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Morningstar | Mesoblast Continues to Burn Cash in 1Q as Expected, but Shares Remain Undervalued

We maintain our recently lowered AUD 2.35 fair value estimate for no-moat Mesoblast following first-quarter fiscal 2019 results which were in line with our expectations. The stock currently screens as undervalued, based on our risk-adjusted assessment of the company's development pipeline. The current discount to our valuation likely reflects concerns around product commercialisation and funding needs, particularly given disappointing trial results only a few days ago, but we believe the market is assigning too high a weighting to these risks.

Revenue in the quarter grew to USD 11.6 million versus USD 1.2 million a year ago due to higher royalty income on sales of Temcell in Japan, and USD 10 million of milestone revenue stemming from the July 2018 establishment of a partnership with Tasly in China. Offsetting these gains, higher R&D and manufacturing costs led to a larger loss in the quarter versus the previous corresponding period, although this is partly due to a noncash remeasurement gain in the prior year. Excluding this item, loss after tax of USD 19.5 million was not materially different from the USD 17.1 million loss in fiscal 2018’s first quarter.

As such, operating cash outflows were flat year on year, at about USD 20 million. Nonetheless, the firm’s liquidity remains supportive despite this cash burn. The company’s strategic alliance with Tasly, a major manufacturer of pharmaceuticals in China, provides USD 40 million in cash on top of the USD 55 million held on the balance sheet as of Sept. 30, 2018, and an additional USD 50 million could be available under arrangements with other partners if certain milestones are reached. Along with potential product launches in calendar 2019, we expect Mesoblast can comfortably continue to fund its ongoing trials, research, and manufacturing obligations.

Mesoblast’s value hinges upon success of these ongoing trials and eventual product launches. We think MSC-100-IV, targeted for use in acute graft versus host disease, represents the most significant value driver, making up about 36% of our valuation. Given its fast-track designation status with the FDA, we expect a potential U.S. launch in 2019. Meanwhile, we note that MPC-150-IM, which saw some mixed results earlier this week following a Phase 2b trial aimed at end-stage chronic heart failure (see our note from Nov. 11, 2018 “Mesoblast’s Latest Trial Data Offers a Mixed Outlook; Reducing our FVE to AUD 2.35”), makes up a still-substantial 25% of our fair value estimate, despite our estimate of only a 15% probability of commercialisation.