Investors, or more accurately, speculators who have followed the MannKind Corporation (NASDAQ: MNKD) saga over the past several years know fully well that the end game is rapidly approaching. Wall Street research coverage has increased of late, trading volume is surging, and the stock has more than doubled in price over the past three months. The pivotal phase 3 clinical trials - Affinity 1 and Affinity 2 - that the developmental stage biotechnology company is conducting of AFREZZA is about to conclude and the recent broad-based enthusiasm clearly reflects the growing collective confidence that the inhaled insulin product could be a "major weapon" in the battle against the global diabetes pandemic, as has been suggested by the company's founder, largest stockholder, and chief executive Alfred Mann. It also may be instructive to note that during a conference call with the investment community on May 9th, Mr. Mann stated "I believe AFREZZA could potentially even become the most significant medical product ever." It would be easy to dismiss this statement as hyperbole or the wishful musings of a corporate chieftain, but the speaker's extraordinary life story, the product's apparent efficacy, and the massive (and rapidly growing) market potential all suggest a different course might be wiser. Indeed, the timing of the statement, this late in the clinical trials, is certainly very encouraging. All that said, we should have a relatively clear picture of MannKind's fate within the next few months. Disappointing data will undoubtedly have the shares plunging down to penny-stock status. Good results and MNKD "could be the best performing stock of 2013," quoting Joe Springer, who penned an incredibly well-researched and comprehensive report for Seeking Alpha in early March.
In the interest of full disclosure, we (as in the royal we) have small long positions in MannKind's common shares and warrants. As well, we have a bullish spread on 2015 call options and a short position in 2014 put options. Needless to say, we are bullish on AFREZZA and MNKD stock. Mr. Springer (and others) has written extensively on the merits of the product and why it will be approved, as noted above, so there seems little point to our regurgitating his arguments (with which we fully agree). The focus of this article is to make a case for why we think an acquisition of MannKind is at least as likely as the securing of a long-anticipated marketing partner. (For investors new to MannKind, an introduction of the company is presented below, as are background information on its flagship product, the diabetes market, and the ongoing clinical trials.)
The Critical Time Line
Both Affinity 1 and Affinity 2 should be completed by the end of next month. Management's plan is to publicly share the clinical data sometime in the middle of August. An amendment to the NDA (New Drug Application) that was filed with the Food & Drug Administration (FDA) several years ago will then be submitted towards the end of September or in early October, triggering a six-month clock for the regulators to make a decision on whether AFREZZA can be commercialized. (The timeline was detailed by management during conference calls on both February 11, 2013 and May 9, 2013.) In between the time that results are announced and the FDA issues its ruling, MannKind will have to either raise additional capital to fund operations, meet debt obligations, and prepare for product launch or it will have to find a collaborative partner, one that will provide both a significant cash infusion and a large sales infrastructure. According to management, there have been extensive discussions with a large number of pharmaceutical and biotechnology companies; the talks should gain in intensity after the data have been released. The conventional wisdom or expectation on Wall Street is for the latter alternative to occur. That said, we think an extraordinary transaction makes the most sense, from both the company's and the prospective buyers' perspective, while noting that either scenario would most certainly boost the stock price.
From MannKind's Perspective
Alfred Mann, the company's founder, chairman, chief executive officer, largest shareholder, with a 42.5% stake, and driving force is 87 years old. The development of AFREZZA has been a long and expensive endeavor, requiring many years of effort and almost a billion dollars of his own money. Selling MannKind would likely yield a nice return and would be consistent with Mr. Mann's long and extraordinarily successful history of starting, nurturing, and then selling companies. Significantly, too, a change in corporate control would obviate the need to find a successor, bring in the expertise necessary to navigate the FDA gauntlet, and set the stage for a seamless market launch. Moreover, considering both the large number of huge-selling blockbuster drugs - Pfizer's (PFE) Lipitor, Merck's (MRK) Singulair, and Bristol-Myers's (BMY) Plavix to name just a few - that have lost market exclusivity in recent years and the difficulty that branded drugmakers are having in developing new large-sellers, the timing probably could not be much better for an auction of the company.
The Prospective Suitors' Perspective
Some of the biggest blockbuster drugs in history lost patent protection in 2011 and 2012, creating "revenue cliffs" for several companies. Lipitor, for instance, the best-selling drug of all time, with revenues of $11 billion in 2010, lost market exclusivity in late 2011 and saw sales crater 59% (down $5.6 billion) in 2012. Plavix, the second-best-selling drug ($9 billion) in the world, lost its patent cover last year, with clearly negative top- and bottom-line implications for Bristol-Myers going forward. At the same time, the branded drugmakers are having trouble developing new large-selling drugs, even though they are spending massive sums of money on research and development. Pfizer, for example, spent an astronomical $26.4 billion on R&D in the last three years, averaging $8.8 billion a year. In fact, even though annual outlays on developing new drugs has exceeded $4 billion for over a decade, most of its revenue gains in recent years have come from acquisitions, a sad reality that's underscored by a stock price that's below where it was 10 years ago.
These dynamics certainly make AFREZZA and its large sales potential look very attractive. A little more than seven years ago, Pfizer paid some $2 billion for the marketing rights to Nektar Therapeutics' (NKTR) since discarded inhaled insulin product Exubera (discussed below), along with a royalty of 15% on sales. In view of AFREZZA's vast superiority over Exubera and the substantial growth in the diabetes market since then, the price for the marketing rights to MannKind's product would have to be far north of $2 billion, which may explain, in part, why a partner has yet to be secured. Throw in the facts that big pharma's coffers are bulging with cash and interest rates are incredibly low, with even junk bonds costing less than 6%, gaining full control of the company seems to be the preferable course of action. This is just a guessing game, but potential suitors include Eli Lilly (LLY), Merck, and Novo Nordisk (NVO), all of which are significant players in the diabetes market and have deep pockets. Pfizer is another possibility, as is Johnson & Johnson (JNJ), each a well-heeled healthcare giant that's struggling mightily for growth. A bidding war would be nice for MNKD stockholders but it ultimately doesn't really matter who marries MannKind.
A Possible Price Tag
As with trying to figure out which corporation may acquire the biotech, the huge number of moving parts and uncertainties make determining a possible price largely a guessing game. That said, one ideally wants to derive a price target using conservative assumptions, which allow for both upside surprises and a healthy cushion when using the price in the buy, sell, or hold deliberations leading up to the forthcoming high-impact events.
Gilead Sciences (GILD) paid $11 billion for tiny Pharmasset's hepatitis C (HCV) experimental drug. HCV is far more expensive to treat than diabetes on an individual basis, but the treatment regimen for the former is measured in months whereas the latter is years, if not decades. Moreover, the number of diabetics is considerably higher than the number of people infected with HCV. MannKind has a large inventory of insulin that has already been expensed and is sufficient to generate about $10 billion in revenues. It also has an accumulated deficit of $2.1 billion. As such, operating margins could be extremely robust for years and the profits produced will be tax-advantaged for some time. The company's Danbury, Connecticut manufacturing facility has the capacity to serve two million patients, equating to roughly $4 billion in annual revenues, which is probably an achievable top-line figure for 2019. Assuming a reasonable 25% net profit margin, net earnings could approximate $1 billion by that year; Biogen Idec's (BIIB) margin is around 23%; Merck's, 25%; Novo Nordisk, 26%; Celgene (CELG), 32%; and Gilead Sciences, 32%. An earnings multiple of 18 would give MannKind a market capitalization of $18 billion. These figures would suggest that the company, if the data ultimately supports the use of AFREZZA throughout the entire spectrum of diabetes, not only type 1 but also for gestational diabetes and almost the entire range of type 2, is worth at least the $11 billion that was paid for Pharmasset; $11 billion is about the present value of $18 billion discounted at a 10% rate, which is significantly higher the prevailing rate on junk bonds. As a sidenote, in the 18 months since the acquisition was announced, Gilead's stock has soared an astronomical 182%, adding $57 billion to the company's market capitalization.
Taking a different, perhaps more conservative approach, what's the minimum in revenues that AFREZZA would have to generate to justify an $11 billion price tag. All of the potential suitors have a lot of cash that's earning virtually nothing. Pfizer, at the top of the list, has $35 billion in cash while Merck has about $16 billion. Moreover, each could probably borrow money for less than 4% per annum. As such, it wouldn't take much for an acquisition of MannKind to be accretive to earnings. Assuming a buyer financed the entire deal with debt at 4%, EBIT (earnings before interest and taxes) would have to total $440 million for the deal to have a roughly neutral impact on the bottom line. This could be achieved with revenues of about $1.5 billion, using a relatively conservative 30% operating margin. The $11 billion for the company would equate to $27.50 a share, assuming 400 million shares outstanding (with all warrants and debt converted into common stock). All in all, our assumptions and projections would have to be considerably off the mark for MNKD stock not to have substantial upside potential. It should be noted, too, that our figures could prove to be very conservative.
MannKind is a Valencia, California-based development stage biotechnology concern that focuses on the discovery, development, and commercialization of therapeutic products for the treatment of diabetes and cancer. Its lead product candidate is AFREZZA, an ultra-fast-acting inhaled insulin that has completed a series of Phase III clinical trials for the treatment of diabetes in the United States, Europe, and Japan. The company has several other prospects in its research program, including MKC1106-MT (for patients with advanced melanoma) and MKC253, MKC1106-PP, and MKC204, which were being assessed as possible treatments for type 2 diabetes, diverse tumor types, and various other health issues; only AFREZZA is being actively developed at present, as management tries to conserve cash.
MannKind has yet to commercialize a product and has generated revenues of only $3.1 million in more than 21 full years since inception. On the other hand, it has spent heavily on research and development, as well as on erecting a substantial manufacturing infrastructure. As such, it has accumulated a total deficit of $2.1 billion in its history. Significantly, too, at the end of March, the company's capital resources consisted of cash and cash equivalents of only $28.0 million and $125.4 million of available borrowings under a loan agreement with The Mann Group, an entity controlled by the company's principal stockholder. Debt, on the other hand, totaled $332.0 million, including $234.2 million that's due within the next 12 months. Based upon a cash burn rate of roughly $35 million a quarter, the existing resources will enable it to continue planned operations only to the fourth quarter of this year, even taking into consideration the conversion of warrants that were issued last fall. As of March 31, 2013, shareholder equity was a negative $215 million, and there are approximately 291 million shares outstanding (and close to 400 million on a fully diluted basis).
The Target Marketplace
There are an estimated 26 million people in the United States with Diabetes, costing the country some $175 billion a year in direct (medical) and indirect (disability, work loss, premature mortality) expenses. According to the International Diabetes Federation, the disease affects roughly 366 million people worldwide and the number is expected to exceed 550 million by 2030, rising along with the incidence of obesity. Diabetes is a serious, lifelong condition that is associated with long-term complications such as blindness, heart disease and stroke, kidney failure, amputations, and death. It is a metabolic disorder characterized by the body's inability to properly break down the foods we eat into glucose, which is the main source of energy in our bodies. Insulin, a hormone produced by beta cells in the pancreas, normally regulates the body's glucose levels, but in people with diabetes, insufficient levels of insulin are produced (type 1), or the body fails to respond adequately to the insulin it produces (type 2). The result is an abnormally high build-up of glucose in the blood, a condition called hyperglycemia.
The primary treatment for type 1 diabetes is daily intensive insulin therapy. For type 2 diabetics, the treatment initially takes the form of lifestyle intervention (diet and exercise) and non-insulin oral medications. Eventually, however, most will require insulin therapy. The currently available insulin products have limitations, including: risk of severe hypoglycemia (excessive insulin); weight gain; inadequate post-meal glucose control; the need for complex titration of insulin doses; and the need for multiple injections daily. Because of these limitations, patient compliance with prescribed treatment regimens is low, and the disease is often undertreated. That said, Americans spend approximately $6 billion annually on insulin and delivery supplies. They spend another roughly $10 billion on non-insulin oral medications.
In the summer of 2006, Pfizer launched Exubera, a much-anticipated inhaled insulin product that had helped its developer, money-losing Nektar Therapeutics, gain a market capitalization of $2 billion. Considering the huge potential market for a non-injectable insulin product, the then-chief executive officer of the pharmaceutical giant predicted that annual sales of the product would reach $1.5 billion by 2010.
Exubera was bulky, the size of a canister of tennis balls, premium priced, and very few patients or insurers embraced the product. It turned out to be a spectacular flop, and Pfizer took a $2.8 billion charge in the fall of 2007 in writing off its investment in the product. Soon thereafter, Eli Lilly and Novo Nordisk, two of the largest manufacturers of insulin, terminated their respective inhaled insulin programs, citing, among other things, inadequate commercial potential and existing alternative therapies.
AFREZZA is a drug-device combination product, consisting of inhalation powder pre-metered into single-dose cartridges and a light, discreet, easy-to-use inhaler; the company's proprietary Technosphere particles are loaded with insulin molecules, aerosolized, and then inhaled deep into the lung using the inhaler. MannKind's inhaled insulin product has a unique pharmacokinetic profile that mimics the early phase mealtime secretions of insulin by a healthy pancreas. Administered at the start of a meal, AFREZZA dissolves in the lung immediately upon inhalation and delivers insulin quickly to the blood stream. Peak insulin levels are achieved within 12 to 14 minutes of administration, compared with around 49 minutes for Exubera and 53 minutes for injected rapid-acting insulins. The clinical program for the product involved 61 different studies and over 5,600 adult patients. In clinical trials, AFREZZA showed a significant reduction in post-meal glucose fluctuations, a lower risk of hypoglycemia, less weight gain than is typically associated with other insulin treatments. Additionally, a two-year pulmonary safety study in Type 1 and Type 2 adult diabetes patients showed that changes in pulmonary function tests associated with AFREZZA were comparable to the changes seen in patients treated using usual care, consisting of insulin or oral therapies. The most common adverse events reported during the clinical trials were hypoglycemia and mild, transient, non-productive cough; the incidence of cough leading to the discontinuation of AFREZZA was low.
In addition to being more effective and safer than Exubera, MannKind's product is far smaller and easier to use, about the size of a thumb. Significantly, too, the California-based company has learned from Pfizer's mistakes and is not expected to price its product at premium levels, auguring well for acceptance by both third-party payers and patients.
AFREZZA's History with the FDA
In March 2009, MannKind submitted an NDA (New Drug Application) to the FDA requesting approval of AFREZZA for the treatment of adults with type 1 or type 2 diabetes using MedTone, the company's first-generation inhaler. In March 2010, the company received a Complete Response letter (CRL) from the FDA, requesting additional information, including data on the comparability of the commercial version of the MedTone inhaler to the earlier version of this device that was used in pivotal clinical trials. After meeting with the FDA in June 2010, management determined that the best way to address the agency's inhaler-related questions was to submit information regarding the bioequivalence of the MedTone inhaler and its next-generation inhaler, known as Dreamboat, which by that time had become the preferred device from a clinical and commercial perspective, given that it is smaller, easier to use and lower in cost than the MedTone inhaler. Soon thereafter, MannKind submitted to the FDA the available bioequivalency data for the two devices along with additional evidence of efficacy of AFREZZA as part of its response to the 2010 Complete Response letter. In July 2010, the FDA accepted MannKind's reply to the CRL and set a Prescription Drug Users Fee Act (PDUFA) action date of December 29, 2010.
In January 2011, the FDA issued a second Complete Response letter in which it requested MannKind conduct two clinical studies with the Dreamboat inhaler (one in patients with type 1 diabetes and one in patients with type 2 diabetes), with at least one trial including a treatment group using the MedTone inhaler in order to obtain a head-to-head comparison of the pulmonary safety data for the two devices. Over the subsequent eight months, the company participated in a number of written and verbal exchanges with the FDA in order to clarify the agency's requirements for approval of AFREZZA, culminating in an in-person meeting in August 2011 in which the two parties reached full agreement on the designs of the two requested studies.
The study in patients with type 1 diabetes is an open-label study in which all patients are first optimized on their basal insulin regimen before being randomized to one of three arms: a control arm, in which patients utilize an injected insulin analog at mealtimes, or one of two AFREZZA arms, one each for the MedTone device and the Dreamboat device. After the mealtime insulin is titrated, there will be a 12-week observation period on relatively stable doses of the mealtime insulin to assess A1c levels. The primary endpoint is to show non-inferiority of the change in A1c levels in the Dreamboat group compared to the injected insulin analog group. The inclusion of two AFREZZA arms will allow a head-to-head comparison of the pulmonary safety data for the two devices, which is anticipated to provide a bridge to the extensive safety data that was collected in MannKind's earlier clinical studies of the MedTone inhaler. The basic design of this study (comparing different mealtime insulins in combination with a basal insulin regimen) is similar in design to a previous Phase 3 study that was conducted in patients with type 1 diabetes using the MedTone inhaler.
The other requested study is a placebo-controlled study in patients with type 2 diabetes who are inadequately controlled on metformin with or without a second or third oral medication. Patients are assigned to treatment with AFREZZA or placebo powder in a randomized fashion. There is a titration period followed by a 12-week observation period to assess A1c levels. The primary objective of this study is to show superiority of the AFREZZA group over the placebo group in lowering A1c levels. The company has previously compared AFREZZA, using the MedTone inhaler, to placebo powder in successful Phase 2 studies involving patients with type 2 diabetes.
Both studies completed enrollment last fall and should be completed by the end of June. As noted above, the results will be announced in mid-August and the FDA will probably issue its decision on whether MannKind can market the product next spring. The FDA's review involves three separate groups of the agency, including: 1. The Metabolic and Endocrine Drug Products Division; 2. The Pulmonary Drug Products Division; and 3. The Center for Devices and Radiological health, which reviews medical devices. There's certainly no assurance that the ongoing trials will prove successful. Indeed, it's also possible that the FDA could issue yet another CRL and require additional study.