I have to eat some serious crow on share valuation

[derek2]

In preparation of defending my $4.50 share price valuation, I decided to get serious and run a monte carlo simulation (only 10,000 iterations per simulation) modelling the following formula:

MNKD profit = Sanofi Sales * Sanofi EBIT * Mannkind EBIT

With EBIT giving the most generous profitability metric for SNY, compared to Net Profit or Operating Profit. Given the terms of the deal, I think it's appropriate since so much operational cost from other drugs, etc. Won't go into Afrezza costs.

I set the model so that I would get a random result each iteration based on a normal distribution of each of the variables, and assigning a standard deviation (sd). For any iteration, Revenue, SNY EBIT and MNKD EBIT will vary up or down around those means. It can make for unpredictable but I think more real-life modelling.

I was shocked at what I found. You probably won't be.

Modeling this and running the simulation took any data cherry picking or bias out of my analysis. Based on this, and I'm confident in my model (it's pretty simple but follows the logic of the deal) I can humbly say that I was dramatically wrong in my low share price call. 


I modeled many sales predictions, but let's concentrate on 3, since I can attach 3 pictures.

$700M sales, $1.5 B sales, $3B sales. I adjusted sd of revenue proportionally.

I modeled SNY EBIT at 37% (as they report) but gave a sd of 7%
MNKD EBIT = 40%, sd = 7%

MNKD PE of 30 - in line with peer group

Well:

$700M sales:

Sanofi Sales Mean ($B) 0.7

Sanofi Sales sd 0.15

Mannkind EBIT Mean 40%

Mannkind EBIT sd 7%

Sanofi EBIT Mean 37%

Sanifi EBIT sd 7%



Average MNKD Profit $103,636,849.82

MNKD Shares 450000000

PE 30



Share Price $6.91


Here's the histogram of $MNKD profit from the monte carlo trial:

Attachment Deleted

Sanofi Sales Mean ($B) 1.5

Sanofi Sales sd 0.3

Mannkind EBIT Mean 40%

Mannkind EBIT sd 7%

Sanofi EBIT Mean 37%

Sanifi EBIT sd 7%



Average MNKD Profit $222,377,893.36

MNKD Shares 450000000

PE 30



Share Price $14.83



Attachment Deleted


Sanofi Sales Mean ($B) 3
.0
Sanofi Sales sd 0.6

Mannkind EBIT Mean 40%

Mannkind EBIT sd 7%

Sanofi EBIT Mean 37%

Sanifi EBIT sd 7%



Average MNKD Profit $444,930,547.30

MNKD Shares 450000000

PE 30



Share Price $29.66


Attachment Deleted


So, in summary. I was wrong wrong wrongity wrong. Not even my most jaded scenario - $700M sales comes anywhere near $4.50 / share.  It would have to be around $430 M sales, and I really don't think that's in the cards. I have to figure out just how I talked myself into such a dramatically lower number than what the model actually shows, so I don't do it again.

Anyway, it looks like there's little need for an argument. I have to change my stance. To not change my stance would involve glossing over the evidence, and that ain't me.

Thanks to jpg for poking as to my rationale. If I hadn't done this analysis in response to him I would still have been ignorant.

Also an apology to Dr Tran. I've been poking him regarding his valuation model, and although we come to our conclusions in very different ways, he has been much more correct than me.

Humbly and more optimistically yours

Derek 

[alethea]

Aug 20, 2014 12:32:36 GMT -5 derek2 said:

In preparation of defending my $4.50 share price valuation, I decided to get serious and run a monte carlo simulation (only 10,000 iterations per simulation) modelling the following formula:.............................


PE 30
Share Price $6.91 .......................


Derek 

You said (on the other board) you were walking away from spending so much time on MNKD for several months and would expending your efforts looking at other opportunities.

What happened to that? 

[derek2]

alethea

Apparently I'm addicted to MNKD.

EDIT: I'm still looking at dialing it back. Other commitments are calling me. Looks, however, like it'll be buy & hold while away as opposed to flat on the stock.


Once again, I'm just shocked at how wrong my estimation of the impact of the deal was. Who knows what the future holds, but I'm perking up.

[dreamboatcruise]

I think the bottom line from several peoples' analysis is that if we assume the current production capacity of Danbury was built out to meet realistic near term needs without a great deal of spare capacity and assume patient numbers grow at reasonable pace from there, which is roughly your worst case Derek, we come up with the fact that the stock is neither hugely over or under valued... assigning no value to Technosphere or other pipeline potential that is, and assuming that this isn't a new type of diabetes blockbuster. Of course if we learn Mannkind has rapid capacity expansion plans, that could change this perspective.

[leepoffaith]

I read this MNKD message board, along with a few others, several times a day but I rarely post messages. I decided to respond to your post because I find it to be one of the most concise and informative posts on WHY MNKD should be valued at a certain PPS. I'm am a numbers guy and although I don't quite understand some of your mathematics lingo it seems like you know what you are talking about when it comes to mathematical modeling.  I have no previous accounting experience so my modeling is much less in depth then yours. I have my own excel spread sheet with numbers that I have collected on insulin usage and then estimate the possible market penetration of that market. I used a 20x PE ratio and estimated $1,600 per patient per year. From my modeling SNY would have to penetrate approximately 10% of the US insulin market in order to achieve $6.72 PPS (very close to your 700m number). The only difference is that my sales numbers are at 1.03 million at that PPS.  Either way, it's great to see hard numbers and rational to back up the why behind the valuation. I feel that the extreme PPS valuations ($1 and $34) are way out of line with what the numbers are currently showing us. The reason I continue to invest in MNKD is because of the future potential. In my opinion the US market is only the tip of the iceberg. We still have the world insulin market as well as the Technosphere technology. I have no way of estimating this value so I don't even try to, but considering where our numbers are at it seems like share holders are in for a wild ride up within the next 3-5 years if not sooner.

Also, it takes a strong person to admit when they are wrong and I appreciate the fact that you were willing to do that. 

[retailinvestor360]

I learn as much from you and from all MannKind shareholders as I hope you guys would learn from me.  No one is expected to be right all the time. And the more insights we share with each other, the more comprehensive our views will be. I learned from both encouragement and constructive criticism. Many MannKind Shareholders at ProBoard is much more accomplished and experienced than me ... and I feel honored/humbled to be a member of the highly intelligent and honorable MannKind shareholders at ProBoard!

As for valuation of biotech, this is a highly difficult tasks as different analysts can come to completely different answers. Neither mine nor anyone's valuation is the  correct one.  However, the true value is usually resides somewhere near the averaging of all valuations.

Thank you Derek for the kind regards. No apology needed Derek! But I see that you are a person of strong character for being able to change your views based on the data. I said anything offensive toward you in the past, please accept my apology. Cheers to the long and strong MannKind Shareholders!

[derek2]

Thanks leepoffaith, although the bigger lesson can be that certainty does not always equal being correct, and boy was I certain. So, you know, maybe take this with a grain of salt, too... (at least it's good news)

The model is not complete in that it doesn't take into account the milestone payments from SNY, nor any follow-on Technosphere partnerships, so that would all be sauce for the goose.

[leepoffaith]

I always analyse my numbers on the conservative side. I feel it's much better to be under and get a bonus later on then to budget over and then be disappointed later on. The fact that neither of our numbers have the milestone payments in them also helps to reinforce how great an investment MNKD is right now. Thanks again for your explanation and histograms!

[engineer4life]

Derek,

Would you be able to share the formula for your analysis? It's perfectly ok to say no. I was hoping to learn from it if you can share.

[dreamboatcruise]

Aug 20, 2014 18:43:49 GMT -5 engineer4life said:

Derek,

Would you be able to share the formula for your analysis? It's perfectly ok to say no. I was hoping to learn from it if you can share.

He states the formula...


MNKD profit = Sanofi Sales * Sanofi EBIT * Mannkind EBIT



with estimates of the two EBIT percentages.

I'm not sure that is a great match to the structure of the deal at hand... but it is within the ballpark of the way I'd calculate things.

In the first of his cases that formula yields an average of $700M * 0.37 * 0.40 = $103.6M

Another way of looking at this is to take the same sales estimate of $700M and use the inferences from Matt's conference call comments about equiv royalty that profit will be 71% of sales and we get a value of $497M profit which is split 65/35 giving Mannkind $174M.  So to match up with what Derek estimated would mean Mannkind's expenses not covered by the joint venture would be roughly $70M.  Maybe that is reasonable or if it is much higher would be indicative of effort being put into pipeline which would probably not be considered something that would lower the valuation from this analysis.

[derek2]

I agree dreamboatcruise - it's only one way, pretty rough and conservative. That's why I was so surprised with the results. You're right that it could be better aligned with the deal.

Another more rigorous way would be to take the 71% inferred by Matt (as calculated by a poster here, I think), apply the 35% for MNKD's share of the profit and then apply an EBIT for MNKD that takes into account that their manufacturing costs will be covered (so maybe 70% EBIT which is huge but possible since COGS is covered)

That would yield $121M MNKD earnings (profit) on $700M sales with a model the comes closer to the deal structure. It still has some guess work with that 71%, though.

It would lead to a sp of $121 M/450 M shares * 30 PE = $8.06

So still in the same ball park, although even better. It's still guess work, but we seem to get to the same general place by coming at it from a few different directions.

[BD]

(Very OT): Hey derek, thanks for teaching me about the "@" feature in posts... to be honest, I had no idea how you were even creating those links to members' profiles until I looked at your BBCode. Here I am, the big ProBoards guru, and I didn't even know that feature was there!

I updated the "ProBoards Tips" thread to include instructions on how to do that. On all 3 boards I'm an admin on.

[jpg]

Hi Derek,

Nice post. Thank you. Don't understand much (any actually...) of the stuff you did but interesting anyway.

The negative bias you wonder why you 'acquired' might have come from social interactions on various boards? We tend to get biased by group think and certain boards are so polarized that even the most analytic can be persuaded to take positions that a more neutral observation would prevent. Again only time will prove individual predictions right or wrong. I do find strange that some of the most vocal bashers state themselves to be long but never explain how they see their long position as being a wise investment? If every step of the MNKD process is a train wreck waiting to happen or actively happening why would you stick around as a long? Where are the predictions of these 'agents provocateurs'?

As you know I am obviously in the extremely bullish camp. I see Afrezza as 'an easy insulin to start' and one of my medium term fears is that MDs start prescribing it a bit to casually and forget it is insulin...

Many analysts look at the 'those on prandials who want to switch to inhaled' market as the primary and only market 'till a paradigm shift happens'. I tried multiple times (obviously unconvincingly!) to state that to me the biggest market will be patients who are on a bunch of oral agents and need insulin but don't want to start insulin (and won't start insulin). Those that insist that the guidelines say 'the next step must be basal and nothing else' (Yahoo bashers like OPC seem to be all over that argument lately) don't get how 'flexible' MDs can become when left with few options. Will they prescribe prandial inhaled insulin to insulin naive patients or forgo insulin and prescribe some drug that makes you pee glucose? I would bet on smart innovator MDs to go with Afrezza. This is the first step in the paradigm shift and will happen without anyone saying 'there is a paradigm shift going on' till after the shift. At the same time this indication (prandial as a first line insulin) is already in the label. I am surprised more observers haven't picked up on this. By definition needle phonics aren't on basal: they don't want needles... If Afrezza has an indication for needle phobes then automatically it can be used as a first line insulin. No paradigm shift needed really but this will lead to other changes in practice that will greatly help us sell Afrezza. Once MDs start being comfortable with giving it late they will probably feel comfortable to give it earlier and earlier. This should be helped by well done studies on Afrezza.

How many of these 'needle phobic' patients are there? I would easily say more then are on Lantus. Now that is a big market. That is also some significant margin of safety...

Again time will tell who was right. The bashers, the pumpers or somewhere in the middle? I will put myself down as being part of the 'pumper camp' and easily believe we will be selling many billions of Afrezza in a few years. When will the share price reflect this? No clue but I am willing and happy to wait for the market to have the same vision of the future I have now.


JPG

[derek2]

Aug 20, 2014 19:42:51 GMT -5 jpg said:

Hi Derek,

Nice post. Thank you. Don't understand much (any actually...) of the stuff you did but interesting anyway.

The negative bias you wonder why you 'acquired' might have come from social interactions on various boards? We tend to get biased by group think and certain boards are so polarized that even the most analytic can be persuaded to take positions that a more neutral observation would prevent. Again only time will prove individual predictions right or wrong. I do find strange that some of the most vocal bashers state themselves to be long but never explain how they see their long position as being a wise investment? If every step of the MNKD process is a train wreck waiting to happen or actively happening why would you stick around as a long? Where are the predictions of these 'agents provocateurs'?

As you know I am obviously in the extremely bullish camp. I see Afrezza as 'an easy insulin to start' and one of my medium term fears is that MDs start prescribing it a bit to casually and forget it is insulin...

Many analysts look at the 'those on prandials who want to switch to inhaled' market as the primary and only market 'till a paradigm shift happens'. I tried multiple times (obviously unconvincingly!) to state that to me the biggest market will be patients who are on a bunch of oral agents and need insulin but don't want to start insulin (and won't start insulin). Those that insist that the guidelines say 'the next step must be basal and nothing else' (Yahoo bashers like OPC seem to be all over that argument lately) don't get how 'flexible' MDs can become when left with few options. Will they prescribe prandial inhaled insulin to insulin naive patients or forgo insulin and prescribe some drug that makes you pee glucose? I would bet on smart innovator MDs to go with Afrezza. This is the first step in the paradigm shift and will happen without anyone saying 'there is a paradigm shift going on' till after the shift. At the same time this indication (prandial as a first line insulin) is already in the label. I am surprised more observers haven't picked up on this. By definition needle phonics aren't on basal: they don't want needles... If Afrezza has an indication for needle phobes then automatically it can be used as a first line insulin. No paradigm shift needed really but this will lead to other changes in practice that will greatly help us sell Afrezza. Once MDs start being comfortable with giving it late they will probably feel comfortable to give it earlier and earlier. This should be helped by well done studies on Afrezza.

How many of these 'needle phobic' patients are there? I would easily say more then are on Lantus. Now that is a big market. That is also some significant margin of safety...

Again time will tell who was right. The bashers, the pumpers or somewhere in the middle? I will put myself down as being part of the 'pumper camp' and easily believe we will be selling many billions of Afrezza in a few years. When will the share price reflect this? No clue but I am willing and happy to wait for the market to have the same vision of the future I have now.


JPG

Actually, I wouldn't classify you as a pumper, since you're sincere. I would call you bullish or optimistic.


I'm looking at refining the model based on some feedback that dreamboatcruise gave, and I'll go into more depth on the theory and even how to do it yourself. The more that's explained, the more it can be improved, since it's far from perfect.

[dreamboatcruise]

Aug 20, 2014 19:42:51 GMT -5 jpg said:

Hi Derek,

Nice post. Thank you. Don't understand much (any actually...) of the stuff you did but interesting anyway.

The negative bias you wonder why you 'acquired' might have come from social interactions on various boards? We tend to get biased by group think and certain boards are so polarized that even the most analytic can be persuaded to take positions that a more neutral observation would prevent. Again only time will prove individual predictions right or wrong. I do find strange that some of the most vocal bashers state themselves to be long but never explain how they see their long position as being a wise investment? If every step of the MNKD process is a train wreck waiting to happen or actively happening why would you stick around as a long? Where are the predictions of these 'agents provocateurs'?

As you know I am obviously in the extremely bullish camp. I see Afrezza as 'an easy insulin to start' and one of my medium term fears is that MDs start prescribing it a bit to casually and forget it is insulin...

Many analysts look at the 'those on prandials who want to switch to inhaled' market as the primary and only market 'till a paradigm shift happens'. I tried multiple times (obviously unconvincingly!) to state that to me the biggest market will be patients who are on a bunch of oral agents and need insulin but don't want to start insulin (and won't start insulin). Those that insist that the guidelines say 'the next step must be basal and nothing else' (Yahoo bashers like OPC seem to be all over that argument lately) don't get how 'flexible' MDs can become when left with few options. Will they prescribe prandial inhaled insulin to insulin naive patients or forgo insulin and prescribe some drug that makes you pee glucose? I would bet on smart innovator MDs to go with Afrezza. This is the first step in the paradigm shift and will happen without anyone saying 'there is a paradigm shift going on' till after the shift. At the same time this indication (prandial as a first line insulin) is already in the label. I am surprised more observers haven't picked up on this. By definition needle phonics aren't on basal: they don't want needles... If Afrezza has an indication for needle phobes then automatically it can be used as a first line insulin. No paradigm shift needed really but this will lead to other changes in practice that will greatly help us sell Afrezza. Once MDs start being comfortable with giving it late they will probably feel comfortable to give it earlier and earlier. This should be helped by well done studies on Afrezza.

How many of these 'needle phobic' patients are there? I would easily say more then are on Lantus. Now that is a big market. That is also some significant margin of safety...

Again time will tell who was right. The bashers, the pumpers or somewhere in the middle? I will put myself down as being part of the 'pumper camp' and easily believe we will be selling many billions of Afrezza in a few years. When will the share price reflect this? No clue but I am willing and happy to wait for the market to have the same vision of the future I have now.


JPG

I'm not sure what you're predicting is necessarily at odds with what I or Derek are saying.  I at least was considering getting to that roughly $700M (current production capacity assuming roughly $2k sales price per patient year by SNY) in first year.  That would basically be matching Lantus roll out roughly speaking.  Actually Derek can correct me if he viewed that as longer term target.  In my view $700M could easily turn into billions in a few years.  Only question is what credit is given by Wall Street for the growth potential and what multiple is attached in the near term.  Derek used 30 p/e which assumes robust growth.

You state "This should be helped by well done studies on Afrezza".   Fully agree.  In fact I'm hoping that when studies exploring early Afrezza intervention are even announced by Sanofi, it will make it evident they believe in this and count on it as part of their marketing plan... and given Sanofi's credibility in the diabetes space, I think it would convince a lot of people that the science is solid even before the study is complete.  In my optimistic scenario, something like that convinces institutional investors that Sanofi has confidence in this being a sea change drug... and the share price will adjust accordingly.  My baseline, conservative estimate is simply related to what the first year roll out might look like not counting on the sea change nature being recognized in the near term numbers.  The baseline gives me the confidence that the price should not be significantly lower in 12 months.  The optimistic scenario is why I'm invested.