Why people sell when everything looks great On Wednesday, my...

Why people sell when everything looks great

On Wednesday, my wife decided it was time for her to take some profits on MSB - the price had doubled and it "felt right" to sell after staring down the prospect of losses only a month or so earlier. She was also worried about my fears that global markets are vulnerable to another big down wave.

I'm personally very bullish for MSB's long-term prospects and my view is that upside by the end of June is $A5 and maybe $10-20 by the end of the year depending on Heart Failure and Chronic Low Back Pain trials. Longer-term, Covid19-ARDS could be worth multiples of this $A10-20. Downside is $A2 to $A3 -as has been mentioned by US analysts following the stock, based on Graft vs Host Disease alone (their smallest potential product). But I have no idea where the stock will trade on a daily basis - I think it's unknowable unless you can get inside the heads of all the human (and hence irrational) buyers and sellers.

So why think you can beat the short term random swings of the share price. The big picture remains that the MSB risk/reward ratio still looks the best of any stock I have ever seen in over 40 years in markets. What feels like a big rise recently (and IS big in % terms) is still just a blip on the long term chart and I have seen several other stocks have similar rises over recent years (eg recently STO $3 to $9 in 2 1/2 years; FMG $1.50 to $12.87 in 4 years and many others). What MSB has in common with these companies is a recovery from a "near death experience" - and the first bounce back always gives the best % gain once a company has put fears of going broke behind it. But MSB has so much more potential than just a bounce back from an oversold level or a near death experience.

So, this current bounce is simply the first bounce, recognising this company has great prospects (if the trials continue to read out as previously indicated in earlier phases) and has no danger of failing (particularly now it is absolutely flush with another $US90m in cash) - it coincides with a "capitulation" low in March at $A1.02 when retail investors were panicking and funds were being forced to liquidate in the middle of the first wave Corona virus crisis. This was hitting small cap funds very hard as redemptions of superannuation funds were allowed, people were suddenly jobless and needing to sell shares to get money to live, and toilet paper briefly became the go-to global investment.

So, my wife, and most other investors had ridden out this storm and were sitting on big MSB profits by this week (see graph below of MSB price vs All-time Daily VWAP). The US market was starting to fall again. Unemployment and bad economic numbers are all over the news and Fed Chairman Jerome Powell said Wednesday night that policymakers may have to use additional weapons to pull the US out of an economic mire that has cost at least 20 million jobs and caused “a level of pain that is hard to capture in words.” That scares people, they had just experienced a first big wave down in markets, and they have experienced many companies in the past (including MSB) having a big bounce and then losing it. Another prospective economic and stock market collapse makes them even more nervous, and these have hammered the share prices of good companies in the past.

So why do I think most people are now in profit on their MSB investment? The following graph shows the MSB share price (blue line) going back to when it first listed and the cumulative all-time daily VWAP or Volume Weighted Average Price (orange line based on daily closing prices). It shows that we are currently above the VWAP - a good (but not perfect) indication that most people are making money. It has been 6 years since most people were making money - and I believe it is one of the reasons that a lot of retail investors are currently breathing a sigh of relief, able to finally book a profit, and are bailing out while they can:



I really can't believe some posters complaining about the odd daily share price fall recently. We all know it's not going to go up every day - but we are at 5-year highs presently. People who have bought in the past 5 years are much better off, and are almost all in profit (apart from two or maybe three days recently above today's price). The daily VWAP for the past 12 months is $A2.34; 2 years is $A2.12; 3 years is $1.98; 4 years is $1.93 and 5 years is $A1.98. Sure, there may be people who bought between December 2010 and Feb 2014 who are still behind on their investment, which is a pity, though many of them have since averaged down - but I am talking about the majority of shares traded, taking into account the volumes traded every day - and even counting all the highest prices back in 2011 the majority of shares traded since MSB was first listed are now in profit.

So, I get it that people are nervous. I don't like recommending anyone buy or sell on any particular day as MSB shareholders can be so volatile and irrational in their reactions (witness the crazy volatility in the share price just this year).

There have been very few times in my investing life that I have attempted to stop people doing what feels right for them, as they start losing sleep, and then blame me if they suffer losses, and of course it's their own decision if the price goes up (the stockbroker-fund manager dichotomy).

Any short-term selling is a form of FOMO - they know they'll kick themselves if the price falls away again. It has nothing to do with the fundamentals of MSB's current and future prospects. It is, for many people, a possibility to finally get out of a situation that has been causing them a lot of psychological pain through the lows - and now they're in profit they see a chance to stop the pain.

Without saying people are right or wrong to be selling MSB now, I would say that investing or divesting because of psychological pain (and letting it override fundamental analysis) is the reason most traders and non-professional investors lose money. The greatest number of people buy at the top after a big rise (their buying actually creates the top) and the greatest number of people panic and sell at the lows, and their selling creates the low. The professionals are humans too, and subject to this pain, however they take measures to mitigate the problem - they have processes, do fundamental analysis and try to stick to it, diversify their portfolios and thus usually have some stocks going up while others fall and aren't totally dependent on one stock, and they are also generally a bit weird (they don't tend to feel the pain of a loss at the same rate as the rest of us, and can offset that pain by visualising the joy of the gain when they eventually get it right).

Doing all of this is very hard, and is not a natural way to act. I find it harder to hold a stock that has run very hard than to hold a stock which has fallen heavily, but which I am sure has good prospects. The urge to take profits and get out of a stressful situation is strong, as there doesn't appear to be any downside, you would be taking a profit after all. With a big fall, the situation is still stressful, but the downside of selling at the bottom is obvious.

At present, I am still holding MSB because I simply can't see anywhere else to put the money which has a better potential risk/reward outcome. Why sell now when the prospects look so good only to put the money into something which doesn't look so good? Why cash up now and wait til the feeling of uneasiness after such a big rise goes away, only to buy back into MSB later at higher prices if my fundamental analysis turns out to be right?

As an aside, I wonder if some people are good at buying and holding through the lows when a stock is demonstrably cheap, but they sell out too early as they get nervous that it can't last. Perhaps others are good at getting on board after a big uptrend has established itself and they find it easy to hold on for the ride as the price rise justifies their decision. I wonder if there are people who are so in control of their emotions that they can do both, accepting all the uncertainty in markets and acting in accord with their fundamental analysis, buying when a share is below their valuation and selling when it is above, and only changing their view if there is an obvious change in the price to fundamentals relationship? I am not talking about short term traders here (those who try to trade the noise, and 80-90% of whom underperform over the long term or lose their money), but I'm talking about long term builders of real wealth - the guys in the garage with Bill Gates who were still holding years later.

I'd like to illustrate the current feeling and why some people can't resist the feeling that it is better to "lock in some profits" now, or the nagging doubts in these troubled times. This is an observation from a friend who is much smarter than me, who is a former head of research for a global investment bank, and who owns MSB:

"I nearly had a heart attack in March and I don't even know why! I was not a seller, plenty of cash and if anything I was a natural buyer. But no - I was scared and glued to my screen working out the virus. Even now, I'm looking at prices all day long as if they will tell me something. It's just a bloody nuisance. And all Mesoblast really depends on is the trial, not interim price moves and who is buying and selling or saying this or that."

If the pro's are feeling like that, is it any wonder the little guys are taking some profits and avoiding a stressful situation?

MSB is currently my most successful investment after starting my professional career back in the 1970's - I could've actually had a better percentage gain from my first investment in Sundowner Minerals NL - they were 0.5c each and subsequently went to 28c - my broker talked me out of investing - so it's his fault! Would I have held on for the full 56-bagger if I had the courage of my convictions? I doubt it, but I'll never know. I must say, I wasn't convinced that Sundowner could even get above 1c and hadn't done the research, so I let it go. There have been many others like that until I came across Mesoblast. I have had the full range of gains and losses over the years, but never identified a stock with this global potential and with such an attractive risk/return profile. This is it - The Big One - and I'm not letting go.


Is this rally in MSB doomed to fail like all the others?

When my wife expressed her feeling that she'd like to sell, I actually thought this was one of those times to stick my neck out. That's why I decided to spend hours going through the MSB numbers and prospects, reading everything I could and updating my research on the latest production techniques, the patents, the competitors and their trials and the relevant aspects of the Covid crisis. I concluded that the other trials attacking the cytokine storm were generally much smaller than MSB's 300 person trial, or that those trials were only sequentially treating one person at a time. The competitors' trials have drawbacks such as: most are generally only at phase 2 trial status, most have very poor funding compared to MSB, most are not in the US, nor supported by the NIH, and some have not even started recruiting yet and have 6 month primary outcomes. Many are too small for the FDA to consider approval and even if they were to be approved, they don't appear to have a commercialisation path as they are probably in breach of MSB's patents.

No other treatment for the aGvHD cytokine storm (apart from MSB) has been approved in the US, or has succeeded in a US phase 3 trial for the cytokine storm in aGvHD and MSB's patents have been unanimously held up in the EU courts when challenged, resulting in licensees such as Takeda and JCR recognising MSB's patents. MSB's cells are the only treatment for all the pathways in aGvHD, "the mother of all inflammation". Covid19-ARDS is the new "mother of all inflammation", so if nothing else has succeeded in treating the inflammation in aGvHD, how is anything else going to treat all the pathways in Covid19-ARDS (which seems much worse and even more deadly than ARDS from other sources)? A vaccine may provide a cure for Covid19, but won't treat ARDS. I am aware of Jakafi being approved for adult aGvHD in the US, but I discount it as a real competitor to MSB due to Jakafi's much lower efficacy and horrible side-effects.


Why this capital raising is different to others

This is NOT capital required to stay in business or avert the collapse of the company. This is GROWTH capital which will be multiplied by using it to upgrade manufacturing processes and by using as working capital to produce cells which can be turned over maybe 3x pa.

This growth capital will be used to invest in high margin profitable operations and which will add to the Economic Value of the company.

This potential from Covid19-ARDS is new and unexpected. It is only in one analyst's forecast that I have seen so far (and even that one is well below my expectation of what Covid19-ARDS could be worth to MSB). If Covid19 doesn't work out for MSB, the production of cells can be used in GvHD - the technology upgrades and cell production would've happened anyway in the future - just at a much slower pace. The potential upgrades IFF the Covid19-ARDS trial works potentially dwarf the current share price - sure the price may have rallied due to the excitement around this product, but the price rise is insignificant relative to the potential value-add.

I went through the potential RoE from using this week's placement money on improving manufacturing processes and building inventory for the Covid crisis (including the impact that providing cells for the current trial would have on the stocks available for the launch of aGvHD in October).

I looked at how many times this new capital could be recycled in a year, each time returning a 60% (and eventually 80%) gross margin, meaning that the sales price could be 2.5x the product cost price (or 5x the cost price if they invest in serum-free 3D technology which potentially gets the gross margin up to 80%). You could potentially recycle this working capital 3x in a year, each time multiplying it by 2.5x to 5x (depending on the technology used, how you account for other costs, and whether you just licence your cells, do a 50/50 jv with a pharma or do the whole thing yourself as in the case of aGvHD).

Thus the initial working capital could produce 2.5x the number of cells in the second batch of the year and 6.25x the number of cells in the 3rd batch (assuming 60% gross margins) and you could eventually get to 25x after 3 batches assuming 80% gross margins). This $US90m of capital could multiply up very quickly.

This is EVA (Economic Value Added) at its finest in potentially one of the world's highest growth companies with Return on Equity potentially far above Weighted Average Cost of Capital.

However, I caution that this hasn't happened yet - it is just the potential. We have yet to gain product approval from the FDA in the US (due by end September, but could come as early as July) and we haven't yet seen the outcome of the Heart Failure, Chronic Lower Back Pain trials (which have completed and are due to read out by end June) and the Covid19-ARDS trial which could run until the end of August, but could also terminate early in July on overwhelming efficacy grounds after the first 90 patients are treated and if the 30 day survival is clearly superior to the control group.

That means MSB is still speculative, and despite all the upside potential, things could go wrong. I'd also like to caution about getting over-ebullient about time frames and I think it is always better to assume the longer time frame is appropriate. That means people should be patient and expect these announcements when the company has indicated - ie late June for HF and CLBP, late August for the Covid19-ARDS trial, late September for aGvHD approval by the FDA. It is also unlikely that we will see major benefits of the current capital raising before the March quarter of 2021 - cell suites (possibly with advanced technologies) will have to be set up and master cell banks created and then passages of the cell lines undertaken - this all takes time and won't happen immediately.


Finally - some thoughts on shorts, index inclusion etc

I'm sure shorts haven't gone away for good, but I don't think they are a major force in the MSB market at present. They will always see an opportunity to sell after a big price rise, hoping to make some money out of the inevitable profit taking. At present they are 27.26m shares short in Australia and 5.3m equivalent shorted via Nasdaq listed MESO ADRs - so that's a total of 32.555m shares short or 5.6% of the new expanded issued capital of about 580m shares post the placement.

I was surprised that the number of ADRs shorted didn't rise by more at the end of April. I still can't explain all of the turnover in the ADRs in late April, but I think it is being cleared with continued high volumes through both the US and Australian markets. The increase in the ADR short in the last two weeks of April was only 460,000 (2.3m shares equivalent) and in the whole month of April, the short increased by 827,000 ADRs (or 4.1m MSB shares) - that's worth noting and it would've contributed to the very high turnover, but still doesn't explain the 30m ADR turnover day (150m MSB shares).

I also note that the number of ADRs on issue in the US did in fact increase in April by 1.67m ADRs (nearly 8.4m MSB shares were converted into ADRs), lifting the number of ADRs from 8.292m in March to 9.965m in April. This has allowed higher volume trading in the ADR market and has no doubt facilitated some buying by smaller US investors. No doubt large US investors continue to buy stock in the Aussie market where the bulk of the liquidity lies, and the larger US instos (who can own Australian listed stock) probably also participated in the insto placement this week.

Having said all this, the US ADR trading is still massive compared to the 10m ADRs issued. That's great, as it all but guarantees inclusion in the US Nasdaq Biotech Index in the annual December rebalance, which should drive even more buying in the next few months in anticipation. MESO appears to conform to all of the requirements of entering that index given the very high volume of the past 3 months (over 1m ADRs per day traded vs requirements of 100,000 per day, so unless there is a change to the methodology or something happens out of left field, it looks like it's going in.

Of course, trading volumes are high after a 43m share placement and there will have been a bit of flipping in the past few days - with the price 14% above the $A3.20 placement price. The volume traded in the market in the past 3 days since the placement has been 13 May: 11.542m at at VWAP of $3.314; 14 May 22.377m at a VWAP of $A3.718; 15 May 9.993m at a VWAP of $A3.644. That all totals to 43.912m shares vs the 43m shares issued in the placement. The volume today was still very high, but was under 10m shares and indicated to me that the profit taking wave is slowing (particularly vs the 22.4m shares traded yesterday). So buying volumes are still strong and have pushed the shares to a premium of 14% above the placement price, and most of the flipping has probably been done (noting the shares are listed Monday, but most went to instos who are perfectly capable of selling ahead of the issue of shares, and existing holders also got stock - so they could've sold existing stock if they had wanted to take some profits).

Bottom line

In the past 3 weeks the price has been consolidating the big rise in April. There has hardly been any trading between $A3.00 and $A4.00 and the past 3 weeks have seen some congestion and consolidation with the profit taking I have mentioned in this range - the first week around $A3.25, the second week around $A3.50 and the limited trading this week after the price was suspended for the placement around $A3.75 - see the red bands on the graph below:



ASX200 Index inclusion is now certain - there are only 10 trading days left in the 6 month period (126 trading day period) - so MSB meets all conditions to go into the index. Again it would have to be something out of left field to stop it (eg another global meltdown delaying the index rebalance, a situation like with ISX, a takeover by a global pharma or something else well outside the normal course of events).

So, the very strong buying for MSB continues with positive developments likely on several fronts - trial read outs, partnerships, balance sheet and cash burn easily covered by the capital raising, price target upgrades by global analysts (one of 30% last week), index inclusion.

These factors are easily overwhelming a modest increase in shorts relative to the volume in the past month and once the profit-taking selling eases off, I expect the strong buying to push the share price to the next level above $A4.00 if the bands on the above graph continue to gain by about 25c each week.

So, did my wife sell? No way! We're in this one together.