Mesoblast — Update 24 January 2016

Mesoblast completed its first public offer in the US on the NASDAQ exchange on 18 November 2015, netting proceeds of US$63.5m (A$86.8m), ~13% of issued share capital. A total of 8.5m American Depositary Shares (ADS) were traded at a price of US$8.00 per ADS (implied ASX share price A$2.20 on FX conversion and a 1:5 ADS share ratio). The offer exceeded the originally targeted sale of 5.7m shares, with pricing pressure on the ADS likely contributing to the increased number of shares in the offer. The listing and simultaneous change to US dollar reporting reflects the company’s increasing portion of expenditure in the US and growing operational focus in the region.

Mesoblast has nine clinical programmes. One of its leads, MSC-100-IV (for aGVHD), is poised to become the first industrially manufactured allogeneic stem cell product launched worldwide, following its recent approval in Japan. The company has six active programmes in Phase III or Phase III ready (two partnered) and three in Phase II studies. Five programmes that are prioritised and funded are recognised as tier one and the rest categorised as tier two.1 MPC-150-IM in chronic heart failure is recruiting two pivotal studies to support regulatory filing in the US, while recruitment is also ongoing for a Phase III programme for MPC-06-ID in chronic discogenic low back pain. The company’s inflammatory programme is also progressing; a Phase IIb/III trial has been finalised in diabetic kidney disease and key data in RA and Crohn’s disease will be reported in the current year.

Forthcoming share price inflection points are as follows:

Mesoblast expects its first commercial sales of mesenchymal lineage cell products from the launch of the recently approved MSC-100-IV in Japan in aGVHD. The regulatory green light in Japan is Mesoblast’s first formal product approval and a key milestone for the company, serving as critical confirmation of its proprietary mesenchymal cell technology. JCR plans to launch MSC-100-IV in February 2016 in Japan under the trademark Temcell. In November the company received approval from the Japanese Government’s National Health Insurance for reimbursement of a treatment course to patients at between $113,000 and $170,000, with the price dependent on persistency of symptoms.

aGVHD is a potentially life-threatening complication resulting from allogeneic hematopoietic cell transplantation (HSCT), a procedure most often performed for cancer patients (particularly with leukaemia or lymphoma), but also for certain types of anaemia and immunological disorders. aGVHD 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 opportunistic 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's activity against aGVHD, 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 aGVHD by the Ministry of Health, Labour and Welfare on 18 September. 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.2 On approval, Mesoblast received undisclosed milestone payments from JCR and will receive royalties on sales and other payments at certain sales milestones. JCR is to bear all commercialisation costs.

MSC-100-IV is also in development for steroid-refractory aGVHD for paediatric and adults in the US, Europe, New Zealand and Canada. We forecast peak global sales for MSC-100 in aGVHD to reach $765m, of which $72m in Japan. Our forecasts are based on the current number of annual stem cell transplants and a cost per transplant ranging from $75,000 to $200,000 (dependent on the treatment course needed per patient).

Mesoblast is now focusing its efforts on an FDA filling for aGVHD in the US. Mesoblast intends to commercialise MSC-100 in aGVHD in the US to a highly targeted physician population. An initial US paediatric filing will be based on data obtained through the US expanded access programme – to date, more than 250 paediatric patients have been treated in the US through expanded access – as well as one additional trial. Data from the initial 160 patients enrolled in the programme showed meaningful survival benefit among responding paediatric bone marrow transplant recipients and recruitment is ongoing for a 60-patient, open-label Phase III registration study in children with steroid refractory aGVHD which, if positive, will support a filing in 2016 in the US for a targeted launch in H217. Given its ultra-orphan status,3 Mesoblast expects to command premium pricing (we model US$250k per treatment in the US based on a traditional US premium to Japan and company guidance). A launch in the US of MSC-100 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. The pediatric program in the US should also results in eligibility for the pediatric rare disease voucher program.4 Mesoblast also plans launches of MSC-100 in children with aGVHD in Canada and New Zealand in 2016 following approval in the US.

Mesoblast provided a full update on its Phase III chronic heart failure programme on the back of a meeting between partner Teva and the US FDA in mid-2015, at which time the trial size was reduced from approximately 1,730 patients to 1,165 patients. Subsequently, on 11 January, the company announced that the size of the Phase III trial would again be substantially reduced following additional discussions between partner Teva and the US FDA. Optimisation of the trial now includes a reduction in patient size from 1,165 to ~600. As previously noted, this trial is enriched for patients with advanced heart failure, based on inclusion criteria of either high NT-proBNP levels or heart failure hospitalisation in the past nine months. The Phase III trial design focuses on those patients at high risk of recurrent HF-MACE (adverse cardiac events), large baseline LVESV (left ventrical end systolic volume) and high prior rates of HF-MACE. Mesoblast management believes the trial could be discontinued early on ‘overwhelming efficacy’ following testing for superiority at the interim analysis. Based on the mid-year FDA discussions, an additional confirmatory trial with ~600 patients is also underway in parallel with the Phase III study. 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.

Two interim analyses of the initial Phase III study are planned for safety and/or efficacy. While completion is expected in the second half of 2018, Mesoblast management comments that the reduction in trial size could shorten the time to trial completion. However, we err on the side of caution and our timing for forecast launch in CHF remains early 2019. Complete enrolment is underway with an interim analysis after 50% occurrence of HF-MACE events. An interim safety analysis is anticipated in Q116 with a second analysis for futility/overwhelming efficacy in Q117 (after 50% occurrence of HF-MACE events).

In September Mesoblast also announced additional Phase II results, which showed MPC-150-IM had the greatest cardioprotective effect in patients with advanced heart failure, ie patients with baseline LVESV >100ml, or rapidly deteriorating CHF patients with a high rate of adverse outcomes.

CHF is a common condition which, 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 statistics provided by the American Heart Association, 5.1 million people in the US are diagnosed with CHF (2% of the population). While progress has been made in treatment, there is high overall annual mortality (5-20%), particularly in patients with severe (NYHA Class IV5) 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.

MPC-150-IM is also under investigation in end-stage Class IV heart failure (c 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 H216. Additionally, a 225-patient Phase II safety study in acute myocardial infarction (AMI) is currently ongoing with MPC-150. The trial recruits patients undergoing a stent procedure two to 12 hours after onset of symptoms and the primary endpoint of the study is the frequency of major adverse cardiac events (MACE) at 24 months.

Exhibit 3 shows the competing stem cell and gene therapies in late-stage trials for CHF.

We reduce our valuation for Mesoblast to A$2.74bn from A$3.68bn (to A$7.20/share basic from A$10.93, or to A$7.07/share fully diluted from A$10.74). Our per-share value declines disproportionately on the increase in total shares from the recent share issue in the US. The breakdown of contribution to the rNPV is shown below (Exhibit 4).

The change to our valuation is primarily due to a change in rNPV for MPC-150-IM to A$1.52bn from A$2.28bn as we shave our expected peak penetration rate in the US/EU to 3% from 4% on the back of Phase II data suggesting the treatment had the greatest cardio protective effect in patients with more advanced heart failure. Pending an update in 2016 on the Phase II programme for MPC-25-IC in acute myocardial infarction, we lower our probability of success to 20% from 25%, hence the rNPV reduces to A$235m from A$292m. We adjust our rNPV for JCR-031 in Japan slightly (to A$65m from $76m) as we move our price per treatment in Japan to US$150k from US$200k on recently announced reimbursement rates, while increasing the probability of success to 100% from 80% on the back of the recent product approval. Given little visibility on the company’s clinical programme in bone marrow transplantation, we reduce our probability of success to 20% from 40% for this tier two treatment.

The strength of the US vs the Australian dollar allows for a slight upward value increase, as do changes to our near-term forecast related to the company’s recently announced cost savings programme. We also adjust our valuation on a drawdown in cash since our last note, which is offset about equally by the proceeds from its NASDAQ listing.

Mesoblast’s share price recently fell following the company’s US fund-raise and ADS NASDAQ listing as investors have been mindful of the inherent risks associated with its ongoing pivotal programme in CHF and the added costs of an additional confirmatory trial in CHF. However, the company’s pipeline continues to make traction, with a first product approval in aGVHD in the coming months and progression of two treatments into large Phase III trials. Our current fair value calculation points to considerable upside on the current share price (A$1.54) and we expect renewed interest in the shares on forthcoming price catalysts including launch and first sales of JCR-031 in Japan (February 2016), interim analysis of the current Phase III trial in CHF (Q116) and top-line Phase II data in cohort 1 for MPC-300-IV in rheumatoid arthritis (Q116).

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

In conjunction with its Q1 earnings call in mid-December, the company announced a cost management effort whereby a 20-25% reduction in operating cash burn is targeted over the next three quarters (Q215-Q415), compared with the last two quarters (Q116: US$28.1m and Q415: US$27.3m) to extend the company’s cash runway and achieve next value inflection points for its tier one product portfolio. In Q116, ending on 30 September 2015, the company reported a loss after income tax of $13.2m, a reduction of 15% from the $15.5m reported in Q115. Management and administration costs of $5.5m declined 20% quarter-on-quarter on cost-cutting and currency fluctuations, while 14% lower R&D expenses of $11.1m resulted from reduced expenses on tier one products and product support costs. R&D primarily reflected the company’s development costs for later-stage programmes in aGVHD (MSC-100) and low back pain (MPC-06) and the cost of employees supporting the MPC and MPS product platforms. Development costs related to MPC-150 (CHF) are predominantly funded by collaborators Teva and the NIH. Our forecasts are adjusted on the new cost-cutting measures.

Following its US listing and fund-raise, we estimate that the company held approximately US$120m (A$168m) in cash at 31 December 2015 which, on its current cash use, should be sufficient to finance operations through 2017, while faster uptake than expected on the launch of MSC-100 (aGVHD) in Japan (2016) could extend this runway. Thereafter, its burgeoning late-stage pipeline will require funds – ideally through partnerships, or alternatively through internal financing. We note that in mid-October Mesoblast extended its agreement with Celgene Corporation (signed in April 2015) by six months for right of first refusal (ROFR) to Mesoblast’s MPC products in aGVHD, certain oncologic conditions, inflammatory bowel disease and organ transplant rejection).