M* on MNKD

[Deleted]

MannKind is on track to bring its inhaled insulin to market in 2014.

Morningstar's Take MNKD 
Price 11-29-2013 4.99 USD
Fair Value Estimate 6.5 USD   Uncertainty Very High
Consider Buy 3.25 USD 
Consider Sell 11.38 USD
Economic Moat None
 
Stewardship Rating
Standard

Analyst Note 11/05/2013
MannKind reported third-quarter results that were generally in line with our expectations and we are maintaining our $6.50 fair value estimate and no-moat, stable trend rating. With the recent positive Phase III trial results from Afrezza, the focus in the coming quarters for the firm remains the potential signing of a commercialization partner and the FDA decisions on approval for the inhaled insulin drug.

For the quarter, research and development expenses were $27.3 million, a 7% increase over last year. General and administrative costs were $17.5 million, up 73.3% compared to the third quarter of 2012, due primarily to an increase in non-cash stock compensation expense. This resulted in a growing net loss of $50.8 million (or $0.17 per share) compared to $42.8 million (or $0.22 per share) last year.

The company finished the quarter with cash and equivalents of $93.8 million and subsequently received $45.0 million in warrant proceeds, leaving it with an improved cash position, compared to the $61.8 million with which it started the year.

The next few quarters will be seminal for MannKind given the uncertainty about its ability to sign a partner, the upcoming FDA decision (expected in mid-April) and the ultimate market acceptance of its novel drug. We model a global partnership scenario that pays MannKind a 35% royalty on sales in the U.S. and abroad. If Afrezza hits the market in 2014, we think MannKind could turn profitable by late 2015 and potentially see its operating margin rise to the upper 40% range. We continue to assign Afrezza an 85% chance of approval, given the drug’s checkered past with the FDA. Our probability-weighted projections assume Afrezza could generate more than $2 billion in peak sales, given the expansive and rapidly growing diabetes market, though we expect MannKind will only see a portion of these sales after striking a deal with a commercialization partner.


Investment Thesis 08/15/2013
MannKind is awaiting FDA approval for its lead drug candidate, inhaled insulin Afrezza. Despite the advantages offered by this therapy, we think the potential rewards have yet to outweigh the substantial risks associated with investing in this speculative biotech.

MannKind is developing Afrezza as a novel, ultra-rapid-acting mealtime insulin therapy for patients with diabetes. In addition to allowing patients to forgo the needle, Afrezza's molecular structure may allow for superior disease management to injectable insulin. Currently available insulin products are characterized by slow onset and slow offset of activity as they must be absorbed by the skin and then broken down by the body. In contrast, Afrezza delivers insulin monomers directly into the bloodstream via inhalation into the deep lung and thus more closely matches the body's natural physiological response to increases in blood sugar. Accordingly, Afrezza has been shown to achieve comparable levels of overall glucose control as seen with current state-of-the-art insulins, while demonstrating a lower risk of hypoglycemia and weight gain.

Despite demonstrating these advantages in clinical trials, MannKind has received two complete response letters from the FDA. The FDA seemed primarily concerned with updated safety data, labeling changes, and information about the comparability of the firm's latest inhaler with the one used in trials. The requirement for additional testing has pushed out Afrezza's potential approval and hastened the unprofitable biotech's cash burn (with no revenue sources and dwindling cash, MannKind already has racked up $2 billion in accumulated deficits). We continue to think there is a good chance Afrezza will be approved, particularly given recent positive data from these additional trials, but MannKind faces an uphill battle in its attempt to turn the product into a commercial hit.

We suspect that much of the FDA's hesitance to approve Afrezza has to do with its predecessor in the inhaled insulin class. Pfizer's PFE and Nektar's Exubera, the world's first inhaled insulin, was removed from the market in 2007 after the drug generated disappointing sales and was linked to a potential risk of lung cancer in former smokers, causing diabetes experts such as Novo Nordisk NVO and Eli Lilly LLY to withdraw their own inhaled insulin products from late-stage trials. Although MannKind plans to remedy Exubera's commercial shortcomings and Afrezza's clinical trials have yet to produce any red flags, we think Exubera's failings will haunt MannKind's efforts to win favor among regulators and prescribers.

Economic Moat 08/15/2013
Without marketed products, MannKind has no moat, in our opinion. MannKind only has one candidate in late-stage development and probably would see its value fall to zero if its lead product does not make it to market. While Afrezza has the potential to offer substantial safety, efficacy, and convenience benefits compared with injectable insulin, Exubera's failings will require MannKind to fight an uphill battle in its attempt to make Afrezza a commercial success. Given these uncertain prospects, we are unconvinced of the firm's ability to generate returns in excess of its cost of capital over the long run.

Valuation 08/15/2013
We are raising MannKind's fair value estimate to $6.50 per share from $4, given that the firm’s positive Phase III clinical results improve its positioning in upcoming partnership negotiations and its recent stock price strength will it allow it to raise capital on less dilutive terms. The company's shares have risen as it approaches its pivotal FDA resubmission date (expected later this year), and recent positive data from two Phase III trials puts the firm on track for a potential launch in 2014. However, we continue to assign Afrezza an 85% chance of approval, given the drug's checkered past with the FDA. Our probability-weighted projections now assume Afrezza could generate more than $2 billion in peak sales, given the expansive and rapidly growing diabetes market, though we expect MannKind will only see a portion of these sales after striking a deal with a commercialization partner. We currently model a global partnership scenario that pays MannKind a 35% royalties on sales in the U.S. and abroad. If Afrezza hits the market in 2014, we think MannKind could turn profitable by late 2015 and potentially see its operating margin rise to the upper 40% range.

Risk 08/15/2013
Exubera's failings have saddled the inhaled insulin class with a negative stigma. Diabetes giants such as Novo and Lilly have pulled their inhaled insulins from development, and MannKind alone must face changing the minds of regulators and prescribers. While no red flags have emerged in trials, there is still the risk that safety concerns could be uncovered once Afrezza faces widespread use in the general population. If Afrezza fails to gain approval or garner attractive sales, MannKind's substantial debt and undeveloped pipeline could leave shareholders empty-handed.

Management 05/14/2012
MannKind is led by billionaire entrepreneur Alfred Mann. Mann has an enviable record with his medical device investments, and we believe his financial backing boosts the fledgling company's chances of success. Mann has invested a large portion of his net worth in the company and has financed the lion's share of Afrezza's development costs to date. However, we are concerned that his substantial influence could cause friction with other shareholders. Mann holds the role of chairman of the board and owns nearly half of the firm's outstanding shares. Mann receives lavish stock grants each year (in 2008, he received more than $2.6 million in options and restricted stock alone), and we think outside influence could help rein in MannKind's practice of heaping equity awards on its CEO and principal stockholder.

Overview

Profile:

MannKind is a development-stage biotech focused on researching treatments for diabetes and cancer. Its lead product candidate, Afrezza, is a rapid-acting inhaled insulin awaiting approval by the U.S. Food and Drug Administration. The development of MannKind's early-stage pipeline, including testing its proprietary inhalation technology in other diabetes treatments and developing several early-stage immunotherapy and oncology therapeutics, has been put on hold until Afrezza's approval.


Bulls Say
• Afrezza has demonstrated a much more favorable side-effect profile compared with injectable insulin therapy. Long-term safety data also indicate that the product does not cause a decrease in lung function.
• MannKind plans to price Afrezza at parity with insulin analogs and has developed its device to fit comfortably in the palm, which should help remedy the reimbursement and design issues encountered by Exubera.
• MannKind is searching for a partner to help market Afrezza. Potential deals could net the firm attractive licensing payments or shareholders a hefty takeover premium.
Bears Say
• MannKind received two complete response letters for Afrezza. With a high debt load and only early-stage drugs remaining in its pipeline, shareholders are likely to be left empty-handed if Afrezza is not approved.
• Even if Afrezza is approved, the product could flop on the market. Exubera was removed from the market after it was deemed a commercial failure thanks to its hefty price tag and bulky design.
• Safety concerns linking Exubera use to lung cancer in former smokers prompted diabetes experts such as Novo Nordisk and Eli Lilly to discontinue their inhaled insulin products.

[spiro]

LOL, only $2 billion in peak sales and MNKD will only get a 35% royalty from partner,  LOL.  Does this guy know anything about Afrezza' or it's  potential market  size?  Sense this guy is obviously guessing, I will guess also, I say between $5  and $10 billion in worldwide Afrezza sales within 5 years of launch. MNKD keeps 55% share, with $1 -$2 billion upfront.    Also, If MNKD only gets a 35% royalty, they will get a monster upfront payment. 

Just My Humble Guess,

Spiro

[alcc]

Re $2B in peak sales. Fwiw, Humalog worldwide annual sales is ~$2.5B and Novolog annual US-only sales is ~$1.4B (so I am guessing worldwide is probably ~$2.5B). So, for Type 1 prandial market, $2B projected peak sales is in the ball park, not a low ball number. As to how much of the Type 2 prandial market we can get and when, that's anyone's guess. Still, a $2B drug qualifies as a blockbuster.

Re the 35% royalty rate (on revenue). Imo, that is actually somewhat optimistic to expect a BP partner to carry a 35% royalty as cost of revenue (even taking into account zero R&D expense). 25-30% is more typical and realistic. A profit-sharing arrangement may be a more viable scenario, in which case a 50-50 plus/minus split might be realistic.

Re the 40% operating margin. That seems about right (assuming ~30% royalty). However, with their huge NOL and depreciation of existing plants their net profit should come mot much less than that for a few years. So that's good.

Net, net, I don't think this analysis is too far off, unless we break into Type 2 in a big way.

[spiro]

It is the type 2's and early intervention that will get Afrezza to $5 billion in annual sales very quickly. i also, do not think doctors will choose the Alzheimer's linked Metformin over Afrezza. 

[babaoriley]

Spiro, not sure at all on the various numbers, all pretty speculative, but the 35% royalty sounds really good to me. I'm thinking more along the lines of alcc's post re that number.

[alcc]

A few further thoughts:

I do not agree with the Morningstar valuation model. Looking at past acquisitions of single blockbuster category drug plays by BPs, it looks to me that a 3x peak sales is the typical ratio. That would make MNKD take out price at $6B, or $ ~$20 using present stock count.

As to the acquisition v. partnership question, I think it will be a partnership agreement with a call (buyout) option on some realistic trigger event, say reaching $500M sales. (If I were Al I would try to negotiate to include a put option for MNKD). I don't think a long term partnership deal makes any sense for either party. First, MNKD does not really have a pipeline of other compounds they are working on, nor are they set up to carry on as a meaningful R&D shop. So, what is their operating model going forward? What do they do with the royalty payments? Second, for the BP, why split the profit with MNKD when it would look a lot better for their P&L to book not only all the revenue but also all the profit as a consolidated entity? That's how a BP would (and should) look at this.

[spiro]

alcc,

IMO,   you are underestimating potential Afrezza revenues. if MNKD's doctor surveys are accurate, within 2 years, MNKD should have quarterly  sales approaching $500,000, with 5 year growth estimates included,  projected sales could be  $5 - $10 billion per year.  This is what a blockbuster drugs looks like. Should this materialize, MNKD will be worth a lot more than $20 per share.  

[alcc]

Hi Spiro,

I am not underestimating Afrezza's potential. I too wish it would become a $10B blockbuster. But nobody knows how to put a value on potential. As the BP's CEO or board member, would you? Your i-banker certainly wouldn't. Maybe the better term to use instead of peak is achievable sales of $2B for Type 1 in say 3-5 years. That's a decent ramp and not chump change (see above for RAA comps). Can it reach $10B? I hope so. But nobody is going to pay based on that. If they do, it will be on 0.5x sales, not 3x.

If I were the BP CEO I would want to make sure, especially post Exubera, that (a) the market accepts Afrezza; (b) any deal is not dilutive to EPS or margins. Thus my guess that it will be a partnership deal with a call option. If I were Al, I wouldn't want to just make the stuff and collect royalty either. BP can make the stuff probably cheaper and better than I can. And what do I do with the cash flow? Pay all out in dividend? Spend it in new risky R&D? Either way, the street won't give you the multiples you want. Thus a phased acquisition is the only outcome that makes sense for both parties -- that's assuming best case scenarios.

[spiro]

a1cc,

There are quite a few big pharmas in urgent need of a new drug in the diabetes market. With the cost to develop a new drug near $5 billion  and taking 10-12 years, I would think that MNKD (Greenhill ) will be able to get an above average deal for Afrezza only. particularly since Afrezza is within months of a likely FDA approval. Some small companies have been getting over $2 billion for drug candidates still in early stage development and with limited market potential.   I believe we will know very soon who the winning company will be. 

www.forbes.com/sites/matthewherper/2013/08/11/how-the-staggering-cost-of-inventing-new-drugs-is-shaping-the-future-of-medicine/

[liane]

Don't forget Gilead paid Pharmasset $11 B for a Hep C drug in Phase II. The diabetes market is far greater than the Hep C market, and many insulins are coming off patent very soon. Personally, I think anything in the 10 - 20 B range would be reasonable at this stage.

[rak5555]

From an accounting perspective, I would hate to see MNKD lose the enormous tax loss carryforward they currently have by selling. Under a change in ownership, this would go away and create a windfall for uncle sam. It's better to wait a few years and book all that tax free revenue and in the interim, build the sales history that will drive top valuation in a takeout.

[biotec]

Any thing under 10Bil is a joke, Remember some of use bought shares in the teens, even high teens and held.

[spiro]

This is worth the time reading again.

klljinvestments.blogspot.com/p/afrezza-paradigm-shift.html

[otherottawaguy]

I'm with Rak on this one and not just for the Tax Losses but from the perspective of a longer term investment, the carry forward value will seem like chump change.

If MNKD can capture 1% of global Type 1 & 2 populations that is in the neighbourhood of 2.8M clients (you can do the math for 5-10%) . I am not even going to attempt to make book for all the other potential applications of Technosphere.

1% of Global Diabetes Insulin Market
Contribution Margin * Clients * P/E / Share Count
=(2200 * 25%) * 2.8M * 18 / 550M
=$550 * 2.8M * 18 / 550M
=$50.4 pps

or

$18 per Million Clients served

I won't bore you with additional calculations, but remember that current capacity at Danbury is limited to 12 lines or about 2M clients annually.

Enjoy the day,

OOG

[alcc]

Don't get me wrong; I would love to see Afrezza valued at $10B. However, I invest based on realistic expectations.

Liane: I was invested in Gilead at the time of the Pharmasset acquisition, so I am familiar with the thesis of that deal. Most felt GILD overpaid. I felt that way and got out of the stock (ok, left some money on the table). Nevertheless, this is not the right analogy. Yes, sofospuvir was only in PII trial at the time. It even had a big scare from poor initial trial results. However, sofospuvir will be launched into the HCV market as the first gold standard. It will be the first promising treatment, replacing the problematic peg-interferon/ribavirin and the underachieving Incivek. Thus, GILD is expected by the street to essentially own the market, at least for a few years before rival compounds make it to market. Projections are it will hit ~$2B in the 1st year and ramp up from there. Using an average street estimate of $5B "achievable" sales, the $11B price is actually short of the 3x multiple I used for Afrezza. Also, at ~$80K/patient, the margins will be huge. Afrezza, otoh, when approved, will be launched into a well established and entrenched market of RAAs. Sure, we all believe Afrezza is a breakthrough, else none of us would be here. Still, to take enough market share from existing RAAs will not be easy and will take time. These RAA players are not going to give up and go home. Afrezza and Pharmasset are apples and oranges, imo.

NOL,Technosphere etc.: The takeout scenario I posited would only cover rights to Afrezza. If I were the BP's CEO I would be happy to leave Technosphere (and NOL) with MNKD to do as it sees fit. The question you need to ask yourselves is: in that event, would you keep your MNKD shares and let it ride as MNKD looks for new discoveries? If not, why not?

Biotec: I am sorry and I feel your pain but what you paid for your shares is unfortunately not relevant. MNKD essentially had a restart after its near death experience with the CRL. The substantial dilution in what amounts to a second round (of recapitalization) wiped out a lot of your (and other early investors') equity. That is how it goes. You need to look at mkt cap, not share price. What was the share count when you paid for your shares in the teens? What is the share count now?

I don't mean to rain on anyone's parade. I am trying to look at this from the perspective of the BP partner. Speaking of which, why is SNY the favorite here? I know Apidra sales has been disappointing. However, seems to me LLY is in worse straits given lispro is going off patent in 2014.