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There could be more pain ahead for Mesoblast limited as credibility sinks

This morning regenerative medicine business Mesoblast limited (ASX: MSB) revealed that Israeli pharmaceutical partner Teva has quit its partnership with the company in conducting a Phase III trial in treating advanced chronic heart failure (CHF) in patients. This is largely as I foreshadowed in several recent articles covering the likely reasons behind the trading halt.

This is bad news for Mesoblast as it was relying on Teva’s financial backing to fund the substantial costs in completing the Phase III trial that will be material to the company’s future cash flows.

Mesoblast refused to confirm how much more it estimates it will now have to pay to complete the trial. Although the news leaves a big hole in its cash flow projections with it having around 15 months’ funding available on forecast cash burns before the news that Teva has decided to stop funding the key trial.

Surprisingly, Mesoblast’s chief executive insisted this was pleasing news for the company and stated: “We are delighted to regain full control of this very valuable asset in our portfolio, and to have been offered a finance facility we can draw on to meet the funding requirements of this program”.

Evidently easy to please, the CEO also refused to disclose any detail around the critical “equity finance facility” Mesoblast has agreed to fund the program in place of Teva’s funding. This despite much of the near two-week delay in releasing news being presumably related to efforts made to seek alternative funding.

Pressed on the issue and the reasons for the two-week delay by analysts on a conference call the chief executive declared the new funding did not involve bank debt and would be “equity-based” without involving a capital raising.

This leaves the question as to whether the equity-based aspect of it will be dilutory and what expected impact it will have on the share register. However, the CEO’s refusal to disclose any basic details over the facility, such as the provider’s name or its basic terms will further reduce his and the company’s credibility in the eyes of investors.

Aside from the unanswered funding concerns, the other big unanswered question is why Teva decided to quit a trial it had already invested huge amounts of funds in?

Again the CEO’s response was limited in stating that it was due to Teva’s decision to “strategically realign” its areas of focus, although it seems unlikely Teva would quit the trial unless it had lost some confidence in its overall success.

As recently as May 5 Mesoblast updated the market via its quarterly report that: “Teva has committed to fund the Phase 3 clinical trial in CHF at least though the first interim analysis, Teva has the right to terminate their agreement with us upon advance to notice us.” In my opinion the logical inference from today’s news is that Teva is either privy to further clinical information that has caused it to quit the trial, or it has surprisingly decided to quit the trial to save cash as it sees superior risk-adjusted alternatives as investments.

Mesoblast says it will actively seek another funding partner for its CHF trial, while it is also seeking commercial partners for its clinical trials in treating, inter alia, back pain and rheumatoid arthritis.

The company retains around US$100 million cash on its balance sheet that will support its market value to a certain extent, although as that amount dwindles with it losing US$22 million in the most recent quarter the market’s valuation of the stock could adjust rapidly downward.

I am surprised the stock is down just 27% to $1.40 in morning trade, although I suspect it will fall further as the market digests the full implications of today’s news. In fact I would not be surprised to see it trade under $1 over the course of 2016.

Speculative biotechs listed on the ASX at the clinical trial stage tend to attract investors looking to get-rich-quick who are overly inclined to believe in their chances of success. This despite there sometimes being about as much evidence in Big Foot’s existence as there is that these companies have new products to successfully commercialise and sell for big profits.

That’s why it often pays to avoid the loss-making biotechs and invest in profitable businesses growing their dividends over the long term.

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Motley Fool contributor Tom Richardson has no position in any stocks mentioned.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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