Background
Mesoblast (MSB:ASX) or Mesoblast ADR (MBLTY.PK) is a leader in novel adult stem cell therapies and is an Australian-listed company with a market cap of $2b ($7.07 and 290mm shares). The company holds $180mm in cash and has a strong track record of execution that is well understood by its institutional investors. As the company is well covered by the Sell Side, I would like to highlight the recent Prochymal Osiris (OSIR) deal announced last week, as I believe the confusion around the deal (see: Deutsche Bank's downgrade of the name after the deal) is intriguing. I've outlined a short overview of the bull and bear on this deal as a means to revisit the story here as an attractive entry point.
Prochymal Deal: Facts
On October 10th, Mesoblast (MBLTY) acquired Prochymal from Osiris , for $20m in cash and $15m in stock, plus an additional $50m (stock) contingent on hitting US/EU milestones. Osiris also earns a royalty on revenues >$750mm.
The Prochymal Deal: The Cons
As per Deutsche Bank (which I am treating as a proxy for the short thesis at this point), the deal is circumspect due to the rationale of "acquiring an inferior technology" and a reduced cash position due to the investment costs itself, and R&D costs. Specifically, Mesoblast will now deploy $80mm annually on R&D, up from $10mm, to develop the Osiris products. Osiris purifies its mesenchymal stem cells (MSCs) via a different and less efficient method than Mesoblast. Theoretically then, Osiris' resultant product contains a more heterogeneous population of cells which heightens the risk of the therapy being less efficacious as there is perhaps fewer stem cells per 100m dose. Finally, on the bearish side, bears would note that the Phase III trials for Prochymal showed that test subjects did not live longer versus patients receiving placebo.
The Prochymal Deal: The Pros
The deal allows Mesoblast to strengthen its position in the cell therapy space, both through IP as well as through the establishment of a commercial enterprise. Procymal is currently in a 330 patient ph III trial for Crohn's disease, and is already approved for acute GvHD in Canada/ New Zealand (peds) and in the US on an expanded basis for peds and adults. Refuting the bear case on the data, Prochymal did markedly improve overall responses in the adult subset with gut or liver GvHD and resulted in improved survival. Further, Prochymal was found to increase the survival rate in children from 20% to 60% and that in a subset of patients with a specific type of GvHD which targets the liver and gastrointestinal tract, a statistically significant response was observed.
The Lead Acquired Market- A Vast unmet need in Graft vs. Host Disease (GvHD)
GvHD is a common complication (50% of patients) in allogeneic hemotopoietic cell transplants- essentially the donor's cells attack the patient's organs & tissues. There are about 10,000 stem cell transplants in the US annually, placing the addressable market here at about 5,000 annually in the US. The range of disease severity can be slight to severe (life threatening), and similarly the symptoms are varied, most commonly a skin rash. There are no approved therapies to prevent or treat GvHD in the US today, but many therapies are used off-label, such as a range of immunosuppressive drugs such as cyclosporine (alone or in combination with systemic steroids, namely prednisone) and methotrexate prior to the transplant as a preventive measure. Besides Osiris (which is approved for children), other companies such as Athersys are developing "MultiStem" for prevention of GvHD.
Beyond these indications, Osiris also has a phase III asset in refractory Crohn's, and 2 phase II: Acute Myocardial Infarction, and Type 1 Diabetes.
2014 Catalyst Pathway
Mesoblast has several pivotal data read outs in 2014 that should be catalysts for the stock, including those across multiple therapeutic areas: Orthopedics, Cardivascular, Crohn's and GvHD.
Based on the current incidence of the disease and competitors here, at a cost of therapy of about $30k a year (for the 5k patients), the market should approach $150mm annually in addressable treatments just for GvHD, of which Mesoblast can capture a decent share considering the lack of real competitors.
Conclusion: Risk/Reward Skews Well
The bear case DCF (again as laid out by Deutsche) is a WACC of 13.1% based on 5.25% bond yield, Beta of 1.3, and a growth rate of 2%. This scenario yields a PV of $2.3b market value (376mm shares) or $6.11, vs. $5.75 current share price. Certainly a "bearish" downgrade with a positive PV yield is somewhat constructive. I note that merely changing the growth rate from 2%, which seems absurdly low considering the plethora of 'shots on goal' the company has to 5% (and tweaking some other assumptions) gets you closer to a $10 per share valuation, or +80% vs. current levels.
With $315M in cash on the balance sheet (15% of market value in cash), several late stage compounds, solid IP position, and again very conservative growth assumptions, I view the downside as only $1-1.50 a share below current value. So, an asymmetric risk/reward that is highlighted even within the debate on this deal, which appears mixed.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in MBLTY.PK over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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