs and adjust the figures yourself.


Upside scenarios for Remestemcel-L and Ryoncil - $A6 NPV now, $A10.50 in 4 years

Now add aGvHD in US and Europe adults and kids, to get a total market MSB has estimated is worth $US700m pa, and which I think is conservative. I think it is likely to generate US total aGvHD sales of at least $US450-500m and European aGvHD sales of $US250-300m. Let’s say US sales would be done direct and European sales probably on a royalty of maybe 25% (lots of different scenarios possible).

So, let’s say US profits after tax of $US277m to $US308m (assuming the 80% gross margin after manufacturing upgrades) and EU royalties after tax of around $US55m, giving a total net profit from aGvHD in 4 years of around $US350m pa or $A245m pa on a P/E of 25x. That gives a share price target in 4 years of $A10.50 – or an NPV of $A6.00 today.

So, $A6.00 might be your valuation of Ryoncil (to treat paediatric and adult SR-aGvHD in US and EU), if everything were to be approved and market share move up to gain the majority of the available market, with no competing product, sales in the next 4 years could move up from initial treatments in the US first year of 200 treatments to supply 3,000 to 3,500 treatments (price likely to be less in Europe, so number of treatments higher to reach the target revenue figure), However, most analysts would NOT use that as their price target due to the uncertainties involved – until at least the FDA has approved the paediatric product in the US. The adult market is worth around 3x the paediatric market – so it would be another big step forward to gain adult SR-aGvHD approval.


Even More Potential Upside From Label Extension In Inflammation and Covid19

The $A6.00 full EU and US adult and paediatric aGvHD valuation is still potentially too low, as Ryoncil approval is likely to see quick application for extension into several other areas of inflammation such as chronic GvHD, Crohn’s (trial completed, but not read out) and many more where trials are likely to quickly start – eg the recently started Multisystem Inflammatory Syndrome in Children (MIS-C) Associated With Coronavirus Disease (COVID-19). It is also this same product which could be used for the potential blockbuster Covid19-ARDS.

This is all just for Remestemcel-L (AKA Ryoncil). I’m not including anything for the potential blockbuster MPC indications in heart failure and chronic lower back pain as I’m just trying to clarify the base case value for aGvHD if all the other trials fail (and I don’t think they will).

The uncertainty of FDA approval and extension into other indications is why the analysts’ price targets are so far below the potential NPV valuation targets.
However, it is important to know the potential upside if things go well, and that’s why CSL gets mentioned as a comparison. If Covid19-ARDS comes off as a blockbuster product, CSL could well be a valid comparison – but there’s still a lot that has to happen first!

The US paediatric SR-aGvHDproduct candidate met the primary endpoint with flying colours in a phase 3 trial completed in the US in Sep 2018. Since then, MSB has lodged the equivalent of semi-trailer loads of data with the FDA and is now waiting on the FDA’s “priority review” due by the end of September. The FDA has already approved the potential marketing name of Ryoncil – and this is a product which has been proved to save the lives of children with no other medical hope – there is nothing else approved for children up to 18 years old who have failed to respond to steroids (“steroid-refractory” – up to 90% of them will die in the worst grade of the disease. So, given the very high conversion for products which have successfully completed phase 3 trials, especially where there is no competing treatment, it seems highly probable that Ryoncil will be approved for paediatric SR-aGvHD by end September.


The difference between a price target in the future and a NPV valuation today

How would you like $100 in 10 years? What would you pay for it today?
Most people would be happy to pay $82 to the Australian government today for a guarantee of $100 in 10 years – that would be a return of 2% pa, well above the current Aust Government bond rate of 0.88%. If they were worried about inflation or the government’s ability to pay back the money, they may demand a higher rate of return - ie they wouldn’t outlay as much today to receive the $100 in 10 years.
To pay for this risk, you may decide an annual return of 5% is required, and you’d only pay $61.39 now to make up for the risks involved in waiting 10 years for your $100.

Well, analysts currently think the risks of MSB are so high that people would demand a 15%, 20% or even 30% per annum return to hold the shares – that means they think people would only pay $24.72 (at 15%), $16.15 (at 20%) or a paltry $7.25 (at a required 30% pa rate of return) today to receive a share worth $100 in 10 years.

That’s how much risk is already priced into Mesoblast just from using a high discount rate in the NPV (Net Present Value) calculation. However, the analysts then double up on the risk discount by applying a probability of success factor to each of MSB’s products. As I have noted previously these POS discounts are anything up to 75% of the expected cash flow to be generated by these products. Once the FDA approves these products, and the healthcare providers approve reimbursement, I would expect a large part of the POS discount to be removed – although the high NPV discount rate will probably still hang around for a few years, but that’s OK as it means that’s the rate of return you will earn if you buy the stock at the analysts’ valuation. Of course, if you buy below their valuation, then your rate of return will be above the discount rate used – and that’s the case at present.

So, even if we pay around $A5.30 per share now we should receive a long-term rate of return of more than 15% pa according to the major analysts’ valuations. If the FDA and health funds approve heart, back pain etc, and MSB gains pharma partners for these products, the POS discount will reduce and the valuations should start to move up into the range of $10-20 – but you will still be receiving annual returns of 15% plus per year even if you pay $10-20 at that stage. Taking the middle ground, if the NPV valuation targets are adjusted up to $A15 now, and a 20% pa discount rate is used, that implies a $A93 share price in 10 years!

If Covid19-ARDS is approved, the numbers go astronomical – and virually no analyst has this in their figures.


Can MSB possibly return 20% or more per year???

The following graph shows the trajectory for CSL. The graph is a Log2 scale graph. YES THE SCALE IS DISTORTED – that means that you can see percentage rises on the graph – ie a move up in price from 50c to $1.00 (doubling) is just as important as a move from $128 to $256 (doubling). So, the slope of the graph shows the best percentage moves over time.

The best percentage gains for CSL were early in its listed life (though it had been operating as a government body Commonwealth Serum Labs for decades before listing, so it clearly wasn’t a new business startup when it listed – it actually came out of the Commonwealth Vaccine Depot in 1916).

The graph below shows the long-term total returns for CSL, adjusted for dividends and also for the 3:1 share split in 2007. The adjustment is done by reducing earlier years prices. Eg in 2007 the price was over $90 and it adjusted down to around $30 after the split and all previous years prices were divided by 3. Similarly, the graph takes care of dividends by assuming the dividend is reinvested in the shares at the price when the dividend goes ex – and then all previous years prices are reduced by the factor of Current Div/Share Price. That way, previous years prices are adjusted down and that’s how the dividend return shows up in the graph – comparing today’s price with last year’s price and all previous years compounds up the dividend returns. I usually ignore this (MSB pays no dividends so it doesn’t matter) but it becomes important when you are looking at long-term returns.

The long-term return on CSL since listing is 27.8% pa, made up of 24.85% pa price return and 2.95% pa dividend return. So that’s well above the 20% pa return I said was possible for MSB.

Look at the red arrow on the graph below showing the return for the 7 years from Dec 1994 to Dec 2001 (admittedly coincided with “irrational exuberance” and the tech bubble) – a total return of 57.7% pa which took the adjusted share price from 44c to $10.65.
The next rise was similar, a total return of 65% pa from $2.62 to $32.27 in 5 years.
There’s no reason MSB should mirror this, but to put it in perspective, a total return of 65% pa for 5 years, taking the recent low of $A1.02 as a starting point gets us to $12.47 in 2025; and a return of 57.7% pa for 7 years gets us to $A24.74 in 2027.
A big success on Covid19 ARDS could therefore blow CSL-like returns out of the water!



You can use some of these calculations in judging the impact of some of the announcements which are likely to come out next week:

1. We have all seen that Lonza has an embargoed podcast interviewing The Prof due for release. If that coincides with a MSB announcement of an expansion of manufacturing with Lonza and there is funding from a global pharma partner, potentially bringing Ryoncil to market much faster, the NPV valuation could be brought forward by several years and the heavy discounting may no longer apply – that could result in big valuation upgrades from analysts, just for the Ryoncil product

1. I still expect an announcement in the near term that the first 90 patients have been dosed in the Covid19 trial. I explained in an earlier note why I thought this was taking longer than people (including myself) initially expected (or hoped). All we have at the moment is a couple of comments that everything is on track – and the initial guidance was 3-4 months from the start of May to dose all 300 patients – that means the end of August before everyone is dosed. Given that there are still only 15 out of 30 hospitals signed up, the last cohort to be dosed should be recruited much quicker than the first 30%. Some people argue that 15 hospital systems = 30 hospitals – I don’t agree as I believe the main regional hospitals will be applying the trial, even if they have junior community hospitals in their system – ie only 15 hospitals are signed up so far and it will eventually go to 30.

1. While it is possible that all 90 of the first 30% of patients have been dosed, I won’t assume it has happened until I see an announcement. I have found patience is a virtue with MSB over the years and that premature jubilation is not rewarded in the medium term. It is also nerve-wracking to be waiting on announcements day-in day-out. I can’t do it, it does my head in. Just assume it comes when they announce it and it is easier to hold on to your position, particularly if you are working on long-term valuations. The value of the company won’t change if the Covid19 “overwhelming efficacy” announcement comes in August or in July – cash flows won’t start until FDA approval comes in, and that probably won’t happen until Ryoncil is approved (by September or possibly after AdComm in August). Sales won’t be significant until manufacturing plants are built or upgraded, and that will probably take at least 6 months – so I’m more comfortable assuming that we haven’t dosed the first 90 until MSB announce it has happened. Why add stress to your position? Having said that, I’d be surprised if we don’t see such an announcement in the near future – possibly that’s why the Lonza podcast was embargoed?

Analysts continue to upgrade

As I have indicated in the past, there is still plenty of conservatism in analysts' forecasts - with overly conservative forecasts likely to continue to be upgraded. I have tried to show the sensitivities involved in cutting NPV discount rates from very high rates of 15%-30% and also in increasing the probabilities of success for MSB's product candidates as trials succeed, FDA approvals come through and partnering deals are completed.

Here is the latest consensus 12-month price target from Nasdaq.com. It shows an average forecast of $US17.42 per MESO ADR ($A5 per MSB share). I use a slightly different group of analysts and include some Aussie analysts, including Bell Potter, and I use the most up to date forecasts - leaving me with a slightly higher consensus of $A5.30. The most important thing is the trend of upgrades - and that has been solidly higher in the past three months, and continues to rise in the latest figures:


The $A5.30 consensus is based on using discount rates of 15% to 30% (Bell Potter uses 19%, but was above 20% until recently). That means that even if you were to pay $A5.30 now, you would still earn a well above average rate of return in excess of 15% pa based on these analysts' forecasts.


Bottom line

What does this mean for us as shareholders now?

Firstly, I’ve shown why I think paediatric SR-aGvHD is worth $A2-$A3 per share right now.

Then, I’ve shown why extensions to aGvHD could be worth $A6 per share to the current NPV valuation IF they happen. That equates to a price target of $A10.50 in 4 years for aGvHD in US and EU, adults and kids IF it all happens.

Then I talked about further upside from label extensions into other inflammation diseases (Crohn's looks like it could be ready to go) and particularly Covid-19 treatment with Remestemcel-L.

Then I showed that the analyst currently using a discount rate of 30% pa is valuing a share price of $100 in 10 years at only $7.25 today. That’s the difference between a NPV today and a price target at some point in the future – it depends very much on the amount of risk you judge exists and the rate of return demanded by investors. As the risk decreases (products are approved by the FDA, health funds and pharma partners emerge), the required rate of return falls, and the NPV of $7.25 today at a 30% discount rate increases to $16.15 at a 20% discount rate and $24.72 at a 15% discount rate. Potentially, I see MSB trading on a 10% discount rate, giving a NPV of $38.55 for $100 in 10 years – and that is 5.3x the valuation of someone currently using a 30% discount rate. These numbers AREN’T PREDICTIONS AT ALL – they are just illustrative of the leverage of valuations as some of these massive discount rates fall.

Finally, I showed that, even if we pay around $A5.30 now, we should receive a long-term rate of return of more than 15% pa according to the major analysts’ valuations. If the FDA and health funds approve heart, back pain etc, and MSB gains pharma partners for these products, the POS discount will reduce and the valuations should start to move up into the range of $10-20 – but you will still be receiving annual returns of 15% plus per year even if you pay $10-20 at that stage.

If Covid19-ARDS is approved, the numbers go astronomical – and virtually no analyst has anything for this in their figures, that's when you start talking CSL type returns!



Addendum – Progress of the Covid19 ARDS trial
@Padlock asked:
“I'm genuinely curious on how to understand the testing part of the trials (apologies if it's an easy answer). Maybe @ecoool2 or @LeftYahoo could assist with.

How do all the medical centres participating in the trials make sure that the conditions of testing are all congruent so they consistently gather the accurate trial information from enrolled patients across a variety of locations and nurses/doctors? I imagine the conditions in a 12 person trial in one location is easier to monitor vs 300 across multiple sites?”

I’m not sure if anyone answered this in all the crazy noise and posts going on recently, but the brief answer is:
Yes this trial is much harder to co-ordinate than 12 patients in the same hospital, while we are in the middle of an out of control pandemic (out of control in the US anyway, at present). In cases like this there will be a principal investigator at each hospital and there will be co-ordination meetings every week or two (probably two in current conditions) where the PI’s discuss how the trial is progressing, any problems, solutions, issues with the cells, patients, standard of care, etc.

This will all be co-ordinated by the Icahn School of Medicine at Mount Sinai. Mount Sinai are highly professional and have the experience of working with the MSB cells in the initial EAP for compassionate use (and who generated such spectacular early results vs the Standard of Care in other NY hospitals during the same period). Annetine Gelijns, of the Icahn School is the Responsible Party.

The conditions of testing will vary a bit between hospitals due to varying standards of care, training of ICU staff, even whether ICU is overwhelmed in some areas but not others. However, the hospitals they have chosen are the best in the country, all with well trained staff and equipment, so while some differences will occur they should be within an acceptable range that don’t affect the study, and that is why you have a control group and a treatment group.

You asked a valid question about randomisation.
Randomised allocation means participants are assigned to the arms of a clinical trial by chance. Not allocated per hospital or according to any other criteria that could unblind the study – it has to be truly random. This is a double blinded, triple masked trial – so nobody knows where the patients will receive the treatment and where they will receive placebo. It is possible 10 patients in one hospital all receive MSB cells and 10 patients in a hospital on the other side of the country all receive placebo (probably not likely however). That’s why you have a 300 person trial, to diminish the potential of skewed results from a smaller sample.
Initially the trial was planned to be 240 patients, then was increased to 300 to provide the FDA with an appropriately “powered” trial.

You can look up plenty of statistical documents related to Bayesian probabilities in powering trials – and how “efficacious” the results have to be to stop the trial early, given results obtained at each stage vs a pre specified probability of success. I have included an outline below of the general thrust of using Bayesian predictive probabilities for interim monitoring of clinical trials. It is just a summary of the general thrust to give you an idea of the main drivers of the early stopping of the trial. I’m not going to give a statistics lecture, which can be better done by others (and isn’t really required here).

Using Bayesian predictive probabilities for interim monitoring estimates the probability of achieving a successful (significant) result at a future analysis, given the current interim data. This can also show futility - a trial that is unlikely to achieve its objective (i.e. unlikely to show statistical significance at the final sample size).

Let’s assume that this trial was powered for a 40% death rate in the control group and 20% rate in the MSB group. That is, after 300 patients, if 60 out of the control group die and only 30 out of the stem cell group die, MSB will have met the primary target of the study and would merit approval, particularly if it is also successful on some of the secondary targets. Any widening of this gap of 30 between the 2 groups would be even better for the chances of approval (not that I hope there are more deaths in the control group, just showing how the stats work and how the FDA think).

I understand that the mortality rate in moderate/severe ARDS patients under standard of care has improved from the original 88% in NYC hospitals in March, but it is still worse than 60% (ie higher than 60%). It is also possible that restricting the trial to people on ventilators for less than 3 days and improving standard of care could mean that very few in the stem cell group die. I believe the 2 mortalities out of 12 people in the original Mount Sinai group were probably people on ventilators for more than 3 days, and that this is why it was part of the trial design – so it is good trial design to exclude these people at this stage of the trial (they can be label extended after approval).

So, after the first 90 patients are dosed and monitored for 30 days, you could have 27 dead in the control group (60% of 45) and as few as none dead in the stem cell group due to good trial design and improved standard of care. That is almost up to the gap of 30 already, just from the first 90 patients. You would then apply the Bayesian probability analysis to effectively say, given we have already almost reached the full gap of 30 patients, what is the probability that the full 30 will be reached by the time the trial has treated all 300? Obviously that probability is extremely high, and this would be “overwhelming efficacy”. I don’t have access to all of the background trial design, and I can’t be sure that these numbers are exactly right (but they would be close) – but this gives you an idea of what the investigators will be looking for.

I’m feeling excited for MSB’s prospects in treating moderate/severe Covid19-ARDS based on all the numbers I’ve seen so far, including the Mount Sinai EAP involving MSB’s cells, the small China trial, the published data by MSB on the COPD trial, the mechanism of action of the MSCs and the fact that they go straight to the lungs to treat the inflammation caused by the cytokine storm, and the spectacular results in the aGvHD trial (which is the “mother of inflammation”.

The upside is spectacular if this trial works and MSB’s trial is well designed, well funded, has enough “power” for an approvable outcome, has the top hospitals signed up and is at phase 3 status with encouraging results in the earlier EAP results (according to Mount Sinai doctors). Combined with the imminent approval by the FDA in September of Remestemcel-L, which could be extended into Covid19-ARDS if this trial succeeds, Mesoblast appears to be the leader to provide a stem cell treatment for Covid19-ARDS.