MannKind Corp. (MNKD)

[Phaeton]

Stay long in Mannkind as the best is yet to come. Nate Pile has been writing about MannKind for many years. This is the best article he has written as it tells you why to stay long and enjoy the future ride up.

http://www.notwallstreet.com/update-on-market-and-mannkind-090114/

An Update on The Market and MannKind 9/1/14


Climbing The Proverbial Wall of Worry

After keeping us on the edge of our seats for the first week or so of August, I am very pleased to report that all five of the major indices we use to gauge the health of the overall market have since rebounded nicely (see “Eyebrow Levels” below).

To be sure, the volume has been fairly light during the move (as is to be expected in the summer month of August), but at the end of the day, “up is up,” as the saying goes, and as discussed so many times before, our job is to position ourselves on the right side of trends… and then ride them until they finally run out of steam.

Yes, there is a chance that the fact that some of these indices are hitting new multi-year and/or all-time highs on fairly light volume means the breakout is actually a fake-out, but given where we seem to be at in the fear-greed cycle right now, my gut feeling is that we will see additional volume come into the market as September gets underway… and if this volume continues to be biased to the buy side, you are strongly encouraged to look at it as an excuse to buy stocks rather than sell them!

In particular, you are especially encouraged to consider adding to your positions scooping up all the MannKind (MNKD – $7.37) you can comfortably sleep with at night while it is still trading under $10.

As you know, literally an hour or so after the August issue was posted to the website last month, MannKind announced that it had partnered with Sanofi (SNY – $54.70) for the commercialization of Afrezza… and, as you are probably all too aware, rather than rising on the news, MannKind’s stock has sold off sharply!

Naturally, the poor performance of the stock has caused a number of you to wonder whether or not the deal is a good one after all… and I hope the following helps you realize the answer is a resounding “yes!”

First off, I believe it is worth noting that there is probably no large pharmaceutical company out there that has become more focused on and aggressive about capturing diabetes market share in recent years than Sanofi – they are “hungry,” they have momentum at this stage of the game, and I have no reason to doubt that they are going to do all they can to educate doctors and patients alike on the benefits of Afrezza.

And, speaking of those benefits, I think it is extremely important to note that while one of the main – and most often cited – selling points of Afrezza is that it can be used by patients (especially newly diagnosed diabetics) who may be averse to giving themselves shots on a regular basis, it is just as important (and perhaps even more important, in the long run) to note that Afrezza’s ultra-rapid acting nature has the potential to redefine how patients control their diabetes, especially when the drug is used in conjunction with other technologies and drugs that will be making their way into the marketplace in the quarters and years ahead… and I believe it is no coincidence that in addition to signing an agreement with MannKind in August, Sanofi also entered into a major diabetes collaboration agreement with Medtronic (MDT – $63.85) back in June.

Not only does it seem clear that Sanofi is planning on putting an awful lot of effort into the diabetes market in the years ahead, I also believe it is worth pointing out that Medtronic is the company that Al Mann sold his last major venture to (MiniMed, maker of insulin pumps and other products, was bought by Medtronic for $3.7 billion in 2001), so there is certainly reason to believe that the pieces of this puzzle may be falling into place with a bigger picture in mind than it might first appear!

Anyhow, getting back to the terms of the deal itself, not only has Sanofi agreed to pay MannKind $150 million upfront for the right to market Afrezza, it will also pay MannKind up to an additional $775 million for various sales and regulatory milestones if/when they are hit. In addition, the two companies will split all profits and losses 65% (Sanofi) – 35% (MannKind), with Sanofi agreeing to advance MannKind up to $175 million if needed.

While short sellers (and other journalists who have had a negative bias against the company for years now) were quick to complain that it was a “horrible” deal for MannKind shareholders, all one needs to do is take out a pencil and piece of paper and run through possible scenarios to realize that it is, in fact, a great deal for MannKind shareholders.

Starting with the worst case scenario (i.e. Afrezza turns out to be a flop), any time an executive can bring in $150 million for “nothing,” I think it is fair to call it a “win” for shareholders.

However, assuming that Sanofi is, in fact, able to sell more than just a few doses of Afrezza, the company’s critics have claimed that “MannKind gave away too much – 35% is far too small a percentage”… but again, when one actually takes the time to look at the math, the deal doesn’t look too shabby at all.

For example, let’s start small and assume that no milestones are hit and Sanofi generates “just” $50 million worth of profit from Afrezza. In this case, MannKind will get it’s 35% cut ($17.5 million), and when this is combined with the $150 million it got upfront, we’re looking at the company receiving $167.5 million for a product that did $50 million in sales.

Moving further along the optimism spectrum, let’s still assume that no milestone payments are triggered but that Sanofi generates $150 million worth of profit from Afrezza. In this case, MannKind will be collecting $52.5 million for its share, plus $150 million, which works out to $202.5 million for a drug that generated $150 million in sales.

Ah, but you’re thinking the critics must have meant it’s a bad deal for MannKind shareholders if Afrezza is actually a blockbuster (which, of course, is an amusing way to look at it since their underlying premise has always been that it will not be a blockbuster… heck, many of them were even convinced it wouldn’t even be approved, never mind find a partner in the world of big pharma), so let’s make our assumptions a bit grander.

Let’s assume that the drug generates $300 million in profits, and because usually at least the first one-third or so of a “milestone” package is meant to be fairly easily attained, let’s also assume that in the process of getting to $300 million, at least a half of that first third is triggered (and, to keep the math simple, we’ll assume the milestone package was for $750 million rather than $775 million).

In this case, MannKind will be receiving it’s cut of the $300 million ($105 million)… plus one-half of one-third of the milestone package (so half of $250 million, or $125 million)… plus the $150 million it received upfront… bringing us to a grand total of $380 million for a drug that generated $300 million in sales!

Of course, we could continue to ratchet up our levels of optimism and see what the numbers look like, but I hope you get the point by now – namely, unless/until Afrezza sales numbers reach the level of being truly “blockbuster,” this deal is actually skewed in favor of MannKind… and even if/when the day comes that Afrezza is doing several billion dollars a year in sales, I don’t think you’ll hear anyone complaining that in addition to the nearly $1 billion in milestone payments MannKind received along the way, the company is still collecting 35% of that revenue stream “in perpetuity.”

To be sure, there will be costs and expenses along the way that will need to be managed in a judicious manner… and those numbers will admittedly impact how much money the company actually earns each quarter… but I think it is fair to say that MannKind did, in fact, find a great partner on great terms.

In fact, though I was certainly not part of the negotiations, I don’t think I am out of line in summarizing the situation as follows:

In a nutshell (and admittedly taking a few percentage points of liberty here and there to help keep the math really simple), Al Mann has put a little over $900 million of his own money into the company and still owns a third of it (actually more than that, but again, I’m trying to keep the math simple). He believes he is sitting on at least one blockbuster (Afrezza), and he has convinced his partner to put roughly the same amount of money into the company as he has put into it… but the partner will not end up with any equity in the company in exchange for its $900+ million; instead, the companies will split the revenue stream from the product into three pieces, with both companies taking one piece for their involvement, and Sanofi keeping the third piece in lieu of getting any equity (i.e. Al got a third of the whole company for his $900 million, Sanofi gets “just”a bonus third of Afrezza).

As pointed out above, if Afrezza flops, MannKind comes out ahead in the partnership, and if Sanofi turns Afrezza into a wild success, all parties involved go home winners… with the bonus for MannKind shareholders being the fact that Al Mann will quite likely utilize the revenue stream coming in from Afrezza to move other products through the pipeline on the Technosphere platform (and these products, in turn, will have the potential to be licensed and/or partnered along the way, further increasing the size of the revenue stream coming in for shareholders).

While I want to remind you yet again that it is never a good idea to put all your eggs in a single basket… and there are no guarantees that Afrezza will ever generate the types of sales numbers that will be required to help produce another 10-bagger for us… I believe the deal with Sanofi has placed the odds firmly in our favor, and with over 70 million shares still sold short, not only do those “investors” (sic) represent a pool of buyers that will likely help keep a floor under the stock for us, they also represent an awful lot of fuel (i.e. buying pressure) that will be poured on the fire IF the stock does start to rally in the months ahead.

Add to this the possibility (but not a promise – I’m not calling the shots at the company) that, at some point, the company may do a reverse split to help bring the share count more in line with what some critics are looking for, and things could get even uglier for the shorts.

No, it won’t change the valuation of the company (fewer shares outstanding times a correspondingly higher stock price will still be the same market cap), but as any poker player will tell you, it is much harder to engineer a betting strategy when you have 10 chips in front of you rather than 100… and though I doubt the company would do a full 1-for-10 reverse split, the idea is the same in terms of how reverse-splitting the stock would force the short sellers to change their approach regardless of the size of the split. Again, I am not predicting this will happen, but it wouldn’t surprise me if it hasn’t at least been considered as part of the company’s longer-term plans.

Anyhow, it has admittedly been a long, frustrating last three weeks to be a MannKind shareholder, but as was mentioned in the blog entry I posted shortly after the partnership agreement was announced, I have seen this happen before in my 25+ years following the biotech sector… and in the long run, the fundamentals always win out over short-term emotions and artificial price depression (so please don’t let the short-term action deter you from sticking to our game plan!).

I think a big part of the sell-off was due to disappointment on the part of traders that an outright buyout of the company did not occur, and, as mentioned above, the usual cast of characters were also quick out of the gate to utilize their soapboxes for criticizing the deal as a bad one.

However, the stock seems to be finding some traction, and I hope the above has helped you understand that the deal is actually a far richer one than all but the most bullish of bulls could have hoped for… never mind how great a partnership it is relative to the “rent-a-sales force” deals that were being called for by the more vocal skeptics (the same folks who, I might add, have yet to be right about a single major call related to the Afrezza story – are you starting to notice a pattern?).


Hang in there – it is still to early to say for sure, but it looks like the worst may finally be behind us!