Mesoblast (MSB) GVHD granted Fast Track, should benefit ongoing negotiations with Mallinckrodt

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1 7 March 2017 Analyst Tanushree Jain Authorisation Chris Savage Recommendation Buy (unchanged) Price $1.90 Valuation $3.22 (previously $3.17) Risk Speculative GICS Sector Pharmaceuticals & Biotechnology Expected Return Capital growth 69.5% Dividend yield 0.0% Total expected return 69.5% Company Data & Ratios Enterprise value Market cap $690.3m $763.2m Issued capital 401.7m Free float 63.5% Avg. daily val. (52wk) $1.41m 12 month price range $1.01- $2.83 Price Performance (1m) (3m) (12m) Price (A$) Absolute (%) Rel market (%) Absolute Price $5.0 $4.0 $3.0 $2.0 $1.0 $0.0 Mar 15 SOURCE: IRESS Jul 15 Nov Mar Jul 16 Nov MSB S&P 300 Rebased Mesoblast (MSB) Speculative See Key risks on Page 4 & Biotechnology Risk Warning on Page 6 Speculative securities may not be suitable for Retail clients GVHD granted Fast Track, should benefit ongoing negotiations with Mallinckrodt FDA Fast Track s MSC-100-IV for GvHD in children The FDA has granted Fast Track designation to MSB s MSC-100-IV product for steroid refractory acute GvHD based on the positive data from the EAP (expanded access protocol) study in US. MSC-100-IV also has orphan drug designation from the FDA. Under Fast Track, MSC-100-IV will be eligible for certain benefits which would shorten the FDA review time. These include priority review (which shortens the review time to 6 months vs. standard 10 months) and a rolling BLA submission and review process (which enables MSB to submit sections of the BLA when completed rather than waiting for all sections to complete). Orphan designation is commercially valuable as it confers additional 7 years of market exclusivity on approval in US, waives the BLA application fee and in MSB s case may make it eligible for the Rare Paediatric Disease Priority Review Voucher (which have been selling in recent years for US$245m to US$350m). Implications for MSB Fast Track status implies a faster path to market for MSC-100-IV and raises its commercial prospects. We note that 73% of new drugs approved by FDA last year had one or more of these expedited designations. Therefore we expect MSB s ongoing partnering negotiations with Mallinckrodt to benefit from the timely grant of this designation. We also believe now more than ever, that the product may yet get another designation, that of regenerative advanced therapy under the 21st Century Cures Act, which being specifically for cell therapies may prove to be the most pertinent of them all. GvHD remains MSB s nearest-term revenue candidate. Modest lift in Valuation to $3.22, Retain Buy We have increased the probability of success for the GvHD product in the US to 75%, which has resulted in a modest lift in our valuation to A$3.22/sh (was A$3.17/sh). No changes to our FY17 and FY18 earnings forecasts. Changes to FY19 forecasts are not material. We retain Buy. Next catalysts: a) interim analysis from Phase 3 CHF trial in March 17; b) conclusion of ongoing negotiations with Mallinckrodt (BPe 2QCY17); c) 12 months data from Phase 2 RA trial in 3QCY17. We expect a deal at the back of this data and d) top line results from MSC-100-IV for paediatric GvHD in US in 4QCY17. Earnings Forecast Year end 30th June 2015A 2016A 2017E 2018E 2019E Sales (US$m) EBITDA (US$m) NPAT (reported) (US$m) NPAT (adjusted) (US$m) EPS (reported) (cps) EPS (adjusted) (cps) EPS growth (%) N/A N/A N/A N/A N/A PER (x) N/A N/A N/A N/A N/A EV/EBITDA (x) Dividend ( ps) Yield (%) 0.0% 0.0% 0.0% 0.0% 0.0% Franking (%) N/A N/A N/A N/A N/A ROE (%) -20.6% -5.5% -18.5% -16.7% -15.8% Note: Revenue includes R&D tax incentive, deferred upfront received from cephalon and commercial milestone and royalty revenue from launch of TEMCELL GvHD product in Japan.FY19 revenue includes GvHD and CHF product sales. BELL POTTER SECURITIES LIMITED ACN AFSL DISCLAIMER AND DISCLOSURES: THIS REPORT MUST BE READ WITH THE DISCLAIMER AND DISCLOSURES ON PAGE 6 THAT FORM PART OF IT INCLUDING THE FOLLOWING DISCLOSURE. DISCLOSURE: BELL POTTER SECURITIES ACTED AS LEAD MANAGER IN A CAPITAL RAISING IN MAY 2010 AND IN MARCH 2013 AND IN A SELLDOWN OF STOCK IN DECEMBER 2010 AND RECEIVED FEES FOR THAT SERVICE. Page 1

2 Earnings and Valuation Changes We have increased the probability of success for the GvHD product in the US to 75%, which has resulted in a modest lift in our valuation to A$3.22/sh (was A$3.17/sh). No changes to our FY17 and FY18 earnings forecasts. Changes to FY19 forecasts are not material. We retain our Buy recommendation. Table 1 - Key Changes to our FY17-19 Forecasts ALL AMOUNTS IN USD IN MILLIONS EXCEPT EPS. Old FY2017E FY2018E FY2019E New Change (%) Old New Change (%) Old New Change (%) Revenues % % % Interest Income % % % Opex % % % EBITDA % % % EBIT % % % NPAT (adjusted) % % % Adjusted Diluted EPS (cents) % % % Our DCF valuation model is based on a WACC of 21.4% and a terminal growth rate of 1%. Table 2 - Summary of Revised Valuation Forecasts Base case (US$m) Base case (A$m) Enterprise Value from DCF Add: Cash at end 1HFY Add: assumed cash from raise in FY17 & FY Less: Debt at end 1HFY Equity Value Total diluted shares incl. additional issue on raise (million) Value per share (US$/A$) $2.41 $3.22 Current Share price (A$) $1.90 Expected Capital Growth 69.5% INCLUDES MALLINCKRODT EQUITY PLACEMENT OF US$21.4M IN 1HFY17 AND ASSUMED US$131.25M GROSS CAPITAL RAISING IN FY17 AND FY18 Table 3 - MSB- Probability-Weighted Sum-of parts Valuation Summary Asset Identifier Stage Partnering Status ALL ASSETS ABOVE SHADED IN GREY ARE TIER 1 PRODUCTS AND THE KEY FOCUS FOR MSB. GLOBAL PEAK SALES ARE PRE-RISK ADJUSTMENT AND ROYALTIES. First Fiscal Year of sales (Est.) Peak Market share Peak Sales Global (US$m) Probability of success Probability adjusted NPV (US$m) Value per share (US$) % Mix SR Acute GvHD (Japan) TEMCELL Approved JCR Pharma % $ % $30 $ % Steroid Refractory Acute GvHD (Pediatric) -Ex- MSC-100-IV Phase III May choose to sell directly 2019 (US, Canada and 80% (US) Rest $227 75% (US), (44% $52 $ % Japan NZ); 2020 (ROW) 50% ROW) Chronic Discogenic lower back pain (CLDBP) MPC-06-ID Phase III In advanced negotiations % $2, % $512 $ % Revascor - Congestive Heart Failure (CHF) MPC-150-IM Phase III Will look to partner % $5, % $483 $ % Diabetic Nephropathy MPC-300-IV Phase II In advanced negotiations % $2, % $133 $ % Rheumatoid Arthritis (RA) MPC-300-IV Phase II In advanced negotiations % $1, % $124 $ % Revascor - End Stage CHF with LVAD MPC-150-IM Phase IIb NIH Funding Trial, will look to partner % $ % $27 $ % Other Pipeline/Non-allocated NA NA NA NA NA NA -$315 -$ % Cash (incl assumed raising in 2017 & 18) NA NA NA NA NA NA $185 $ % Equity Value $1,233 $ % Page 2

3 Key Near-term Catalysts Increase in royalties from TEMCELL in Japan: JCR Pharmaceuticals launched its acute Graft versus Host Disease (GvHD) product TEMCELL on 24th Feb 16. MSB has received in 4QCY15 US$3.5m in pre-commercial milestones triggered by the approval of TEMCELL. Under the deal sales milestones (BPe ~US$4m) as well as royalties in the mid 20% range are also payable by JCR. MSB recorded US$651,000 in royalty revenues in 1HFY17. We assume that at peak penetration (peak sales of US$83m); MSB will receive ~US$20m in annual royalty revenues from TEMCELL. Results from ongoing Phase II Rheumatoid Arthritis Trial: MSB will report 12 months (52 weeks) data from its Phase II Rheumatoid Arthritis trial in 3QCY17. This would give additional insights into the durability of the impressive clinical benefit seen with MPC treatment at 12 weeks and 9 months. We expect a partnering deal at the back of the 52 weeks data. Interim analysis from Phase III CHF Trial: The interim analysis for futility will be released by end of March 17. Since the trial is blinded, the DMC will look at the data on primary end point of the trial and provide their recommendation based on pre-specified thresholds. A positive recommendation to continue the trial as per protocol, will strengthen the partnering prospects of this asset and also allow MSB to make a prudent decision on continuing to make significant investment in this program. Positive results could also be the trigger for a partnership deal for the asset. Top line results from MSC-100-IV for paediatric GvHD in US in 4QCY17. Following discussions with the FDA, MSB is running a 60 patient Phase III trial in paediatric GvHD patients. The trial is currently enrolling. Recent interim analysis for futility was successful. Top-line results are expected in 4QCY17. Completion of enrolment in ongoing Phase III MPC-06-ID trial in chronic discogenic lower back pain (CLBP): MSB expects to complete enrolment in the first Phase III trial for CLBP in 2HCY17. Results from Phase IIb trial in end stage Heart Failure patients requiring LVAD with MPC-150-IM: The US National Institutes of Health (NIH) run and funded Phase IIb end stage HF trial is expected to yield results in 4QCY17. Potential positive conclusion of negotiations with Mallinckrodt and a partnering deal for MSB s chronic discogenic lower back pain product and GVHD product: MSB continues to be in advanced partnering discussions with Mallinckrodt under its equity purchase agreement signed in December 16. Mallinckrodt has exclusive rights to negotiate on the back pain and GvHD products (Ex Japan and China) till end of September We believe it is highly likely that a commercial deal between the two companies could materialise before the end of June 2017 (2QCY17) and understand that MSB may not release any interim data from the back pain trial to the market while it is in such discussions. Potential partnering deal for any of MSB s products for Japanese Market: We expect to see licensing interest building towards MSB s products for the Japanese market. Our belief is based on the growing interest of pharma companies in Japan towards regenerative medicine, the pro-regulatory environment allowing an expedited path to commercialization and nearer term revenues, the size of the market and high demand for treatments for diseases applicable to an ageing population. MSB s MPC- 150-IM CHF product and MPC-300-IV product targeting inflammatory indications including Rheumatoid Arthritis are likely lead candidates for partnering in Japan. Ideally MSB would look to partner with a single company for a suite of its advanced products that may be approvable under the conditional pathway in Japan. Page 3

4 Mesoblast (ASX: MSB, NASDAQ:MESO) COMPANY DESCRIPTION MSB has 3 late stage Tier 1 products The Melbourne-based Mesoblast (MSB) is a biotechnology company commercialising the therapeutic use of mesenchymal lineage cells (MPCs and MSCs) a kind of adult stem cell. MSB s MPC technology allows these cells to be extracted from the bone marrow of donors, grown into therapeutic quantities and administered allogeneically ie, to patients that are not related to the donor. It has one of the most diversified pipelines, with 3 Tier 1 products in late stage. The first commercial product from its pipeline for GvHD launched in Japan in 1QCY16. Substantial shareholders include Silviu Itescu, M&G, Thorney, Capital Group and pharmaceutical company Teva. Mallinckrodt pharma also holds 4.99% stake. INVESTMENT STRATEGY MSB is the leading allogeneic stem cell player with several late-stage clinical assets in multiple therapeutic indications. We expect progress of the Tier 1 products towards commercial launch to be the key value driver for MSB. MSB has focused its strategy on reducing cash burn and directing the savings to fund its CHF programme and other Tier 1 products to their next inflection point. A standby equity facility removes near term financing uncertainty and provides time to conclude a strategic partnering deal which in many ways could be truly transformative for the company. First commercial royalty revenue from GvHD product started from CY16 marking MSB s transition from a development stage company to a commercial organization. In our view, a partnership deal over the next 3-6 months with Mallinckrodt for the back pain and GvHD products could result in substantial cash injection and trigger a re-rating. We also expect further deals either for MSB s product targeting CHF or Rheumatoid Arthritis over the next months, also helped by the pro-regulatory environment created in the US with the 21 st Century Cures Act. KEY RISKS We see the following key stock specific risks to our investment thesis on Mesoblast: Clinical risk: There is a risk that MSB s clinical trials fail to reach their endpoints. Failure of a Phase III trial may significantly impact markets confidence on Mesoblast s technology and in case of an un-partnered product will reduce its partnering prospects. Commercialisation risk: MSB needs a partner to undertake commercialization for its CHF product. Ideally this partner would be one with an existing cardiovascular franchise and existing and established sales force in the area. The ability of MSB s product to finally reach the market will depend on them doing a partnering deal. Delays or failure in attracting a suitable partner at suitable terms will impact MSB s ability to generate revenue from this asset. Manufacturing risk: The key success of Mesoblast s business model is dependent on its ability to manufacture its stem cells on commercial scale as well as at a costeffective price. Mesoblast has partnered with Lonza to manufacture its stem cells. Our underlying assumption is that together the companies will be able to drive down the COGS by driving efficiencies in the manufacturing process. Failure to cost-effectively manufacture would impact our valuation. MSB had ~US$55.3m cash at the end of 1H17 Regulatory risk: Successful commercialisation of MSB s products is ultimately dependent on getting approval from the regulatory authorities to commercially launch the product. Failure to satisfy regulatory requirements could mean that the product will fail to reach the market. Funding risk: Although MSB has a high cash balance currently, the company may need to raise additional capital (through the equity financing facility with Kentgrove Capital and other means) if there are delays in partnering its late stage assets before commercialization or if its burn rate increases significantly. If the raising price is below our current assumptions, it could lead to more dilution than we have currently assumed. Page 4

5 Mesoblast as at 7 March 2017 Recommendation Buy, Speculative Price $1.90 Valuation $3.22 Mesoblast (MSB) 7 March 2017 Table 4 - Financial summary Mesoblast (MSB) Share price (A$) $1.900 As at 7 March 2017 Market cap (A$m) Profit and Loss Valuation data Y/e June 30 (US$m) 2015A 2016A 2017E 2018E 2019E Y/e June A 2016A 2017E 2018E 2019E Revenue Net profit (US$m) Gross profit (loss) adjusted EPS (c) Total Operating costs EPS growth (%) N/A N/A N/A N/A N/A EBITDA P/E ratio (x) N/A N/A N/A N/A N/A Depreciation & Amortisation CFPS (c) EBIT Price/CF (x) Net interest & Other Income/(expense) DPS ( c ) Pre-tax profit (loss) Yield (%) 0.0% 0.0% 0.0% 0.0% 0.0% Tax Franking (%) N/A N/A N/A N/A N/A Adjusted Net Profit (Loss) EV/EBITDA Less minority interests EV/EBIT Net profit (loss) to shareholders Reported net profit (loss) to shareholders Share price now (A$) $1.90 Cashflow Valuation: (A$) $3.22 Y/e June 30 (US$m) 2015A 2016A 2017E 2018E 2019E Premium (discount) to price 69.5% Reported NPAT Recommendation: Buy Non-cash items Risk Rating Speculative Working capital Profitability ratios Other operating cash flow Y/e June A 2016A 2017E 2018E 2019E Operating cashflow EBITDA/revenue (%) N/A N/A N/A N/A N/A EBIT/revenue (%) N/A N/A N/A N/A N/A Capex Return on assets (%) -12.3% -4.2% -14.3% -12.9% -11.8% Investments Return on equity (%) -20.6% -5.5% -18.5% -16.7% -15.8% Other investing cash flow Return on funds empl d (%) -20.6% -5.5% -18.5% -16.7% -15.8% Investing cashflow Dividend cover (x) N/A N/A N/A N/A N/A Effective tax rate (%) 0.0% 0.0% 0.0% 0.0% 0.0% Change in borrow ings Equity issued Liquidity and leverage ratios Dividends paid Y/e June A 2016A 2017E 2018E 2019E Other financing cash flow Net cash (debt) (US$m) Financing cashflow Net debt/equity (%) N/A N/A N/A N/A N/A Net interest cover (x) N/A N/A N/A N/A N/A Net change in cash Current ratio (x) Cash at end of period* * I nc l ude s e f f e c t of e x c ha nge r a t e f luc t ua t i ons on c a sh ba l a nc e Free cash flow Balance sheet Interims Y/e June 30 (US$m) 2015A 2016A 2017E 2018E 2019E Y/e June 30 (US$m) 2H15A 1H16A 2H16A 1H17A 2H17E Cash Revenue Current receivables EBITDA Inventories Depreciation & Amortisation Other current assets EBIT Current assets Net interest & Other Income/(expense) Pre-tax profit (loss) PPE Tax Non-current receivables Adjusted Net Profit (loss) Intangible assets Less minority interests Other non-current assets Net profit (loss) to shareholders Non-current assets Reported net profit (loss) to shareholders Total assets Payables Debt Provisions Other liabilities Total liabilities Shareholders equity Minorities Total shareholders funds Total funds employed W/A shares on issue Page 5

6 Recommendation structure Buy: Expect >15% total return on a 12 month view. For stocks regarded as Speculative a return of >30% is expected. Research Team Staff Member TS Lim Sam Haddad Jonathon Higgins Title/Sector Head of Research Phone tslim shaddad jhiggins Hold: Expect total return between -5% Chris Savage csavage and 15% on a 12 month view Jonathan Snape jsnape Sell: Expect <-5% total return on a 12 month view Tim Piper John Hester Tanushree Jain Healthcare Healthcare/Biotech tpiper jhester tnjain Speculative Investments are either start-up enterprises with nil or only prospective operations or recently commenced operations with only forecast cash flows, or companies that have commenced operations or have been in operation for some time but have only forecast cash flows and/or a stressed balance sheet. Financials TS Lim Lafitani Sotiriou Resources Peter Arden David Coates Associates James Filius Banks/Regionals Diversified Resources Resources Associate Analyst tslim lsotiriou parden dcoates jfilius Such investments may carry an exceptionally high level of capital risk and volatility of returns. Bell Potter Securities Limited ACN Level 38, Aurora Place 88 Phillip Street, Sydney 2000 Telephone The following may affect your legal rights. Important Disclaimer: This document is a private communication to clients and is not intended for public circulation or for the use of any third party, without the prior approval of Bell Potter Securities Limited. In the USA and the UK this research is only for institutional investors. It is not for release, publication or distribution in whole or in part to any persons in the two specified countries. 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Biotechnology Risk Warning: The stocks of biotechnology companies without strong revenue streams from product sales or ongoing service revenue should always be regarded as speculative in character. Since most biotechnology companies fit this description, the speculative designation also applies to the entire sector. The fact that the intellectual property base of a typical biotechnology company lies in science not generally regarded as accessible to the layman adds further to the riskiness with which biotechnology investments ought to be regarded. Stocks with Speculative designation are prone to high volatility in share price movements. Clinical and regulatory risks are inherent in biotechnology stocks. Biotechnology developers usually seek US FDA approval for their technology which is a long and arduous three phase process to prove the safety, effectiveness and appropriate application or use of the developed drug and even after approval a drug can be the subject of an FDA investigation of subsequently discovered possible links between the drug and other diseases not previously diagnosed. Furthermore, the Australian exchange listed biotechnology sector is subject to influence by the global biotechnology sector, particularly that in the USA. Consequently, Australian exchange listed biotechnology stocks can experience sharp movements, both upwards and downwards, in both valuations and share prices, as a result of a re-rating of the sector both globally and in the USA, in particular. Investors are advised to be cognisant of these risks before buying such a stock including Mesoblast. For a list of risks specific to Mesoblast please refer to Page 4 of this note. ANALYST CERTIFICATION: Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report. Page 6