- Mesoblast is a leader in adult stem cell technology - Sector set for strong growth given interest from Big Pharma - Partner agreement with Cephalon provides funding for trials - Southern Cross Upgrades to Buy from Spec Buy

By Chris Shaw

Mesoblast ((MSB)) is an Australian biotech involved in the development of adult stem cell technology, which involves extracting bone marrow from donors, growing it into therapeutic quantities and administering to non-related patients. Mesoblast's technology has applications for a wide range of diseases including heart failure.

Southern Cross Equities has upgraded Mesoblast to Buy from Speculative Buy previously, the broker viewing stem cells as a wave of the future in medicine now Big and Specialty Pharma are becoming increasingly attracted to the technology.

This suggests significant growth for the sector in general is possible in coming years, as Southern Cross notes at present the entire listed stem cell sector of 15 companies is capitalised at just more than US$3.3 billion.

What also supports the positive view of Southern Cross is Mesoblast's Mesenchymal Precursor Cell (MPC) technology, which primarily targets the othopaedic and cardiovascular space. The technology is delivering clinical data showing it is effective when compared to existing therapies.

This offers good potential as Southern Cross notes in both areas there are a largely number of high-value applications where Mesoblast's technology can be applied to make a difference. There are also no immune system issues as MPCs do not get rejected by the recipient.

With the Food and Drug Administration (FDA) in the US only requiring one Phase II and one pivotal trial before approving a successful stem cell therapy, Southern Cross estimates Mesoblast could be generating commercial revenues by 2012/13.

A specific advantage for Mesoblast is last December's partnership deal with American specialty Pharma company Cephalon, which took a 19.9% stake in Mesoblast and agreed to partner the group in developing heart failure, heart attack and bone marrow transplant (BMT) applications. Cephalon has also agreed to fund new programs in Alzheimer's and Parkinson's Disease.

The deal with Cephalon substantially de-risks Mesoblast as there is now adequate funding for current programs and an established distribution channel for products gaining regulatory approval. The agreement provided Mesoblast with about $280 million in cash, which negates the need for any further capital raisings.

A further key element of the deal for Southern Cross is that Mesoblast has retained the manufacturing rights to its MPCs, which it will then sell to Cephalon for a set transfer price out to patent expiry in around 2026.

Looking forward, Southern Cross sees potential for Mesoblast to sign additional partnering agreements as MPCs can work to not only improve the quality of existing medical devices but approved drugs as well.

At present, Southern Cross notes Mesoblast is conducting or working towards Phase II trials in nine different applications. The Phase II trial of its MPC technology in bone marrow transplantation was successful and means a Phase III trial is close to commencing.

The bone marrow transplantation sector has a patient population as large as that enjoyed by Cochlear ((COH)) in the hearing implant sector according to Southern Cross.

Recent heart failure trials were also successful and Southern Cross expects a further trial in the middle of this year, with success potentially opening up multi-billion dollar market opportunities. Upside potential is also seen in spine-related procedures, where Mesoblast is starting to build a valuable franchise.

Over the next 6-9 months Southern Cross expects significant news flow from Mesoblast, including the initiation of clinical work on diabetes and AMD/diabetic retinopathy, the potential completion of the spinal fusion, heart failure and knee osteoarthritis trials and the Phase II BMT trial.

Based on a per-product methodology Southern Cross has a base-case valuation on Mesoblast of $7.34, while more optimistic assumptions with respect to royalties and clinical success generates a valuation of $14.56. Taking the middle ground, Southern Cross has set a price target on Mesoblast of $11.00 per share, up from $7.00 previously.

There is little with which to compare Southern Cross's views on Mesoblast, as despite a market capitalisation of more than $1.6 billion the FNArena database shows no current coverage of the stock.

FN Arena is building the future of financial news reporting at www.fnarena.com . Our daily news reports can be trialed at no cost and with no obligations. Simply sign up and get a feel for what we are trying to achieve.

Subscribers and trialists should read our terms and conditions, available on the website.

All material published by FN Arena is the copyright of the publisher, unless otherwise stated. Reproduction in whole or in part is not permitted without written permission of the publisher.