EUR 850.00 For Business Accounts Only

Morningstar | Funding Challenges and Later Product Launches Mean a Lower FVE for Mesoblast

We are lowering our fair value estimate for no-moat Mesoblast to AUD 1.50 from AUD 2.35, based on a re-evaluation of product launch timelines and pricing. Mesoblast doesn't have a marketed product yet and estimated launch timelines have shifted to between three and five years on average, compared with dates originally indicated by management. We now anticipate the firm’s first owned product, to treat acute Graft Versus Host Disease, or aGVHD, in children will be launched in fiscal 2021 versus our prior forecast of a fiscal 2020 launch. Our FVE of AUD 1.50 includes only the Tier 1 potential products, which are in the late stages of clinical trials and limited to the U.S. and Europe.

Mesoblast's cash flow is constrained and requires about USD 100 million annually to fund operations. To date it has sourced equity and debt funding, supplemented by selling rights to develop and commercialise certain drugs in specific countries. We anticipate further equity capital will be raised because the balance sheet won’t be able to accommodate only debt funding, until Mesoblast reaches a stage where its able to generate positive free cash flow, which we forecast to occur in fiscal 2025. Shares on issue could be diluted 50% to 70% from current levels based on our assumption and debt levels above USD 200 million would be unlikely given the risk profile of the firm. By March 2019, the firm had USD 70 million of debt and access to a further USD 35 million facility. Equityholders are further at risk because existing debt agreements have preferential rights to cash flows linked to specific drugs. We don’t believe the firm will pay a dividend.

As a biotech firm without approved products, the valuation has extreme uncertainty. Approval success rates, drug pricing, production costs, and the success of commercialisation and ultimate share of the treatable market achieved are highly variable. Our valuation range has a bull case scenario of AUD 5.50 and a bear case of AUD 0.50.

Our bear case assumes per share dilution from future funding coming from equity and existing debt converting to equity, which is common in financially stressed companies. Further sales of rights outside of the U.S. and Europe would provide funding relief and not detract from our fair value estimate because we only include these regions in our valuation. The company has raised $40 million so far in fiscal 2019, with $20 million received by March 2019, for rights to certain potential drugs in China. This is the fourth such deal to date. This effectively pulls forward cash flow at the expense of longer-term upside to profits.

Mesoblast has indicated it intends to commercialise remestemcel-L for the treatment of aGVHD in the U.S. without a partner. This will require the company to build a team to market the drug, get it onto formularies, and engage with payors about reimbursement. As a result we forecast a rise in employee costs over the next two years. The alternative commercialisation strategy is to earn a share of the revenue stream with a partner, which we assume for the other product candidates and non-U.S. markets. We estimate the ultimate profit stream from these arrangements could be in the mid-single-digit to low-double-digit range.

Over the near term we forecast cash losses ranging between USD 0.20 and USD 0.25 per share, translating into losses of AUD 0.30 to AUD 0.36 per share up to fiscal 2023 based on a USD/AUD exchange rate of 0.69.