Post by savzak on Mar 9, 2015 11:47:25 GMT -5
seekingalpha.com/article/2985366-a-close-up-look-at-the-report-that-had-mannkind-investors-reeling?auth_param=aib6b:1afrj0o:8b9d0fc465752b8d4d406f01fc8ca614&uprof=45
Summary
The pace of new-drug uptake is extremely difficult to predict.
Three or four weeks of early scripts data can have minimal predictive value.
Valuation models are only as good as the numbers that go into them.
The analyst has given himself lots of outs to change his recommendation.
In an article published last month, we detailed information provided by executives of MannKind Corporation (NASDAQ: MNKD) and followed that factual presentation with our two cents worth of analysis. The purpose was to let investors assess the actual information themselves, to supplement the interpretations put forth by third parties who invariable have their own biases and agendas. Considering the stock's prevailing price, it's probably fair to say that our article had very little impact. On the other hand, the "Sell" recommendation from Goldman Sachs last Monday certainly had a substantial impact, triggering a four-day-long selloff that totaled 16.1%; there were other negative comments from some of the usual detractors but Goldman is the 800 pound gorilla. As such, we thought it might be worthwhile to look more closely at the reasoning behind the analyst's decision to change his recommendation from "Neutral" to "Sell;" would it contain the long-elusive thesis that explains the large short interest? In this article, we once again present the facts, as derived from the Goldman report, and then give our two cents worth. As always, we welcome any corrections, particularly with respect to how accurately we lay out the GS analyst's case.
The Downgrade
On Monday March 2, 2015, Wall Street heavyweight Goldman Sachs issued an "Action" research report recommending investors sell MannKind stock. The reason cited was a change in key dynamics since the investment bank initiated coverage on October 19, 2014 with a "Neutral" rating. The dynamics included "more difficult pricing, slower diabetes product launches in general and for Afrezza in particular albeit based on limited data." The 12-month price target was lowered from $6 to $3, based on a DCF (discounted cash flow) model that utilizes projections out to the year 2030.
Diabetes Market Dynamics
According to the analyst, the diabetes market has deteriorated as reflected by growing pressure on prices and slow launch uptakes, with both influenced unfavorably by third-party payors. As such, the expectation is that Afrezza will sell at a net discount of 40%, rather than the 20% originally anticipated; the discount figure is based on Goldman's "analysis of data from LLY, a company which generates a large percentage of revenues from diabetes products." With respect to product launches, the author(s) of the report notes the prescription trends of Jardiance (introduced in the third quarter of 2014) and Trulicity (fourth quarter), both of which apparently fell 75% short of Goldman's estimates in 2014's final quarter. The report also notes that Afrezza's launch trajectory, based on only a few weeks of script data, has fallen short of expectations. Given these dynamics, the analyst lowers his sales forecast for 2025 from $2 billion to $1 billion. All earnings estimates from 2017 onwards are reduced as well, although he still believes MannKind will achieve the targets needed to capture $925 million in milestones from Sanofi.
Revenue Projections For Afrezza
The earnings model, which extends to 2020, shows total Afrezza revenues of $37 million in 2015, rising to $128 million, 225 million, 355 million, $494 million, and $645 million in 2016, 2017, 2018, 2019, and 2020, respectively. As well, it shows MannKind turning profitable in 2019, to the tune of $0.25 a share, helped by $180 million in milestone payments. The bottom-line estimate for 2020 is $0.36, with $110 million in milestone payments. Pricing for Afrezza is pegged at $150 per month, down from the $200 per month targeted previously.
Risks To The Price Target And Sell Rating
In the report, the analyst details a list of potential developments that would make him more positive on MNKD stock. The first would be an improvement in weekly scripts for Afrezza, considering the revised sales estimates were based on only a few weeks of actual script data. The second would be progress in advancing an R&D pipeline for the Technosphere drug delivery platform, although the analyst notes concern by "the lack of progress." He also thinks that potential partners may want to wait for a successful Afrezza launch before investing heavily in other inhaled drugs. The third item is a significant restructuring and expense reduction. Last, the analyst notes that "a sooner than expected DTC campaign," which is viewed as unlikely, could drive Afrezza sales unexpectedly high.
Our Two Cents
In reading through the impressive-looking Goldman Sachs report, chockfull of graphs, tables, and spreadsheets, one couldn't help but wonder the following:
1. How meaningful is a price target that's based on a 15-year discounted cash flow model when the numbers can change so dramatically in just a matter of months and the analyst's numbers, looking very short term, for Jardiance and Trulicity were off by 300%?
2. Given the dynamics of both a soft launch and the delays associated with getting a prescription for Afrezza - getting an appointment with an endocrinologist, the testing required, 10-day samples, and securing reimbursement - how meaningful are three or four weeks of script data?
3. Considering the sparse data points, which Goldman readily acknowledges, wasn't a slashing in the price target and revenue projections both premature and excessive? It seems to us a little patience would've been prudent.
4. The pricing dynamics are very different for me-too drugs and innovative drugs, so how reasonable is it to use Eli Lilly, the maker of the two diabetes drugs cited above, as the comparator in estimating discounts for Afrezza?
5. When is Goldman expecting Sanofi to launch a DTC (direct to consumer) advertising campaign? And in terms of generating that 15-DCF model, how significant is the precise timing, whether it's in May, June, July, or August?
6. In looking at the earnings model out to 2020, the analyst shows research and development expenses for MannKind but no revenue contributions from any other products. The same is presumably true for the DCF model. Does that mean that Goldman thinks Technosphere has absolutely no value?
7. The revenue projections imply that only some 197,000 patients will be using Afrezza in 2018 and 358 thousand in 2020. Given the roughly 30 million diabetics in the United States and nearly 380 million in the world, the myriad problems with the existing products, and Sanofi's marketing muscle, are microscopic market share expectations reasonable?
8. Perhaps a reflection of our ignorance, but why is Wall Street blue-chip Goldman Sachs providing research coverage on a tiny company for which it's had such low expectations from the very beginning?
9. Despite reviewing SEC filing after SEC filing, we have yet to see any details on the thresholds for the sales-related milestone payments. It would be interesting to know the source of the analyst's numbers.
All in all, the Goldman report left us perplexed. Will the analyst double, triple, or even quadruple his revenue and price targets if there are a few good data points for prescriptions in the weeks and months ahead? Having recently reviewed MannKind's annual filing with the SEC, which, incidentally, is a little more encouraging, in terms of sales expectations for Afrezza and new applications for Technosphere, we will look forward to Goldman's next report. As to the annual filing, the company confirms that it's poised to triple production capacity for Afrezza. Moreover, although probably not necessary if GS's projections prove to be reasonably accurate, production capacity at the Connecticut facility could be expanded another four-fold. MannKind further notes that "Before the Connecticut facility reaches its maximum capacity, we and Sanofi expect to coordinate the construction and qualification of an additional facility, which may be owned and operated by Sanofi."
As a closing comment, it may be worthwhile to mention that both the GS report and the filing briefly discuss the $100 million in convertible notes that come due on August 15th. Since most, if not all of it, may have been hedged through the short selling of MNKD stock, the redemption, or conversion, should result in some short covering, perhaps with positive implications for the stock price. The public float of MannKind shares should also fall in conjunction with the debt's maturity since Bank of America will have to return some nine million borrowed shares at around that time. That said, it's difficult to know how the unwinding of the notes is going to play out. Goldman suggests that some 14.7 million MNKD shares, or 17% of the short interest, could be connected to the notes. Throw in many million more shares that might be hedged against both the 2016 warrants and equity options, and one has to wonder about the true convictions of the short position, which has taken on a life of its own, with respect to how the stock is viewed....a truly complicated picture that might be fodder for another Seeking Alpha article. Another unknown is MannKind's ability to refinance the debt if that's what becomes necessary.
