Mesoblast — Update 8 July 2016

Mesoblast is an Australia-headquartered biotechnology company focused on adult stem cell therapies. Listed on the ASX in 2004, the company’s pipeline is based on proprietary culture-expanded mesenchymal precursor cell (MPC) and mesenchymal stem cell (MSC) technologies. Mesoblast purchased the MSC technologies from Osiris Therapeutics in 2013. Mesoblast has entered into a number of strategic alliances including partnerships with JCR Pharmaceuticals for commercialising Temcell in aGvHD, and an alliance with Lonza for the exclusive use of manufacturing facilities in Singapore. Teva has withdrawn from its alliance for cardiovascular disease but remains in an ongoing partnership for the development and commercialisation of select MPC products for central nervous system (CNS) and oncology indications.

Our valuation for Mesoblast moves down to A$1.8bn from A$2.8bn (A$4.67 per basic share from A$7.36). Notably, we now assume that the confirmatory Phase III trial in CHF will not start until top-line results from the first Phase III trial are known - previous guidance was that Teva would conduct the two trials in parallel. This has delayed our forecast launch date for CHF by four years to FY23 and lowered our NPV for MPC-150-IM in CHF from A$4.01 to A$2.79 per share (excludes R&D costs). Mesoblast’s share price has fallen by 75% over the past year, having been affected by a poorly received US IPO in November 2015, Teva’s withdrawal from the cardiovascular disease collaboration and Celgene allowing its first right of refusal to lapse. We highlight key upcoming potential catalysts that could allow for share price inflections; interim results from MSC-100-IV Phase III in paediatric aGvHD (Q316), full results from the same trial in Q416, full Phase II data for MPC-300-IV in rheumatoid arthritis (Q316) and results of the CHF interim futility analysis (Q117).

Mesoblast ended Q316 with cash of US$99.9m and has indicated that cash at 30 June was ~US$80m. Operating cash burn in Q216 and Q316 averaged US$21m, 25% below the preceding two quarters, in line with expenditure reduction plans. Mesoblast is now responsible for ~US$90m costs related to the MPC-150-IM Phase III CHF trials previously funded by Teva (~US$22m per year for four years). Guidance is for cash burn in FY17 to be no more than US$80m, including the cost of the CHF Phase III. Given that cash burn has averaged ~US$21m over the past three quarters (when Teva was funding CHF costs), achieving the cash burn target will require significant cost reductions and deferral of development programmes, while continuing to prioritise tier 1 programmes in degenerative disc disease, aGVHD, CHF and rheumatoid arthritis. With a cash burn of US$80m/year, the company would require an additional US$85m to fund operations until end FY18, which could be supplied by the discretionary equity facility with Kentgrove Capital.

Mesoblast continues to face typical development risks including the outcome of pivotal trials, regulatory decisions, success of competitors and commercial risks. With Teva’s withdrawal from the cardiovascular programme, funding of Mesoblast’s annual cash burn of ~US$80m is a significant source of uncertainty, although the A$120m discretionary equity facility with Kentgrove Capital will support operations to end FY18. With a current market capitalisation of A$470m (~US$350m) equity funding could involve significant dilution of existing shareholders. We expect Mesoblast to seek non-dilutive funding from partnering deals. Potential partnering catalysts could include filing a US BLA for paediatric aGvHD in H117, interim futility analysis from MPC-06-ID back pain Phase III in Q417, interim CHF Phase III futility analysis in Q117 and top-line CHF Phase III results (2018).

Mesoblast is a leading mesenchymal stem cell development company. Its technology is based on allogeneic, off-the-shelf adult stem cells. The development of mesenchymal stem cells (MSCs), multi-potent stem cells that can differentiate into a variety of cell types, has been the most advanced area of stem cell research showing multiple anti-inflammatory and regenerative effects in human tissue. MPCs, the precursors of MSCs, are harvested from the bone marrow of young, healthy, unrelated donors using a proprietary technique to identify and isolate the cells. Both MPCs and MSCs have broad intellectual property protection and can be purified, expanded and manufactured on a commercial scale.

The company’s technology platforms have produced eight clinical candidates to date, with one of the lead candidates, MSC-100-IV in aGvHD, poised to become the first industrially manufactured allogeneic stem cell product approved in the US, following on from approval in Japan last year. Mesoblast has five active programmes in Phase III, one that is Phase III ready and two in Phase II.

Mesoblast works on a two-tier product structure with the primary goal to support late-stage or top-tier products on their path toward commercialisation either through own-company financing or partnership agreements (Exhibits 1 and 2). The first tier comprises four products with a significant mid-term revenue opportunity: MPC-150-IM in congestive heart failure, MPC-06-ID in low back pain due to degenerative disc disease, MSC-100-IV in aGvHD and MPC-300-IV in a number of chronic inflammatory conditions including biologic refractory rheumatoid arthritis and diabetic kidney disease. The remaining tier two products are in Phase II or III and will advance into tier one on the basis of data, market opportunity or partnering capability.

Teva’s withdrawal from the cardiovascular programme and Celgene’s decision to let its right of first refusal for selected products lapse means Mesoblast has lost the implied validation of its technology that comes from having a big pharma or biotech partner. This factor, combined with the low pricing of the shares issued as part of the US IPO and the increased risk that dilutive capital raisings may be required to fund its ongoing development programme, has seen the stock price fall by 75% over the past year, despite reporting good clinical progress over the period. The results from the first cohort in the Phase II trial of MPC-300-IV in biologics-refractory rheumatoid arthritis were particularly impressive in our view, with response rates in this refractory patient population comparable to response rates typically seen to TNF alpha biologics in first line therapy.

Teva’s withdrawal from the cardiovascular programme brings both upside and downside risks for Mesoblast.

Mesoblast could potentially obtain non-dilutive funding from development partners for the cardiovascular, aGVHD, degenerative disc disease, rheumatoid arthritis or other programmes. If non-dilutive funding is not forthcoming Mesoblast could fund its development programme through equity issues, including through the A$120m Kentgrove Capital equity financing facility. However, with a current market capitalisation of A$470m (~US$350m), equity financing could involve significant dilution of existing shareholders. We estimate an additional ~US$85m could be required to fund operations to the end of FY18.

Mesoblast entered into a Development and Commercialisation Agreement (DCA) with Cephalon in - December 2010 in a deal that included an upfront payment of US$130m and potential milestone payments of up to US$1.7bn. Teva acquired Cephalon for US$6.8bn in October 2011. In September 2013 Teva and Mesoblast amended the DCA such that the Phase III CHF trial included two interim analyses of efficacy and of safety. Teva was obligated to conduct and fund the Phase III CHF trial until at least the first interim analysis was completed.

Teva is finalising its US$40.5bn acquisition of Allergan Generics announced in July 2015. It has said it will seek to extract US$1.5bn of synergies as it integrates Allergan Generics with its existing operations. Teva has stated several times over the past few years that it intends to focus its R&D resources on its core CNS and respiratory interests. In this environment it is understandable that it has withdrawn from development of a cardiovascular disease product that is still several years from market, although with a carrying value of US$258m for in-process R&D associated with Mesoblast’s cardiovascular programme, it is not a decision that would have been taken lightly.

Mesoblast’s management has reiterated that Teva and Mesoblast did not see any efficacy data from the recent interim safety review by the data monitoring committee (DMC). There had previously been an expectation that data on surrogate measures of cardiac function would be released following the first interim analysis, including volume-based measures such as systolic and diastolic volumes. However, the FDA advised that all efficacy data should remain confidential because its release could potentially bias investigators and trial participants.

Mesoblast has entered into an equity facility with the Australia-based investment management firm Kentgrove Capital to provide funding of up to A$120m (~US$90m) over the next three years. Under the facility, A$60m will be available at Mesoblast’s discretion over the next 18 months, with Mesoblast having the option to increase the facility to A$120m over 36 months. For each placement Mesoblast determines the timing, amount and minimum share price. Kentgrove Capital will receive a fee of 4.5% of the funds raised and will be granted 1.5m three-year incentive rights priced at double the average share price in the 10 trading days before the date of the facility. The facility will extent Mesoblast’s funding runway beyond the end of FY18.

The FDA recently approved the use of the Carto-3 mapping catheter from J&J’s Biosense Webster subsidiary for the intracardiac injection MPC-150-IM cells in the Phase III trial. The Carto-3 catheter is widely used to map the position of an RF ablation catheter used to treat patient s with cardiac arrhythmias, and is installed in around 2,000 major hospitals in the US. In contrast, only about 80 US hospitals have the NOGA Myostar mapping catheter used for injecting MPC-150-IM to date. The NOGA Myostar system is dedicated for transendocardial injection of biologicals for research and clinical trial purposes. Approval to use the Carto-3 catheter is expected to speed the opening of additional recruitment centres in the Phase III trial programme, including hospitals in Europe.

Mesoblast is fortunate that, following several rounds of discussions with the FDA, the size of first Phase III CHF trial has been progressively reduced from the original target of 1,730 patients to a current target of 600 patients. The reduction of the trial size occurred in two steps: the first reduction from 1,730 to 1,165 was announced in August 2015 and the reduction from 1,165 to 600 subjects and a change in primary endpoint was announced in January 2016. At that time, the primary endpoint was changed from the time to first recurrent heart failure-related major adverse cardiovascular event (HF-MACE) to a comparison of HF-MACE event rates between the treatment and control groups.

An additional confirmatory Phase III trial with ~600 patients will also be conducted. HF-MACE is defined as a composite of cardiac related death or resuscitated cardiac death, or non-fatal decompensated heart failure events. These non-fatal decompensated heart failure events require use of intravenous diuretics during an in-hospital stay or an outpatient visit.

The rate of recurrent HF-MACE as a primary endpoint for the two trials was chosen on the back of encouraging analysis of the previous Phase II study showing patients treated with MPC-150-IM had no HF-MACE over 36 months of follow-up vs the control group with 11 recurrent MF-MACE. All of the HF-MACE events in the control group occurred in patients with advanced CHF who had baseline LVESV (left ventricle end systolic volume) >100ml.

As previously noted, the trials will be enriched for patients with a high risk of recurrent HF-MACE, based on inclusion criteria of either high NT-proBNP levels or a history of heart failure hospitalisation in the past nine months, two criteria known to predict adverse outcomes in CHF. This enrichment is expected to result in the majority of enrolled patients having baseline LVESV>100 mL and high rates of recurrent HF-MACE.

The DMC reviewed the clinical data on the first 175 patients in the Phase III CHF trial in April 2016 and recommended that the study continue unchanged.

The second interim analysis has been brought forward and is now planned for Q117 when 150 of the overall target of 550 HF-MACE events are expected to have accrued. Following an analysis of HF-MACE event rates, the independent data monitoring committee could recommend that the trial continues to completion or that it should be stopped for either futility or overwhelming efficacy.

The company intends to discuss with the FDA the possibility of testing for a pre-specified biological signal in addition to the HF-MACE event rates as part of the interim analysis review.

The trial started recruiting patients in February 2014 and currently about 240 ( ~40%) of the target of 600 patients have been recruited. With additional sites to be opened in Europe and approval of the Carto-3 mapping catheter to be used in the injection process making more sites suitable for involvement, Mesoblast expects the recruitment rate to accelerate. Recruitment is likely to be completed in H217, with results available in mid-2018.

The timing of the confirmatory Phase III trial is not yet settled, and will likely be influenced by partnering discussions. In our forecasts we assume that Mesoblast will adopt a conservative strategy and wait until the results of the first Phase III trial are known before initiating the confirmatory trial. If all of the trial sites are migrated to the confirmatory trial, recruitment of the 600-patient confirmatory trial could probably be completed in around 18 months. Under this strategy, which is illustrated in Exhibit 3, we forecast the confirmatory Phase III trial to be initiated in Q418 with recruitment completed in Q220 and results available in Q221. If the trials are successful this could potentially allow a US launch in early 2023.

We note two scenarios that could lead to a significantly earlier market launch. Firstly, if the first Phase III trial demonstrates overwhelming efficacy in reducing recurrent HF-MACE events in patients with advanced heart failure, Mesoblast could potentially seek accelerated approval from the FDA based on the outcome of a single pivotal trial. Accelerated approval could potentially allow a market launch of MPC-150-IM in 2020. A second pivotal trial would still need to be conducted to obtain full approval, but this could be conducted after market launch.

Secondly, if Mesoblast were to partner with a pharma company with significant cardiovascular infrastructure, it could speed recruitment and provide funds to allow the confirmatory trial to start soon after the second interim analysis, which is planned for Q117. If the confirmatory trial were to start in Q317, it could allow a market launch in H221.

A paper published in Lancet in June by Patel et al reported the results of a trial of Vericel’s Ixmyelocel-T autologous MSC therapy in patients with advanced class III or IV CHF. The trial in 108 patients found that patients treated with intracoronary injection of MSCs had 37% fewer HF-MACE events in the 12 months following treatment compared with placebo (risk ratio 0.63, p=0.034). A total of 88 events (38 in the treatment group and 50 in the placebo group) were observed in the 108 patients.

It is encouraging that a significant benefit from stem cell therapy was seen in this trial of modest size. We note that 70% more HF-MACE events will be assessed in the Q117 interim analysis of Mesoblast’s CHF Phase III trial. It is also of interest that the benefit was seen in patients with more severe (class III and IV) heart failure symptoms. Mesoblast’s MPC-150-IM has also shown greatest benefit in patients with more severe heart failure symptoms.

CHF is a common condition that, despite treatment advances, is still associated with poor prognosis. About half of CHF patients die within five years of diagnosis. Heart failure occurs when the failing heart cannot pump enough blood and oxygen to support other organs. According to the American Heart Association, 5.1 million people in the US have been diagnosed with CHF (2% of the population). While progress has been made in treatment, there is a high overall annual mortality (5-20%), particularly in patients with severe (NYHA Class IV1) symptoms. Current state-of-the-art treatment for advanced systolic heart failure includes a combination of medical and device therapy. Renin-angiotensin-aldosterone (RAAS) blockers (along with beta blockers) are the key pharmacological therapies, as they improve mortality, heart function, heart failure symptoms and exercise tolerance. Devices are increasingly used in mild-to-severe (NYHA II-IV) CHF. Implantable cardioverter-defibrillators (ICDs) decrease mortality and the addition of cardiac resynchronisation therapy (CRT) to optimal medical therapy improves symptoms and mortality.

The approval of Entresto (sacubitril/valsartan, Novartis) in the US and Europe in 2015 provided another option for treating patients with CHF and a reduced ejection fraction. The drug is a combination of sacubitril, a neprilysin inhibitor, and valsartan, an angiotensin II receptor blocker. Entresto reduced the risk of cardiovascular death or HF hospitalisation by 20% versus the ACE-inhibitor enalapril in the Paradigm-HF Phase III trial in 8,442 patients (76% had NYHA Class I or II HF), with a trend towards greater benefit in Class I/II patient than Class III/IV patients. The US price for Entresto is about US$4,500 a year before discounts.

MPC-150-IM is also under investigation in end-stage Class IV heart failure (5-10% of heart failure patients) through a clinical trial programme sponsored and funded by the National Institutes of Health (NIH) and co-ordinated by NIH-funded Cardiothoracic Surgical Trials Network (CTSN). Full trial results are expected in Q317. Additionally, a 225-patient Phase II safety study in acute myocardial infarction (AMI) is ongoing with MPC-150-IM. The trial recruits patients undergoing a stent procedure two to 12 hours after the onset of symptoms and the primary endpoint of the study is the frequency of major adverse cardiac events (MACE) at 24 months.

Mesoblast initiated a pivotal Phase III trial of MPCs in low back pain resulting from moderate degenerative intervertebral disc disease in Q115. The company remains on track for the completion of enrolment in a pivotal Phase III trial in low back pain and interim analysis in Q316.

The company has received guidance from the FDA that a composite primary endpoint is acceptable for approval. The composite endpoint includes agreed thresholds for pain (50% decrease in VAS) and function (15 point improvement in Oswestry disability index), and no surgical intervention at the treated disc level through 24 months of follow-up. There are to be two time points (12 and 24 months) for meeting pain and functional improvement criteria. There are two planned interim analyses; the first when 80% of patients have competed 12 months of follow up and the second will be a Bayesian analysis when all patients have completed 18 months of follow up.

Company guidance is for enrolment to complete in Q416 and the first interim analysis in Q417 (presumably when 80% of patients have completed 12 months follow up). We estimate that the second interim analysis could be conducted in Q318.

Mesoblast will also conduct a second, confirmatory Phase III trial of MPC-06-ID for chronic low back pain. We assume that a second Phase III trial will be initiated in Q217 and is able to complete recruitment in 12 months by using centres that recruited patients for the first Phase III trial. The 24-month follow-up period for the composite primary endpoint would see results in Q220 and a potential market launch in H122 (Exhibit 6).

Chronic low back pain due to degenerative disc disease is the result of a complex process initiated by the degeneration and loss of proteoglycan and water content of the nucleus pulposus, and increased stress on and fissure formation of the annulus fibrosis. An estimated 30 million people in the US suffer from low back pain (Frost & Sullivan, 2008). Frontline treatment options are normally analgesia, anti-inflammatory agents, or epidural steroid injection but ~15%, or 4.5 million, fail to respond to these conservative therapies, which focus on pain relief. Only about 10% of those patients failing to respond to these therapies resort to surgical intervention such as spine fusion, discectomy or artificial disc replacement while surgeons report that ~40% of patients ultimately fail back surgery.2 Therefore, there is a considerable market opportunity for a non-surgical solution that addresses the underlying degenerative nature of the disease. We conservatively estimate that 25% (around one million) people in the US have moderate degenerative disc disease (DDD) that could be targeted with MPC injections.

Positive clinical data thus far have confirmed Mesoblast’s preclinical work showing that intradisc injections of MPCs can restore the extracellular matrix of degenerate discs. In February 2014 the company reported highly positive results from its 100-patient Phase II trial in patients with chronic moderate-to-severe low back pain due to degenerative disc disease, showing strong indications of sustained efficacy across a broad range of clinical and radiographic parameters after a single intradisc injection. The large majority of the outcome measures showed a statistically significant improvement vs controls with MPC-treated patients using fewer opioids for pain relief, achieving a greater radiographically determined disc stability and a lower requirement for additional surgical and non-surgical treatment interventions.

February 2016 saw the first commercial sales of Mesoblast’s mesenchymal lineage cell products with the launch of the MSC-100-IV in Japan in GvHD by partner JCR Pharmaceuticals. JCR launched MSC-100-IV in February 2016 in Japan under the trademark Temcell and Mesoblast reported that it earned US$99k of Temcell royalties in the quarter. In November 2015 the company received approval from the Japanese government’s National Health Insurance for reimbursement of a treatment course to patients at between US$113,000 and US$170,000 with the price paid dependent on persistency of symptoms. Mesoblast earns escalating double-digit percentage royalties in the twenties on Temcell sales and is also entitled to undisclosed sales milestone payments. JCR bears all commercialization costs.

GVHD is a potentially life-threatening complication resulting from allogeneic hematopoietic cell transplantation (HSCT, also known as a bone marrow transplant), a procedure most often performed for cancer patients (particularly leukaemia or lymphoma). GVHD can result from the activation of mature donor T-cells, which are co-infused with the HSC transplant (the graft) and attack the patient’s body cells (the host), resulting in cytolytic effects that target several organs including the skin, gut and liver. Immunosuppressive agents, particularly IV steroids, are administered with HSCT, but treatment can be suboptimal and may increase the risk of infections and disease relapse. In patients with severe visceral (gut, liver) complications, mortality is c 85%. There are no approved treatment options for steroid refractory patients and off-label options have proved toxic with mixed efficacy. MSC-100-IV's activity against GVHD, a T-cell mediated disease, is due to the immunomodulatory properties of mesenchymal stem cells.

In Japan, MSC-100-IV is partnered with JCR and was approved for children and adults with GVHD by the Ministry of Health, Labour and Welfare on 18 September 2015. Approval was made on the basis of Phase II data ahead of legislation enacted in November 2014 by the Japanese government. The new bill (the PMD act), established a framework for expedited approval of regenerative medical products, creating the considerable opportunity for Mesoblast’s MSC and MPC products on relatively limited (ie Phase II) clinical data.3

MSC-100-IV is also in development for steroid-refractory aGVHD for paediatric and adult patients in the US, Europe, New Zealand and Canada. We forecast peak global sales to reach US$390m. Our forecasts are based on the current number of annual stem cell transplants and a cost per transplant ranging from US$75,000 to US$200,000 (dependent on treatment course needed per patient).

Mesoblast is now focusing its efforts on an FDA filing for GVHD in the US. Mesoblast intends to commercialise MSC-100 in acute GVHD in the US to a highly targeted physician population. More than 250 paediatric patients have been treated in the US through an expanded access programme. Data from the initial 241 patients enrolled in the programme showed a 65% response rate and a more than doubling in survival in responders vs non-responders (82% vs 39%, p<0.0001).

Recruitment is ongoing for a 60-patient, open-label Phase III registration study in children with steroid refractory acute GVHD. Top-line results from the trial are expected in Q416. Before this, results from an interim analysis of this trial are expected in Q3 CY16. This pre-specified interim analysis could potentially support an early BLA filing by the end of 2016.

The company plans to have discussions with the FDA over the trial design for a potential Phase III trial to support approval of MSC-100-IV for adults with liver or gut aGVHD.

Given its ultra-orphan status,4 Mesoblast expects to command premium pricing (we model US$250k per adult treatment in the US based on a traditional US premium to Japan and company guidance). We model US$170k per paediatric patient due to the lower dose of cells required. A launch in the US would make it the first allogeneic stem cell product to market, and we believe it would pave the way for other indications using Mesoblast’s proprietary stem cell technologies.

In February Mesoblast announced impressive early results from the first cohort of its Phase II trial of MPC-300-IV MPC therapy in RA patients who are refractory to biologics such as TNF alpha. Patients treated with 1m cells /kg showed ACR20 responses in 47% of MPC-treated patients vs 25% on placebo, ACR70 response in 27% vs 0% on placebo and remission at 12 weeks (DAS28/CRP<2.6) of 20% vs 0% on placebo. These data represent impressive efficacy in refractory patients: they are comparable to response rates seen to TNF alpha biologics in first line therapy, and better than the approved JAK inhibitor Xeljanz in comparable biologic refractory patients (ACR70 in 10-14% of patients). No statistical analysis was presented. Final results of the trial including the high dose cohort (2m cells/kg) are due in Q316.

Data from a six-month 30-patient study of MPC-300-IV in diabetic nephropathy announced in June 2016 showed that the treatment deduced damaging inflammation and preserved or improved kidney function over at least 24 weeks.

MPC-300-IV, which is under development in various immune-related diseases, was upgraded to Tier one ranking in February on the back of the positive data from the rheumatoid arthritis and diabetic nephropathy trials.

Mesoblast has four other products in clinical development that it has categorised as Tier 2. The current Tier 2 programmes are in biologic refractory Crohn’s disease, acute cardiac ischemia, spinal fusion and bone marrow transplantation. Given the increased funding requirement for the tier one CHF programme we have delayed our development time lines for the Tier two programmes by one to five years. The shortest delay is for the bone marrow transplant programme, which is remains part of the collaboration with Teva.

Mesoblast is subject to the risks typically associated with biotech company drug development, including the possibility of unfavourable outcomes in clinical trials, regulatory changes, success of competitors and commercial decisions by partners or potential partners. With Teva’s withdrawal from the cardiovascular programme, funding of Mesoblast’s annual cash burn of ~US$80m is a significant source of uncertainty. The company has entered into an equity finance facility that will provide up to A$120m (~US$90m) to fund the CHF Phase III programme, but with a current market capitalisation of A$470m (~US$350m) that could result in significant dilution of existing shareholders. We expect Mesoblast to seek non-dilutive funding from partnering deals, which could reduce the equity funding requirement. Potential partnering catalysts could include filing a US BLA for paediatric aGvHD in Q117, interim futility analysis for MPC-06-ID degenerative disc disease Phase III in Q417 and the second interim futility analysis in the CHF Phase III in Q117.

We reduce our valuation for Mesoblast to A$1.8bn from A$2.8bn (A$4.67 per basic share from A$7.36 or to A$4.62/share diluted for options that would be in the money if shares traded in line with the NPV, from A$7.07). Most notably, our NPV for MPC-150-IM in CHF decreases from A$4.01/share to A$2.79/share due to a four-year later forecast FY23 launch date, while the NPV for MSC-100-IV for acute graft vs host disease decreases from A$0.66/share to A$0.27/share. Note that these product NPVs do not account for R&D costs, which are grouped together as a single line item. We have rolled forward the DCF to FY17 and have extended cash flow forecasts to 2034 vs prior 2030 to capture the 12-years of US market exclusivity for MPC-150-IM in CHF. The breakdown of contribution to the rNPV is shown below (Exhibit 7).

With Mesoblast having assumed responsibility for funding the Phase III CHF programme we have revised forecast time lines for each of the company’s main projects. Notably, we assume that the company will take a conservative approach and wait until it has top line results from the first Phase III trial of MPC-150-IM in CHF before initiating the confirmatory phase III trial, in contrast to previous guidance that Teva would conduct the two trials in parallel, resulting in a four year delay in forecast market launch to FY23 (previously FY19 launch). In contrast, in light of the smaller trial size and greater potential time savings, we assume that the confirmatory Phase III trial of MPC-06-ID in chronic low back pain will start in Q217, not long after recruitment in the first Phase III trial is completed. As a result of our revised assumptions we have deferred forecast launch dates of individual products by up to six years, as shown in Exhibit 7.

We retain similar revenue share assumptions for the CHF and acute myocardial infarction programmes to those that we used under the Teva collaboration, on the assumption that if the development programme is successful it could negotiate similar terms with a new partner given the more advanced stage of development. These assumptions include a revenue share that ranges from the twenties to reach 40% when sales exceed US$2bn, and COGS that range from 14% down to 10% as sales increase. However, we have reduced our forecast combined milestone payments for approval for CHF in the US and Europe by half to US$125m (vs prior US$250 total), risked to 50% likelihood, and have removed approval milestone for tier 2 cardiovascular product MPC-25-IC entirely (previously US$150m) given the uncertain development timeline for this product.

We have revised down our estimate of the proportion of allogeneic (donor) haematopoietic stem cell transplants (HSCT) recipients who would be candidates for treatment with MSC-100-IV and Temcell from 25% to 15%. The median incidence of clinically significant (grade II-IV) aGVHD is about 40% (range 10-80%) according to the European Society of Blood and Marrow Transplantation (EBMT)5. With about 75% of patients having disease that affects the gut or liver, or severe skin disease and about half of patients not responding to first line treatment with corticosteroids, we estimate that about 15% of all allogeneic ESCT recipients would be potential candidates for MSC-100-IV or Temcell therapy (ie develop steroid resistant aGVHD that affects the liver or gastrointestinal tract or severe (grade IV) skin disease). We assume that peak penetration of this target group reaches 30%. We now separately forecast sales in paediatric and adult patients, with a paediatric product launch in FY17 and adult launch in FY20.

In April 2014 MSB guided that it expected to have a readout by the end of 2014 on the primary endpoint of 28-day remission in biologic-refractory Crohn’s disease patients (trial NCT00482092). With no announcement so far about the results of the trial, and Celgene having let its option which included inflammatory bowel diseases lapse, we lower the likelihood of success for the Crohn’s programme to 10% from 30% and lower forecast market uptake among patients with moderate to severe disease to 10% from 28%.

Mesoblast’s share price has fallen by 75% over the past year, having been impacted by a poorly-received US IPO in November 2015,Teva’s withdrawal from the cardiovascular disease collaboration and Celgene allowing its first right of refusal to lapse. We highlight key upcoming potential catalysts that could allow for share price inflections; interim results from MSC-100-IV Phase III in paediatric aGvHD in Q316, full results from the same trial in Q416 and full Phase II data for MPC-300-IV in rheumatoid arthritis (Q316).

Mesoblast changed its reporting currency to US$ ahead of its IPO in the US in 2015.

Mesoblast ended Q316 with cash of US$99.9m and has indicated that cash at 30 June was ~US$80m. Operating cash burn in Q216 and Q316 averaged US$21m, 25% below the previous two quarters, in line with cost reduction plans. Mesoblast is now responsible for ~US$90m costs related to the MPC-150-IM Phase III CHF trials previously funded by Teva (~US$22m per year for four years). Guidance is for cash burn in FY17 to be no more than US$80m, including the cost of the CHF Phase III. Given that cash burn has averaged ~US$21m over the past three quarters (when Teva was funding CHF costs), achieving the cash burn target will require significant cost reductions and deferral of development programmes, while continuing to prioritise tier 1 programmes in degenerative disc disease, aGVHD, CHF and rheumatoid arthritis. We have trimmed forecast FY17 operating cash outflow by 2% to US$79m.

In the absence of additional financing and/or partnerships, we estimate that Mesoblast has sufficient cash to fund operations including key late-stage trials into late FY17, while faster uptake of MSC-100 (aGvHD) in Japan could extend this runway. Thereafter, its late-stage pipeline will require funds – ideally through partnerships, although the timing of partnering agreement is uncertain. We estimate that an additional US$85m will be required to fund operations until end FY18, which could be supplied by the discretionary equity facility with Kentgrove Capital.

Management has indicated that it does not intend to take on debt to fund its development programmes, however, for purely illustrative purposes we follow our standard practice and add long term debt of US$85m in FY18 in our forecasts. We note that a scenario where US$85m was raised through an equity issue at the current share price of A$1.20/share would see our diluted valuation fall from A$4.62/share to A$3.95/share.