Mesoblast — Update 28 February 2017

Mesoblast has reported strong nine-month efficacy data from its MPC-300 Phase II trial in biologic-refractory rheumatoid arthritis (NCT01851070). There are 48 enrolled patients split into three groups of 16: placebo, an infusion of mesenchymal precursor cells (MPC) at 1m cells/kg and the final group receiving MPC at 2m cells/kg. The primary endpoint was safety at 12 weeks; this was met. All patients had failed to respond to at least one biological anti-TNF agent.

A predefined subgroup was patients who had received only one or two prior biological agents. In practise, about two-thirds of patients in each arm of the study fell into this group. The rest had tried three or more biological agents.

The secondary efficacy endpoint showed an improvement in symptoms based on American College of Rheumatology (ACR) criteria at 12 weeks after MPC at the 20%, 50% and 70% improvement levels in the number of affected joints and other symptoms. The current view of the ACR (from 2007) is that an updated version of ACR20 is the best threshold for efficacy in clinical trials. The latest RA therapy (run by Lilly) in clinical Phase III, baricitinib, used ACR20.

The Mesoblast data presentation of the new 39-week data MPC-300-IV at ACR20%, 50% and 70% is in Exhibit 1. This indicates that the treatment effects persisted with a consistent pattern of sustained improvement, although the 39 week values are not statistically significant. We hypothesise that these long-term efficacy indications are due to the single dose MPC infusion potentially immune-modulating the severe inflammatory state observed in these biologic-refractory patients. No long-term side effects were noted. The 12-month follow-up data is expected in Q317.

As a further test, the ACR-N mean area under the curve is shown in Exhibit 2. ACR-N is a derivative of the ACR core criteria (Pincus (2005)) but rather than being a threshold value, for example of an improvement of 20% or more as in ACR20, it provides a numerical value. ACR-N is the lowest value at any time of one of three things: either the number of swollen joints or tender joints or the median of five Core ACR factors. It is discussed by Single and Zhen (2005); Boers (2005) takes an alternative view. ACR-N is therefore flexible and can be better tracked over time including measuring the area under the curve (AUC). The FDA 2013 guidance recommends of various numerical scores to determine dose but still uses thresholds (ACR20) for efficacy.

Exhibit 2 shows the use of AUC with the week 39 data. The multiplication of the numerical gaps over a long time period increases the ability of the test to detect differences. It gave a highly significant outcome: p=0.004.

The Health Assessment Questionnaire – Disability Index (HAQ-DI results are shown in Exhibit 3. This shows that treated patients experienced a greater reduction in disability Index. This difference was sustained at 39 weeks.

The oral Janus Kinase (JAK) inhibitor Xeljanz (tofacitinib, Pfizer) was approved in the US in November in 2012 and reported global sales of US$927m in 2016 (vs US$609m in 2015). It was initially rejected by the EMA but was accepted for review with additional data in March 2016. It is for methotrexate refractory patients and required a large clinical trial programme. It gave an ACR20 improvement in 59% of patients versus 35% who received methotrexate. The price is $48,000 per year in the US, although it could be half that online and non-US sourced.

A further oral JAK inhibitor is Olumiant (baricitinib, Lilly) which was recommended for approval in December 2016 by the European regulatory agency (EMA). It will be launched this year in Europe. In the US, the FDA has extended the review period after requesting additional data. The Phase III found a 55% ACR20 improvement at the 4 mg dose, a 49% gain at 2mg with placebo at 27%..

In addition, the well-established anti-TNF monoclonal agents like Remicade and Humira (adalimumab) are now either off patent or coming off patent and biosimilar products are already approved. Humira sales topped $20bn at one point. The number of biosimilars means that the RA market is likely to become very competitive and the overall market may increase if therapies become more widely used. This might expand the market for MPC therapy as more patients means that more biological refractory patients will be generated.

In our view, the data reported would support further development in a Phase IIb or one or more Phase III studies. While the design of pivotal trials will depend on the outcome of discussions with potential partners, the FDA and other regulators especially the EMA, Mesoblast’s current expectation is that the primary endpoints for a Phase III trial of MPC-300-IV in RA would be an improvement in ACR20 score at 12 weeks, in line with FDA guidance. However, any cell therapy needs a long follow-up period. Expensive, one-off cell therapies also need to show sustained response so the one-year MPC-300-IV data will be interesting.

If MPC-300-IV in larger studies can show similar or better efficacy than the existing therapies but with much lower side effects and after one dose, it could take a dominant market position despite the competitive market. JAK inhibitors, for example, have known side effects and although baricitinib may be safer than tofacitinib, as the EMA approval implies, these therapies still have side effects. MPC offer the potential to reset the immune system as shown in the 39-week data. No current therapy offers this. MPC could also be combined with other agents.

The 21st Century Cures Act that became US law in December 2016 will allow the US FDA to grant accelerated approval to specific regenerative advanced medicine products and gives the FDA wide discretion in creating new approaches to regenerative medicine. The definition of regenerative advanced therapy includes “cell therapy, therapeutic tissue engineering products, human cell and tissue products…”. To qualify for this pathway the product must be aimed at a serious disease and have the potential to deal with currently unmet medical needs.

Similar to the existing accelerated approval pathway for drugs and biologics, the new pathway would allow a regenerative medicine product to be approved on the basis of surrogate or intermediate clinical trial endpoints such as imaging data or biomarkers in the blood rather than longer-term clinical outcomes. Regenerative medicine products will still need to demonstrate safety and efficacy under the accelerated approval pathway, but the level of evidence required is less stringent than required for a full approval. This is clearly an exciting opportunity for Mesoblast to advance a number of projects.

While our view is that MPC-300-IV in RA could qualify as regenerative advanced therapy if it “resets” the immune response, it is possible, and unquantifiable, that the FDA may take a cautious approach. This is because RA is a mass-market condition so generally requires a higher level of clinical evidence. Physicians will also need to have a recognised efficacy benchmarks, like ACR20. A classic improvement in ACR20 may not be regarded by the FDA as an unmet medical need even in patients who have failed one or two biologics given the new JAK inhibitors.

At this stage in our forecasts, we therefore assume that at least one traditional positive Phase III trial will be required in order to gain approval. However, faster routes to approval are possible.

We have increased the probability of success for MPC-300-IV for rheumatoid arthritis from 20% to 35% in light of the 39-week sustained response in the Phase II trial. We have also rolled forward the DCF model by six months. This increases our rNPV for MPC-300-IV to A$184m (formerly A$99m). The breakdown of contribution to the rNPV is shown below (Exhibit 4). The fee on the GvHD deal has been added to the product valuation as a milestone. This increases the GvHD value to A$150m (from A$120m). The deal also covers disc repair but we have allocated the fee to the more advanced product. To avoid double counting, estimated FY17 cash is not used in the value.

These changes increase the overall value to A$1.67bn from A$1.47bn. The new value is equal to A$4.16 per share, formerly A$3.84. Note that product NPVs do not account for R&D costs; these are grouped together as a single line item. Year-end cash will offset FY18 funding needs.

On December 31, 2016, Mesoblast had cash of US$33.9m. Effective cash was higher at US$55.6m when the US$21.7 million of equity purchased by with Mallinckrodt (agreement on 23 December 2016) is included; the cash was received on 6 January 2017. Mesoblast has cash to fund operations beyond the end of FY17 (June 2017).

Operating H1 cash outflows were US$46.4 m. down US$1.5m from H1 FY16 at US$47.9m. This includes US$11.5m spent on the MPC-150-IM Phase III for chronic heart failure. The cost of the trial was absorbed by reducing other expenses by UAS$11.5m. The majority of these savings came from fewer production runs saving US$7.2m. However, production may We estimate that an additional US$65m will be required to fund operations through to FY18 (until mid-2018). Most of this could be supplied through partnerships such as the one currently the subject of ongoing negotiations with Mallinckrodt, although the timing of any partnering agreement is uncertain. As a stand-by, Mesoblast has a US$90m discretionary equity facility with Kentgrove.

Management has indicated that it does not intend to take on debt to fund its development programmes. However, for purely illustrative purposes we follow our standard practice and add long-term debt of US$65m in FY18 in our forecasts. Equity funding would raise more cash but cause further dilution, the extent depends on the share price.

Mesoblast is subject to the risks typically associated with biotech company drug development, including the possibility of unfavourable outcomes in clinical trials, regulatory changes, success of competitors and commercial decisions by partners or potential partners. With Teva’s withdrawal from the cardiovascular programme, funding of Mesoblast’s annual cash burn of ~US$80m is a significant source of uncertainty. The company has entered an equity finance facility that will provide up to A$120m (~US$90m) to fund the HF Phase III programme. This could result in further dilution of existing shareholders.

We therefore expect Mesoblast to seek non-dilutive funding from partnering deals, which could reduce the equity funding requirement. Key potential catalysts that could allow for share price inflections in the near term are: