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Mannkind Corporation (NASDAQ:MNKD) is set to release top-line data from the Affinity 1 and Affinity 2 trials of their lead drug, Afrezza, in the next 2 weeks. We believe that both trials are likely to show positive results; however, given MNKD's current valuation, investors on the long side would do well to have a plan to book gains either before the data release or soon after since the company will have to conduct a large capital raise soon after the data is released as we outline below.
About the Drug
Afrezza is a drug-device combination product that enables delivery of human insulin to the lungs (Pulmonary delivery) via an inhaled dry-powder with an inert carrier. Afrezza is not remarkable because it is inhaled, but rather because the pharmacokinetics of the drug mimic the insulin response of a healthy non-diabetic person. The insulin from Afrezza peaks about 15 minutes after dosing, and is cleared from the body within 90 minutes. Giving people with diabetes the insulin response of a non-diabetic person is potentially a great step forward in diabetes management.
MNKD has fumbled their new drug application (NDA) approval process in the past by trying to switch devices mid-stream where they used one inhaler for the clinical trials and tried to get approval to go to market using another, more efficient design. The FDA told the company to do clinical trials on the inhaler they will actually market - primarily because the new device uses 30% less Afrezza insulin powder than the old device. Because the active drug is insulin, and because the real issue was with the device and not the drug, we believe the current trials should meet their primary and key secondary endpoints.
The Affinity 2 trial (also known as the MKC-175 trial) in patients with type-II diabetes has a comparator arm meant to show superiority of Afrezza vs. the placebo inhaled powder (plus whatever oral medications the patients are taking). This arm is interesting because is opens up the future potential for Afrezza to be used much earlier in the treatment spectrum for Type 2 diabetes management.
Nevertheless, investors need to keep in mind that paradigm shifts in treatment of chronic diseases such as diabetes do NOT happen overnight. They require a concerted effort over a significant period of time to generate doctor and patient adoption of the new treatment approach. This means that the commercial launch effort to realize Afrezza's full potential will be expensive.
Over the past 6 months to one year investors long MNKD have done extremely well as the stock has advanced from below $2 per share to the recent closing price of $8.29. This has sent MNKD's market capitalization to $2.32 billion ahead of the data release. We believe that soon after the data release MNKD will need to raise capital either through a partnership with a significant up-front milestone payment, or, (more likely in our view) through a further dilutive financing round. Our analysis of MNKD's cash position is outlined below.
MNKD currently burns about $10 million per month. As of their Q1 2013 quarterly report, the company had $28 million in cash on hand, meaning that, by the end of June, MNKD was running on fumes (to use a piloting analogy). At the Wells Fargo healthcare conference on June 18, MNKD CFO Mathew Pfeffer indicated that the company had not yet tapped the $50 million At-the-Market financing facility which was initiated back in March. To fund continuing operations, MNKD either used that facility immediately after the Wells Fargo conference, or possibly tapped into the additional borrowing available under the credit line from the Mann Group. If they did neither or these, then the company coffers were truly empty by the end of June just prior to the most recent convertible debt financing with Deerfield.
The $40 million from each tranche of the Deerfield (DF) deal buys about 4 months of runway. Counting the July 1st tranche and the $40 million tranche when top-line data come out, MNKD's cash runway extends for 6.5 months after the data are released. Here's where things get tricky. The senior convertible notes due December 15th have a conversion price of $22.47. The 30 million warrants expiring in October of this year bring in $78 million (exercise price is $2.60 and there is no cashless exercise provision as long as the shares are registered with the SEC.) The 30 million warrants sold to the Mann group potentially bring in another $78 million. So MNKD potentially has $236 million of cash inflow between now and December 15th. The 2013 notes have an outstanding balance of 114.6 million and the credit line to the Mann group has a balance of $119.6 million for a total of $234.2 million due before the end of January. If the company meets their goal of an NDA resubmission by October, and if FDA gives them a 6 month review (which they should), a PDUFA decision will come by April 1 2014. Assuming expenses stay relatively unchanged as the R&D expense decreases but commercial ramp-up increases, that's another $90 million in cash required bringing us to $324.2 million. MNKD still has the $50 million ATM facility that is untapped, and the payment of the notes in December allows for borrowing of Tranche 3 of the Deerfield notes. The table below summarizes MNKD's cash inflows and outflows between now and April 1, 2014.
|Deerfield Financing Pre-Approval Tranches||$120 m|
|October Warrants||$78 m|
|Mann Group October Warrants||$78 m|
|ATM Facility||$50 m|
|Total Cash Inflows||$326 m|
|9 months Cash Burn July - March||$90 m|
|Notes Due Dec 15th 2013||$114.6 m|
|Mann Group Line of Credit Due January 2014||$119.6 m|
|Total Cash Outflows||$324.2 m|
|Net Cash By Approval||$1.8 m|
Bottom line: Even with the Deerfield financing, by the time the FDA approval decision comes around, MNKD will once again be running on fumes unless the company does another financing. The $40 million tranche available upon FDA approval of Afrezza is nowhere near enough to launch the product.
The cash situation may be slightly improved if the Mann group debt is settled by converting to equity. In this case $119.6 million of outflows are eliminated; however, it is likely that the $78 million due from the Mann Group for exercise of warrants would be part of that deal thus the net impact would be to increase available cash by $41.6 million. In this scenario, counting the Deerfield tranche due upon Afrezza approval, the company could potentially have $83.4million cash on hand to launch the product, a definite improvement, but still not enough to fully launch.
Regardless of the success or failure of the Affinity 1 and 2 trials, there is most probably another financing coming this fall. If MNKD lands a partner who makes a significant up-front milestone payment, the company will have some further runway but this will come at the expense of a share of future Afrezza revenues which then requires re-evaluation of the company's valuation.
Pay Attention to the Share Count
While all of these financings and warrant exercises are going on, the shares outstanding for MNKD continues to increase, by at least 60 million shares if all warrants are exercised, and by even more if Deerfield converts their notes, and/or if the 2013 note holders convert (not likely unless the share price reaches above $22.47). With each conversion, there is an imbalance in the market cap of MNKD.
For the purposes of calculating net loss per share, MNKD uses 280.1 million shares, which equals their total outstanding share count less 9 million shares loaned to Bank of America as part of a hedging transaction against debt issued. However, the company excluded 133.5 million shares issuable due to stock options, restricted stock units and warrants because these shares are anti-dilutive for the purposes of calculating net loss (the same loss spread over more shares = lower loss per share which overstates the company's performance.) Here's the problem: When the 60 million warrants convert this fall, they bring in $156 million in cash, but, if the price per share of MNKD stock is say $8, those 60 million shares increase the company's market capitalization by a whopping $480 million. That's a $324 million increase in market cap backed by no increase in assets. Should MNKD's stock price be higher, the imbalance grows even larger (up to half a billion in excess market cap if the share price is $12).
2015 Warrants A Potential Additional Source of Cash
The warrants issued in connection with the February 2012 $75 million financing are a potential source of additional cash. There are warrants covering 21,562,500 shares of MNKD stock with an exercise price of $2.40 per share. If all of these warrants were exercised, MNKD would receive and additional $51.75 million in cash. However, since the warrants do not expire until 2015, it is difficult to determine whether or not holders of these warrants will exercise early and give up the time-value of these long-dated options.
The Mann Group Could Extend Their Credit Line
If the Affinity trials show positive data, it is entirely possible that the Mann Group, which is controlled by MNKD founder and chairman Al Mann, could extend the due date for the company's line of credit. The line of credit has had it's due date and last date to borrow extended in the past. This could potentially move the $119.6 million due to the Mann group out past a PDUFA date for Afrezza; however, until such an extension happens, investors would do well NOT to rely on this scenario in their investment thesis.
Simplified Fair Value Model
Given the binary nature of MNKD's data release, we use a very simplified fair value model. We take the estimated peak sales of Afrezza, discounted to present day multiplied by the expected probability of successful results and approval, blended with the value of the stock on trial failure multiplied by the probability of trial failure to arrive at a fair value.
We believe that the current trials have a 90% probability of success and that following the trials, the drug has a 90% chance of FDA approval, yielding an overall 0.81 weighting for a positive outcome. The probability of trial failure is, in our view 10% while the probability of FDA rejection after a successful trial is 10%
Without doing a detailed discounted future cashflow analysis, we assume peak sales of a theoretically fully penetrated Afrezza to be $5 billion, and further assume that, on trial failure or on FDA rejection, the stock is worth $100 million (zero may be a more appropriate lower bound).
Using a 3 year sales ramp (again unrealistic, but let's see where it takes us), we get a present-day value of the future sales equal to approximately $3 billion (using a 10% discount rate). Thus our simplified model predicts a fair value for MNKD of
$3BX81% + $100mX19% = $2.45 Billion.
Given that MNKD's market cap is $2.32 billion, our simplified model suggests that shares are essentially fairly valued if one assumes this optimistic scenario.
At Red Acre, our aim is to find trades that are so significantly undervalued that even a first order model with many simplifying assumptions demonstrates a deep value play. Such was the case for MNKD when the stock was trading at $2 but at the current price we do not find that same value.
Investors should use such a model as a starting point rather than as a conclusion. Feel free to plug in your own numbers and use a more refined DCF analysis to come up with a more precise answer - chances are our simplified model is not too far off the mark.
It is well known that MNKD has a huge short interest of some 46.09 million shares (30% of the float). While inexperienced longs may dream that this high short interest will lead to the "mother of all short squeezes", and inexperienced shorts may help realize at least a bit of that dream, the cash analysis above should indicate the more likely course of unwinding the high short interest. Institutional shorts will have plenty of opportunities to cover through the likely secondary financings that MNKD will have to conduct.
Mannkind 3-yr daily chart (click to enlarge)
The 3-year daily chart above (data from TD Ameritrade) shows likely support and resistance levels for MNKD's Stock. The 20-day, 50-day and 200-day exponential moving averages stand at $7.37, $6.79 and $4.69 respectively. Just this past week, the stock broke above the previous highs from the May - June time frame, This appears to be the final push higher ahead of the data. If data are not released before then, the next short interest dissemination date of August 9th should be an interesting data point. If the short interest has increased dramatically this may be a sign that the market expects a significant pullback ("sell the news") after data is released.
After the data, MNKD will have to quickly announce their go-forward plans to manage the balance sheet. Since the company is likely delaying their Q2 conference call until top-line data are available, analysts will be able to ask management about the financing plan soon after the data are released.
Investors who have been long since MNKD was trading below $2 (as we recommended over a year ago), would do well to book some gains, or consider a covered call strategy to lock in profits. While a short term run to $10 or above is not out of the question, profit taking is to be expected after the data release.
It is well known that MNKD is a retail investor driven stock. Where retail investor enthusiasm eventually carries the stock is impossible to predict. We have presented herein, our analysis of MNKD's valuation and considerations for trading. As we have indicated in our Free newsletter since May, we have been steadily scaling out of our long MNKD position. While we are still long MNKD, our position is now just 10% of our original position size. These are "free" shares in the sense that our gains from already exited shares more than cover our cost basis. While we believe that the current trials are likely to succeed, and that Afrezza is likely to be approved; given MNKD's current balance sheet, we do not find a long investment to be worthwhile in the short term. Should the cash position and balance sheet picture change for the better, or should new information regarding the eventual sales potential of Afrezza be uncovered, we may revisit our investment thesis.