Mesoblast (MSB) Closes NASDAQ IPO, TEMCELL pricing finalised in Japan

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1 23 November 2015 Analyst Tanushree Jain Authorisation TS Lim Recommendation Buy (unchanged) Price $1.705 Valuation $4.50 (previously $9.01) Risk Speculative GICS Sector Pharmaceuticals & Biotechnology Expected Return Capital growth 163.9% Dividend yield 0.0% Total expected return 163.9% Company Data & Ratios Enterprise value Market cap $454.6m $648.1m Issued capital m Free float 62.6% Avg. daily val. (52wk) $1.99m 12 month price range $ $4.60 Price Performance (1m) (3m) (12m) Price (A$) Absolute (%) Rel market (%) Absolute Price $7.0 $6.0 $5.0 $4.0 $3.0 $2.0 $1.0 Nov 13 SOURCE: IRESS Mar Jul 14 Nov Mar Jul MSB S&P 300 Rebased Mesoblast (MSB) Speculative See Key risks on Page 13 & Biotechnology Risk Warning on Page 15 Speculative securities may not be suitable for Retail clients Closes NASDAQ IPO, TEMCELL pricing finalised in Japan MSB makes NASDAQ debut at a heavy discount Mesoblast has announced the closing of its NASDAQ IPO, raising net proceeds of US$58.8m (~A$82.7m) by issue of 8.5m American Depositary Shares (ADS) at a price of US$8/ADS (1 ADS = 5 shares). Disappointingly, MSB had to take a pricing cut, issuing ADS at a 34% discount to its last close on ASX of A$3.41/sh (~US$12.10/ADS). Since mid-september concerns over a political backlash to rising drug prices have not only led to a selloff of biotech stocks but has also affected the IPO valuations of stocks looking to make a debut on Wall Street. MSB has turned out to be the latest victim of this alarming trend of IPO s being downsized and finally priced well below original expectations. Notwithstanding the discount, the listing does extend MSB s cash runway to 16 months (from Oct 15 out to Jan 17) and provides access to US biotech specialist funds and gives additional liquidity to existing investors. TEMCELL approved for listing, launch imminent in Japan In Japan, partner JCR has received listing approval for GvHD product TEMCELL. Reimbursement price has been fixed at ~US$113,000/patient. MSB expects JCR to launch the product in 1QCY16. We assume that at peak penetration (peak sales of US$110m), MSB will receive ~US$28m in annual royalty revenues from TEMCELL. Valuation reduced to $4.50, Retain Buy Our revised assumptions, dilution from raising and increase in WACC has led to a substantial decrease in our valuation to A$4.50/sh (was A$9.01/sh). Our NPAT est. changed as follows -4% FY16, -7% FY17 and -21% FY18. We are discouraged with the loss in value of MSB following the NASDAQ listing and the increased vulnerability of the company to a corporate takeover. We believe MSB miscalculated the timing of the listing given the market conditions. We expect the overhang from this to continue for some time. However, we continue to believe in MSB s technology and expect it to rebuild from here by delivering on its announced clinical and commercial milestones over the next 12 months which should help the sentiment for the stock to improve and it to re-rate. We retain Buy. Key catalysts include results from Phase II trial for RA, launch of TEMCELL and interim analysis from Phase III CHF trial in 1QCY16. Earnings Forecast Year end 30th June 2014A 2015A 2016E 2017E 2018E Sales (A$m) EBITDA (A$m) NPAT (reported) (A$m) NPAT (adjusted) (A$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 (%) -14.2% -19.6% -22.3% -19.7% -23.2% 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 SOURCE: BELL POTTER SECURITIES ESTIMATES BELL POTTER SECURITIES LIMITED ACN AFSL DISCLAIMER AND DISCLOSURES: THIS REPORT MUST BE READ WITH THE DISCLAIMER AND DISCLOSURES ON PAGE 15 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 Contents MSB makes NASDAQ debut at a heavy discount... 3 TEMCELL approved for listing, launch in Japan imminent... 8 Earnings and Valuation Changes Key Near-term Catalysts Page 2

3 MSB makes NASDAQ debut at a heavy discount Mesoblast has announced the closing of its NASDAQ IPO. It has issued 8.5m American Depositary Shares (ADS) at a price of US$8/ADS (1 ADS = 5 MSB shares). The company raised gross US$68.3m (~A$96.0m). Net proceeds from the offer were US$58.8m (~A$82.69m). Disappointingly, although the company managed to get the funds and complete its IPO, it had to take a pricing cut, issuing ADS at a 34% discount to its last traded price on ASX of A$3.41/sh which was equivalent to US$12.10/ADS. The company reported cash of US$77.7m for the quarter ended 30 th September, With the proceeds from the IPO, MSB s cash reserves have lifted to ~US$136.6m (~A$193.5m), based on the cash balance at the end of 1QFY16. The stock has taken a tumble since the listing, with the market not pleased about the significant cut in its valuation. We examine the funding and what has changed and not changed for MSB since the listing below. MSB price cut on listing a one-off event or a wider trend with biotechs on Wall Street? Since mid-september biotechs have been affected by the widespread drug pricing controversy which was triggered by the 5000% price hike of an old drug called Daraprim by Turing Pharmaceuticals. Concerns over a political backlash to rising drug prices have not only led to a selloff of biotech stocks but has also affected the IPO valuations of biotech stocks looking to make a debut on Wall Street. In Table 1 on the next page, we examined the pricing of biotechs who listed on NASDAQ from mid-september to now and saw an alarming trend of IPO s being downsized and finally priced well below original expectations. This was despite some companies having strong strategic investors on the register as Mesoblast does. Although the IPO window is not closed for biotechs, it is evident that the conditions in recent months have not been conducive, at least in terms of expected valuations. This has also caused a few companies to withdraw their proposed listing plans. Hence MSB s IPO being priced below expectations although disappointing is not dissimilar to what has now become a trend in recent months and reflects tough market conditions. Our view on MSB s IPO listing Needless to say we were very discouraged with MSB s IPO pricing. We believe the company miscalculated the timing of the listing given the market conditions. MSB reported cash balance at end of 30 th September of US$77.7m. At an average burn rate of ~US$8m/month over the last 12 months, in our view, MSB would have cash runway well into 2QCY16. We believe that the strategy behind considering a listing on NASDAQ in the first place is sound. The listing should provide additional liquidity to the stock and access to specialist biotech investors in the US market. It also extends MSB s cash runway to 16 months i.e. from Oct 15 through to January 2017 and strengthens its balance sheet which should help in ongoing partnering negotiations. Page 3

4 However, in our view, where MSB stumbled was in the execution and reading the market conditions and therefore in our view the timing. We would have rather preferred that the company waited for a significant milestone achievement and then on the back of that explored a US listing. Considering that we were due to get the first interim look from the Teva run Phase III congestive heart failure (CHF) trial in 1QCY16, to us, listing at the back of the potentially positive results would have been a better strategy. Table 1 Recent Biotech IPO s on NASDAQ Pricing below initial expectations Company Business Offer Date Lead Managers Axsome Pain and CNS 19-Nov-15 Ladenburg Thalmann, Cantor Fitzgerald Final Pricing vs. IPO size Initial IPO IPO Price original mid (US$mn) pricing Range point 51 $9 $11 - $13-25% Comments Mesoblast Regenerative medicine 12-Nov-15 JP Morgan and Credit Suisse 68.3 $8 $ % Partnered with Teva. Has both Teva and Celgene in the form of strategic invetsors on the register. Voyager Gene therapy targeting Parkinson's and other CNS 10-Nov-15 Cowen & Company and Piper Jaffray Kura Oncology Oncology 04-Nov-15 Citi and Leerink Partners 70 $14 $15 - $17-13% Partered with Sanofi's subsidiary Genzyme who is also a shareholder in the company. 50 $8 $16-50% Was to raise $60mn at its trading price of $16 MyoKardia Genetically triggered heart disease Oasmia Drug-delivery for Pharmaceutica oncology drugs ls 28-Oct Oct-15 Credit Suisse and Cowen & Co. Rodman & Renshaw, Joseph Gunnar & Co. 54 $10 $15 - $17-38% Listed at discount despite help from partner and existing shareholder Sanofi who invested another $9m in the company at the IPO price 9 $4 $ $ % Company also decreased deal size from original $23m to $15m, ultimately raising just $9m. It also decreased offer price range from original $5.25-$8.25 to $ $6.70. Announced in August but pushed back to mid-sep and then completed in october. Dimension Cerecor Strongbridge Biopharma Preclinical stage gene therapy targeting rare genetic disorders CNS, targeting Depression Focused on rare endocrine disorders 21-Oct-15 Goldman Sachs, Citi 72 $13 $14 - $16-13% 15-Oct-15 Maxim Group 26 $6.5 $6-$7 0% Priced within range. Issued concurrently dilutive warrants exercisable at $4.55 per share and at $3.90 per full share. 15-Oct-15 Stifel 25 $10.0 $ % Cut Initial deal size by 67% from $76m to $25m, reduced offering price from last traded price of $17.93 to $10 and removed one lead manager BofA Merrill Lynch during the process. CytomX Preclinical- Cancer immunotherapy 07-Oct-15 BofA Merrill Lynch, Jefferies and Cowen & Co 80 $12.0 $14 - $16-20% Aclaris NovoCure Skin lesions 06-Oct-15 Jefferies and Citi 55 $11.0 $14 - $16-27% Device for treating glioblastoma brain cancer 01-Oct-15 JP Morgan, Deutsche Bank and Evercore Partners 165 $22.0 $26 - $29-20% Cut initial deal size from $300m to $165m and price range from $26-$29 to $23 to $24, finally listing at $22. This was despite strategic investors such as Johnson & Johnson Development Corporation, Pfizer Ventures and Medtronic on the register. Edge Mirna Targeting acute life-threatening neurological conditions including brain aneurysms microrna drugs for cancer 30-Sep Sep-15 Leerink Partners, Credit Suisse Leerink Partners, Citi 80 $11.0 $14 - $16-27% $7.0 $13 - $15-50% Cut deal size from $80.5m to finally raise $43.75m. Also has Pfizer, Celgene and Baxter as strategic investors Nabriva anti-infectives. Antibiotic 17-Sep-15 RBC Capital markets and Leerink Partners 92.3 $10.25 $15 - $17-36% Cut deal size from $96m and also slashed price from $15-$17 to $10.50, finally raising at $ SOURCE: COMPANY DATA AND BELL POTTER SECURITIES Page 4

5 What has changed after the listing? Mesoblast is now listed with the ticker MESO on NASDAQ. It also maintains its listing on the ASX under the ticker MSB. MSB s cash runway is extended. Its current cash reserves of ~US$136.6m (~A$193.5m) - based on cash balance at the end of 1QFY16 and including net proceeds from the listing - provides 16 months cash runway (from Oct 15 to Jan 17). MSB gets access to specialist US investors. MSB will potentially get coverage by US brokers. We note that there were 4 US brokers involved with MSB s NASDAQ IPO. We expect after the blackout period we may hear of these brokers assuming coverage on the company. MSB s stock has taken a deep hit, down 50% from its last traded price of A$3.41 before the listing announcement. Trading now at a historically low price, MSB is now extremely vulnerable to a corporate takeover. We note that in April 2015, Celgene took a 4.5% stake in the company investing A$58.5m in In 2010, Cephalon (now Teva) acquired ~20% stake in MSB at A$4.35/sh, making ~US$220m equity investment in the company. MSB s NASDAQ IPO price was ~A$2.25/sh, a significant discount from both Teva s and Celgene s investment in the company. In Japan, partner JCR has received listing approval for GvHD product TEMCELL and reimbursement price for TEMCELL has been fixed at ~US$113,000/patient. What has not changed after the listing? The underlying fundamentals of the company including its technology. Development progress of its pipeline. The timeline for the company to deliver on its near term clinical milestones. We expect Top line data from cohort 1 of the Phase II rheumatoid arthritis trial by end of CY15, interim data from Phase III CHF trial in 1QCY16 and interim data from Phase III Paediatric GvHD trial in 3QCY16. The timeline for the company to deliver on its near-term commercial milestones is unchanged. The company s partner JCR pharma is expected to launch the GvHD product TEMCELL in Japan in 1QCY16. As far as we know the company continues to be in advanced negotiations with various parties for its chronic discogenic low back pain (CLBP) product and with Celgene under their first right of refusal agreement. The company will need additional cash injection before it becomes self-sufficient to fund it beyond January A partnering deal could remove the need for additional capital. We continue to believe that the prospects of a partnering deal in the next 6-9 months are encouraging. Funding outlook for MSB We note that the market seems to be looking at MSB s last quarter burn of US$29m and assuming that is indicative of the company s annual cash burn. In our view, MSB s average cash burn over the last twelve months is a better indication of its annual funding needs. MSB on average has burned ~US$8.1m/month or ~A$11.4/month over the last 12 months. Page 5

6 Assuming an annual burn rate of US$98m, MSB s cash reserves after the listing ~US$136.6m (~A$193.5m) - based on cash balance at the end of 1QFY16 - provides them with roughly 16 months cash runway (from Oct 15 to Jan 17). The company is currently running the following trials: A Phase III trial in CLBP A Phase III trial in acute steroid-refractory GvHD in children A Phase II trial in biologic refractory Rheumatoid Arthritis Apart from the above, there are 2 other Congestive Heart Failure (CHF) trials ongoing which are being funded by third parties, with product being manufactured by MSB. These include: A Phase III CHF trial being funded by Teva An end stage CHF with LVAD trial being funded by the US NIH We expect MSB will continue to fund and advance its 3 tier 1 products which are closest to revenue, namely: Teva funded CHF trial, with manufacturing to be done by MSB. We note that Teva has indicated to MSB that the second confirmatory 500 patient trial in CHF will be run in parallel to the ongoing 1730 patient trial. As such we believe the timeline for potential launch of this product is dependent on timeline for completion of the first CHF trial. We assume approval and launch in FY19 which would trigger a milestone payment to MSB of ~US$125m from Teva. Phase III CLBP product. MSB expects enrolment for first trial to be completed in 3QCY16. A second Phase III trial will potentially be started within the next 12 months. MSB expects to complete the full program in 1HCY18. The second trial will only have one year follow up and should complete in parallel to the first trial. We assume approval and launch of the product in FY19. For paediatric GvHD, we expect MSB to be in a position to file BLA for approval in US by end of CY16, 1HCY17. Given it s a rare paediatric diseases, we expect priority review and expect MSB in position to launch the product in FY18. Based on the above we see the following timeline for revenue flow for MSB: Acute GvHD revenue from Japan from TEMCELL in FY16. This includes US$3.5m in milestones in 4QCY15 and royalty revenue (mid-20% of net sales) to start on launch from 1QCY16. We assume that at peak penetration, MSB will receive ~US$28m in annual royalty revenues from TEMCELL in Japan. We discuss the revenue flow from TEMCELL in detail in the next section. Potential upfront revenue from a partnering deal for CLBP within next 6-9 months. We expect launch in FY19 which should start any milestones and royalty revenues on the product. Potential launch of the CHF product by Teva in FY19 which should trigger a US$125m milestone payment to MSB and royalty revenues (transfer price net of COGS). Apart from the above we expect MSB will make a decision in CY16 based on the Rheumatoid arthritis (RA) trial as to which of the two Tier 1 products (RA or diabetic kidney disease), will it move to Phase III from the IV franchise. We expect MSB will be judicious in applying its resources over the next 12 months to essentially Tier 1 products. The one flexibility it likely has to manage its cash burn in 2016/2017, is to defer the initiation of a Phase III trial from its IV franchise or look for a partner to move it ahead. We now assume that MSB will need another gross A$250m cash injection by 1QCY17 to give it another 2 years cash runway. This along with the revenue flow from GvHD both in Page 6

7 Japan (over 2016/17) and US (in 2018), should help the company to meet its funding needs before the TEVA milestone and revenues from CHF and CLBP products kick in from FY19. We note that if a partnership deal for the back pain product or GvHD or the inflammatory franchise materialises within the next 6-9 months, then the cash injection from the deal will in all likelihood remove the need for MSB to raise money by 1QCY17. Our summary comments In summary, we are discouraged with the loss in value of MSB following the listing on NASDAQ at a significant discount and the increased vulnerability of the company to a corporate takeover. The company is at all time low prices and we expect the overhang from the listing to continue in the stock for some time. However, we continue to believe in MSB s technology and expect the company to rebuild from here by delivering on its announced clinical and commercial milestones and addressing its funding needs beyond Jan 2017 through better cash management and potentially proceeds from a partnering deal. The company will need additional cash injection by 1QCY17 of around A$250m based on our forecasts. We expect revenue flow from the three advanced Tier 1 products by FY19 will position the company to be self-sufficient beyond. Key near term catalysts: interim results from Phase III CHF trial due in 1QCY16, launch of TEMCELL in Japan in 1QCY16 and results from Phase II RA trial by end of CY15. For a more detailed discussion on near term catalysts please refer to Page 12 of the note. Page 7

8 TEMCELL approved for listing, launch in Japan imminent MSB/JCR Pharmaceuticals acute graft vs. host disease (agvhd) product JR-031 received approval in Japan in September. JR-031 has been branded as TEMCELL HS Inj. JR-031 is known as MSC-100-IV Ex-Japan. TEMCELL is being targeted for use in both adult and paediatric GvHD patients in Japan. TEMCELL becomes the first allogeneic (off the shelf) regenerative medicine product to be approved in Japan. It also becomes MSB s first commercial product. TEMCELL approved for listing and pricing finalised JCR has been in pricing discussions for health insurance reimbursement. Given that TEMCELL has characteristics close to those of pharmaceuticals, Japan s Chuikyo (Central Social Insurance Medical Council), agreed that TEMCELL s reimbursement price would be set by the Drug Pricing Organization. The final discussion on listing was to be conducted by Chuikyo. Last week, Chuikyo approved the listing of TEMCELL. TEMCELL becomes one of the first regenerative medicine products to obtain listing under the Pharmaceuticals and Medical Devices Law. TEMCELL is scheduled for listing on November 26. TEMCELL was priced using the cost calculation method and received an NHI price of ~870,000 yen. A course of treatment of TEMCELL is expected to cost ~13.9 million yen. This equates to ~US$113,000/patient or ~US$7,000 per dose (based on 16 doses per treatment). We had assumed a reimbursement price in Japan per patient from US$112,000 to US$130,000. We are encouraged that the final reimbursement is within our assumed range. It also helps to support our belief that the pricing of MSB s GvHD product in the US will be several times over US$113,000/patient. TEMCELL needs to be distributed and stored at ultra-low temperature. Therefore, JCR has also created a refrigerated transport system for TEMCELL in collaboration with Medipal Holdings in preparation for the launch of the product. MSB expects JCR to launch the product in Japan in 1QCY16. Terms of Mesoblast s agreement with JCR JCR has exclusive rights in Japan to MSB s MSC technology for treatment of haematological malignancies including acute Graft vs Host disease (GvHD). MSB retains worldwide rights to develop its MSC-100-IV product for all clinical indications, other than for hematological malignancies in Japan. JCR has first negotiation rights to commercialize other MSC based orphan designations in Japan. As per the terms of the 2003 agreement, JCR will be responsible for registration, manufacturing and launch of TEMCELL and will bear related commercialization costs. MSB will be paid up to US$5.5m (~US$2m of this has already been received) in precommercial milestones on filing, approval and launch and certain amounts based on hitting milestones in cumulative sales (BPe ~US$4m) as well as royalties in the mid 20% range. Revenue Flow from TEMCELL in Japan We expect MSB to receive the remaining balance (~US$3.5m) of pre-commercial milestones in 4QCY15. Page 8

9 We continue to assume that MSB will receive ~US$4m in sales milestones based on reaching cumulative sales thresholds. We assume that at peak penetration, MSB will receive ~US$28m in annual royalty revenues from TEMCELL in Japan. Our market assumptions to calculate royalty revenue from TEMCELL to MSB are as follows: As per the Asia-Pacific Bone Marrow Registry there were ~3,245 allogeneic transplants in Japan in We assume ~3% annual growth rate in transplants to arrive at an estimated 3,800 allogeneic transplants in Japan for We assume that 50% of these patients get agvhd (i.e. ~1900 patients) which is the target population for TEMCELL. ~50% of the agvhd population our steroid-refractory i.e. ~950 patients. We estimate peak sales from the acute GvHD Japan market to JCR at US$110m (assuming 80% market penetration in the steroid refractory population which translates to 40% market penetration in the acute GvHD market). We note that the label for TEMCELL in Japan allows it to be used as first line therapy. However, given the premium pricing of TEMCELL we are unsure at this stage as to what its usage will be in the non-refractory population. Increased usage in the first line setting will be an upside to our current sales forecasts. We now use flat rate of annual reimbursement in Japan per patient of US$113,000. We assume royalty rate in the mid 20% range. This is based on company guidance which explicitly says that they expect to receive escalating double-digit royalties in the twenties. Strategic Value of TEMCELL approval and pricing Notwithstanding the revenue flow from TEMCELL, we believe that the strategic value of the TEMCELL approval and pricing is also of significance based on the following: Approval for TEMCELL and subsequent launch marks the transformation of MSB from a R&D stage company to a commercial organization. This also serves as a validation of MSB s underlying platform technology. In our view, the approval in Japan should bolster the confidence of potential licensees of the MSC-100-IV product and its prospects Ex-Japan. We note that the GvHD indication (Ex-Japan) is part of Celgene s 1 right of first refusal agreement. The pricing for a course of treatment of TEMCELL in Japan has been set at ~US$113,000/patient or ~US$7,000 per dose (based on 16 doses per treatment). We believe that the pricing of MSB s GvHD product in the US will be around 44% to 55% over Ex-US pricing. Based on Japanese pricing of US$113,000/patient, this would equate to a US pricing per patient in the range of US$200,000 to US$250,000. This is not unreasonable pricing for an orphan drug indication. There is scope for further expansion of MSB & JCR s existing partnership and also for potential label expansion of the product. In an Oct 14 interview published in a Japanese news site, JCR s EVP Katsuya Nishino hinted at the possibility of expanding the drug s indication in the future. He said that the priority is to gain approval for GVHD, but the company may consider developing the drug for other indications. 1 Celgene has a first right of refusal to license MSB products covering certain disease fields, which expires in April The company acquired a 4.5% stake in MSB and the first right of refusal in April 2015, which was subsequently extended for another 6 months in October Page 9

10 Earnings and Valuation Changes We have revisited our assumptions for Mesoblast and made adjustments to our forecasts following its recent US listing and the information in the prospectus filed with the SEC. Key changes to our modelling assumptions We have updated our model for the net US$58.8m (~A$82.69m) cash injection from the placement with the US listing. The company issued 42.7m to raise gross US$68.3m (A$96.0m). We have pushed out launch timelines by ~6 months for various indications as follows - launch of chronic discogenic low back pain product in FY19 (from FY18), diabetic nephropathy product in FY20 (from FY19), spinal fusion product in 2HFY20 (from 1HFY20) and rheumatoid arthritis indication in 2HFY20 (from 1HFY20). We have also pushed our timelines for end-stage CHF with LVAD in FY21 (from FY19). We have removed Age-related Macular Degeneration indication from our forecasts. We now assume annual reimbursement in Japan for TEMCELL for acute GvHD per patient at US$113,000 (was US$112,000 to US$130,000). Our peak sales for Japan agvhd is now US$110m (was US$125m). We have increased our operating cost forecasts based on the 1QFY16 cash flow numbers and the anticipated increase in G&A costs due to being a NASDAQ listed company, while also maintaining its listing on the ASX. As per our revised forecasts we expect MSB s current cash reserves of ~US$136.6m (~A$193.5m) - based on cash balance at the end of 1QFY16- provides 16 months cash runway through to January MSB on average has burned ~US$8.1m/month over the last 12 months, which translates to an annual burn rate of ~US$98m (~A$137m). With the gross A$96m raised with the US listing this month, we now assume that MSB will need another gross A$250m cash injection by 1QCY17. We note that if a partnership deal for the back pain product or GvHD or the inflammatory franchise materialises within the next 6-9 months, then the cash injection from the deal will in all likelihood remove the need for MSB to raise money. To account for the increased vulnerability of MSB to a corporate takeover caused by MSB pricing its IPO at US$8/ADS, a significant discount from the original target of US$12.10/ADS and the overhang from it reflected in the stock price, we have increased our WACC from 16.4% to 20.1%. We value MSB at A$4.50/sh Our revised assumptions, dilutive impact of the recent capital raising and increase in WACC has resulted in a substantial decrease in our valuation to A$4.50/sh (was A$9.01/sh). We continue to believe that the underlying fundamentals of the business remain unchanged, including the potential of MSB s technology. We expect the company to deliver on its announced clinical and commercial milestones over the next 12 months which should help the sentiment for the stock to improve and it to re-rate. We retain our Buy (speculative) recommendation. Table 2 - Key Changes to our FY16-18 Forecasts ALL AMOUNTS IN AUD IN MILLIONS EXCEPT EPS. SOURCE: BELL POTTER SECURITIES ESTIMATES Old FY2016E FY2017E FY2018E New Change (%) Old New Change (%) Old New Change (%) Revenues % % % Interest Income % % % COGS % % % Opex % % % EBITDA % % % EBIT % % % NPAT (adjusted) % % % Adjusted Diluted EPS (cents) % % % Page 10

11 Our DCF valuation model is based on a WACC of 20.1% and a terminal growth rate of 1%. Table 3 - Summary of Revised Valuation Forecasts Base case (A$m) Enterprise Value from DCF (AUDm) Add: Cash at end FY16E (AUDm) 87.7 Add: assumed cash from raise in FY17 (AUDm) Less: Debt at end FY16E (AUDm) 0.0 Equity Value (AUDm) Total diluted shares incl. additional issue on raise (million) Value per share (AUD) $4.50 Current Share price $1.71 Expected Capital Growth 164.0% INCLUDES ASSUMED A A$250M GROSS CAPITAL RAISING IN FY17 SOURCE: BELL POTTER SECURITIES ESTIMATES Table 4 - MSB- Probability-Weighted Sum-of parts Valuation Summary Asset Identifier Stage Partnering Status 40% PEAK MARKET SHARE OF ACUTE GVHD MARKET IN JAPAN TRANSLATES TO ~80% PEAK PENETRATION OF THE STEROID REFRACTORY ACUTE GVHD MARKET IN JAPAN ASSETS SHADED IN GREY ARE TIER 1 PRODUCTS AND THE KEY FOCUS FOR MSB. GLOBAL PEAK SALES ARE PRE-RISK ADJUSTMENT AND ROYALTIES. SOURCE: BELL POTTER SECURITIES ESTIMATES First Fiscal Year of sales (Est.) Peak Market share Peak Sales Global (US$m) Probability of success Probability adjusted NPV (A$m) Value per share (A$) Acute GvHD (Japan) TEMCELL Approved JCR Pharma % $ % $52 $ % Steroid Refractory Acute GvHD (Pediatric) -Ex- MSC-100-IV Phase III Celgene has first right of 2018 (US, Canada and 80% (US) Rest $ % $36 $ % Japan refusal NZ); 2019 (ROW) 50% Chronic Discogenic lower back pain (CLDBP) MPC-06-ID Phase III In advanced negotiations % $2, % $790 $ % Revascor - Congestive Heart Failure (CHF) MPC-150-IM Phase III Teva % $5, % $790 $ % Diabetic Nephropathy MPC-300-IV Phase II In advanced negotiations % $2, % $131 $ % Rheumatoid Arthritis (RA) MPC-300-IV Phase II In advanced negotiations % $1, % $73 $ % Revascor - End Stage CHF with LVAD MPC-150-IM Phase IIb Teva % $ % $78 $ % Revascor - Acute Myocardial Infarction (AMI) MPC-25-IC Phase II Teva % $1, % $42 $ % Bone Marrow Transplant (BMT) MPC-CBE Phase III Teva % $ % $77 $ % NeoFuse -Spinal Fusion MPC-25-Osteo Phase II complete NA % $ % $166 $ % Other Pipeline/Non-allocated NA NA NA NA NA NA -$399 -$ % Cash (incl assumed raising in 2017) NA NA NA NA NA NA $330 $ % Equity Value $2,165 $ % % Mix Upside risk to our valuation There is upside risk to our valuation given the promising pipeline candidates not included in our valuation. At this stage, we do not include any value for MSC-100-IV (for Ex-Japan markets) for graft versus host disease (GvHD) in adults. Mesoblast is targeting the subset with gut and liver GvHD. The company plans to run a confirmatory Phase 3 trial in this adult subset in parallel to the paediatric trial. Once we get more clarity on the trial and timelines for the adult product launch we will add it to our model given it is a Tier 1 product. We also do not include any value for MSC-100-IV for Refractory Crohn s disease in our model at this stage. Mesoblast has a Phase III trial ongoing currently. We expect to get results from this trial in CY16. Depending on how strong the results are, MSB could look to partner this product early. We expect that another phase III trial may need to be conducted by a potential partner before applying for approval. This is a Tier 2 product for MSB. Page 11

12 Key Near-term Catalysts Launch of TEMCELL in Japan in 1QCY16: MSB expects its partner JCR Pharmaceutical to launch its acute GvHD product TEMCELL in 1QCY16. MSB will receive ~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. Reimbursement pricing for TEMCELL has been fixed at ~ 13.9mn. This equates to ~US$113,000/treatment or ~US$7,000 per dose (based on 16 doses per treatment). We assume that at peak penetration (peak sales of US$110m), MSB will receive ~US$28m in annual royalty revenues. Results from ongoing Phase II Rheumatoid Arthritis Trial: MSB has completed enrolment of the first dose cohort of its Phase II rheumatoid arthritis trial. Enrolment of the second cohort is ongoing. 6 month Top-line results from cohort 1 are expected to be released by end CY15. Results from cohort 2 are expected in 1HCY16. MSB is also in partnering discussions for this product. Interim analysis from Phase III CHF Trial being conducted by Teva: The first interim analysis point for this trial is when 125 patients (BPe) have been enrolled into the trial. Enrolment for first interim analysis has been completed. Interim results are expected to be reported in 1QCY16. Second interim analysis for futility, resizing and possible overwhelming efficacy will occur in 1QCY17. Expiry of Celgene s 6 month right of first refusal to license certain products: Celgene s first right of refusal to license MSB products covering certain disease fields expires in April Should Celgene decide to license any of MSB s pipeline candidates before the expiry, it will be a source of near term cash injection for MSB in the form of potential upfront payment. Submission to the FDA for approval of MSC-100-IV for paediatric GvHD in US by end of CY16. Following discussions with the FDA, MSB is running a 60 patient Phase III trial in paediatric GvHD patients. The trial is currently enrolling. Interim results from the trial are expected in 3QCY16, with Top-line results expected in 1QCY17. MSB expects to file for approval in the US by end of CY16. We estimate that the product could launch in the US by end of CY17. Interim results from 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 3QCY16. Results from this trial are expected in 4QCY16. The second Phase III trial is expected to complete in CY1H18. Potential partnering deal for MSB s chronic discogenic lower back pain product: MSB continues to be is in advanced partnering discussions with major companies for its chronic discogenic lower back pain product. The potential partners include top medical device companies with existing presence in the orthopaedic market and pharma companies with a strong pain franchise. We remain optimistic of a deal materialising within the next 6-9 months. 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- 300-IV product targeting inflammatory indications is likely a lead candidate for partnering in Japan. Page 12

13 Mesoblast (ASX: MSB, NASDAQ:MESO) COMPANY DESCRIPTION MSB has 5 late stage products i.e. in Phase III or Phase III ready 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 cells. 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 5 products in late stage. The first commercial product from its pipeline for GvHD is slated to launch in 1QCY16. Substantial shareholders include Silviu Itescu, M&G, Thorney, Capital group and pharmaceutical company Teva. INVESTMENT STRATEGY MSB is the leading allogeneic stem cell player and in our view the best placed in the space to successfully commercialise its technology. MSB s strong cash position and ability to attract industry stalwarts with extensive Big Pharma executive level experience to its team makes the story more credible. We expect progress of the Tier 1 lead products towards commercial launch to be the key value driver for MSB. First commercial revenue from GvHD product is expected to start from FY16 marking the transition of the company from a development stage company to a commercial organization. We expect to see considerable M&A interest building towards MSB s currently un-partnered indications as they progress through clinical trials. In our view, a partnership deal over the next 6-9 months with Celgene for selected disease fields, or with any other company for MSB s back pain product or its product targeting inflammatory indications or a deal in Japan for any of its pipeline products could result in substantial cash injection and trigger a re-rating. 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. Timing and clinical risk on products partnered to Teva: For its partnered products to Teva, MSB is reliant on that company for development timelines. The ability of MSB s products to finally reach the market and translate into royalty revenue streams for the company depends on Teva. Delays in timelines as seen in the past will affect market sentiment. Also, if the products fail at any stage of clinical development or if Teva decides to discontinue the development of MSB s products, MSB s ability to generate revenue from those assets will diminish/or fail totally. 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 has ~US$136.6m cash at the end of FY1Q16 including the IPO proceeds and on average has burned ~US$8.1m/month over the last twelve months 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 further bolstered by the US$58.8m net cash injection from the NASDAQ IPO, the company may need to raise additional capital if its burn rate increases significantly or there are delays in partnering its spinal or Inflammatory franchise or pipeline for Japan or if the Celgene deal does not materialise, before commercialization. Page 13

14 Mesoblast as at 23 November 2015 Recommendation Buy, Speculative Price $1.705 Valuation $4.50 Mesoblast (MSB) 23 November 2015 Table 5 - Financial summary Mesoblast (MSB) Share price (A$) $1.705 As at 23 November 2015 Market cap (A$m) Profit and Loss Valuation data Y/e June 30 (A$m) 2014A 2015A 2016E 2017E 2018E Y/e June A 2015A 2016E 2017E 2018E Revenue Net profit ($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 $1.71 Cashflow Valuation: $4.50 Y/e June 30 (A$m) 2014A 2015A 2016E 2017E 2018E Premium (discount) to price 163.9% Reported NPAT Recommendation: Buy Non-cash items Risk Rating Speculative Working capital Profitability ratios Other operating cash flow Y/e June A 2015A 2016E 2017E 2018E 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 (%) -9.0% -11.7% -13.3% -12.8% -14.3% Investments Return on equity (%) -14.2% -19.6% -22.3% -19.7% -23.2% Other investing cash flow Return on funds empl d (%) -14.2% -19.6% -22.3% -19.7% -23.2% 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 2015A 2016E 2017E 2018E Other financing cash flow Net cash (debt) ($m) Financing cashflow Net debt/equity (%) N/A N/A N/A N/A N/A Net interest cover (x) N/A N/A N/A N/A N/A Net change in cash Current ratio (x) Cash at end of period* * I nc l ude s e f f e c t of e x c ha nge r a t e f luc t ua t i ons on c a sh ba l a nc e Free cash flow Balance sheet Interims Y/e June 30 (A$m) 2014A 2015A 2016E 2017E 2018E Y/e June 30 (A$m) 2H14A 1H15A 2H15A 1H16E 2H16E 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 SOURCE: BELL POTTER SECURITIES ESTIMATES Page 14

15 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 Industrials Sam Haddad John O Shea Title/Sector Head of Research Industrials Industrials Phone tslim shaddad joshea Hold: Expect total return between -5% Chris Savage Industrials csavage and 15% on a 12 month view Jonathan Snape Industrials jsnape Sell: Expect <-5% total return on a 12 month view Sam Byrnes John Hester Tanushree Jain Industrials Healthcare Healthcare/Biotech sbyrnes 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. Such investments may carry an Financials TS Lim Lafitani Sotiriou Resources Peter Arden David Coates Associates Hamish Murray Tim Piper Banks/Regionals Diversified Resources Resources Associate Analyst Associate Analyst tslim lsotiriou parden dcoates hmurray tpiper 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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While this document is based on information from sources which are considered reliable, Bell Potter Securities Limited has not verified independently the information contained in the document and Bell Potter Securities Limited and its directors, employees and consultants do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this document is complete or accurate. Nor does Bell Potter Securities Limited accept any responsibility for updating any advice, views opinions, or recommendations contained in this document or for correcting any error or omission which may become apparent after the document has been issued. Except insofar as liability under any statute cannot be excluded. Bell Potter Limited and its directors, employees and consultants do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this document or any other person. Disclosure of interest: Bell Potter Securities Limited, its employees, consultants and its associates within the meaning of Chapter 7 of the Corporations Law may receive commissions, underwriting and management fees from transactions involving securities referred to in this document (which its representatives may directly share) and may from time to time hold interests in the securities referred to in this document. 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. 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 13 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 15