I was compelled to compare the buyout prospect of Arena Pharmaceuticals (ARNA) with MannKind Corporation (MNKD) after reading "Pricing A Highly Probable Takeover Of MannKind" by George Rho. Undoubtedly, late stage development and early-stage sales companies are ripe for picking, as the potential acquirer averts the early-stage risks. If chosen wisely, the gains can far outweigh the premium over the prevailing market price. In comparing the two, there are striking similarities - market capitalization, institutional ownership, short interest, novelty of their lead drug, and the potential future valuations. Mr. Rho contends MNKD could be worth over $11B in 2019, and an analyst at Jefferies Securities maps out a 2018 valuation of over $11B in 2018 for Arena. Arena seems to be the much surer proposition, and a take-over attempt seems much more likely to me. I see the potential price in hostile for Arena would be $13-15 and a more friendly offer would be $18-20. Mr. Rho writes:
Investors, or more accurately, speculators who have followed the MannKind Corporation 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.
Arena investors also know fully well that the end game is rapidly approaching - the June 7th launch in 15 days will provide visibility into the company's long-awaited Belviq sales. Also, Wall Street research coverage has increased of late (Piper Jaffrey, Jefferies - see below). However, the trading volume has been held-in-check, and the stock has been stuck in neutral at best, having lost $3 in price since a January spike to $11.
MannKind hopes vs. Arena realities
Mr. Rho points out that MannKind has an approval possibility approaching for flagship drug AFREZZA, but Arena has already been approved for Belviq. The upcoming 'event' for Arena is the launch of the drug, on June 7th, a mere 15 days away, while MannKind might have their launch in a year.
George Rho provides a quote from Alfred Mann, the biggest cheerleader (and shareholder) of MannKind, where Mr. Mann stated, that he "believed AFREZZA could potentially become the most significant medical product ever". Believed, could and potentially; those are not very convincing words to place together. In an earlier article, SA writer Joe Springer stated, that with good results MannKind "could be the best performing stock of 2013".
Interesting parallels here, because Arena was already one of the best performing stocks - of 2012 - and Arena supporters feel Belviq will soon be a "very significant medical product", as it not only takes off weight as an obesity medication, but lowers glycerides for diabetics and pre-diabetics, and reduces heart risks (with the lowered toll on the organs).
Parallels for take-over possibilities
Both AFREZZA and Belviq are useful for diabetics. Both are, or were, heavily shorted (table). Both have vocal cheerleaders, and novel and seemingly effective products. Both aim to be "game-changers". And, both are apparently ripe for a take-over.
As Mr. Rho points out, big pharmaceutical companies (BP) have lots of cash, share-prices that are bulging, and access to low-interest debt. They also are starving to fill pipelines with drugs that are going off patent, to be replaced with new technology and potential blockbuster (> $1B annual sales drugs). As Mr. Rho also points out, these companies have imprudently purchased some companies that did not pan out, so a late stage company would be a smart entry point, especially with cash on hand.
Arena Further along
Rho on MNKD: "Both studies completed enrollment last fall and should be completed by the end of June ... 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." Ending the article, "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."
Marketing partner Eisai's (GM:ESALF) CEO Lonnel Coats, from the May 11th conference call, states that by June 11, Belviq will be available in 20,000 pharmacies and within the first 30 days on the market, the sales force will have touched 20,000 physicians. "We will penetrate this market very quickly."
By comparison, Arena is ready.
Arena negotiates from strength
Arena's Q1 2013 financials (balance sheet income statement) show cash available to pay operating expenses and SG&A for 7 more quarters, with a milestone payment from Eisai of $65M in Q2 will cover another two. MannKind has less than one quarter of cash, with a credit line of $100M which will need to be tapped before the August FDA decision.
Arena - Q1 2013
MannKind - Q1 2013
|Q1 2013 Selected Financials||Arena||MannKind|
|(1) Cash burn review:|
|Selling General and Admin||7,251||10,039|
|Cash And Cash Equivalents||136,250||28,005|
|Short Term Investments||-||-|
|Other Current Assets||3,756||3,830|
|Total Current Assets||148,669||32,285|
|Quarters of Cash Burn||7.0||0.9|
|(2) Financial strength review:|
|Short/Current LT Debt||2,751||114,593|
|Other Current Liabilities||15,449||-|
|Total Current Liabilities||27,236||264,211|
|Long Term Debt||82,518||97,791|
|Deferred LT Liability Charges||46,481||-|
|(3) Key take-aways:|
|Arena will receive $65M payment from, Eisai Q2 2013|
|Point: Total current assets + 65M over $200M and > Total liabilities|
|MannKind will need to draw from $100M credit line Q2 2013|
|Point: Cash burn > Current assets|
By comparison, Arena is fine on its own.
Arena's future has been charted
Mr. Rho opines that, "With approval, and with market acceptance of the product, AFREZZA could see sales of $4B in 2019". He suggests that this would impact the acquirer's bottom line to the tune of $1B. Given that sales estimates for Belviq range widely, it is hard to determine the sales by 2019, but one thing is certain, and that is, with royalties and incentives, the sales would only need to be $2.5B, as the payout provided by Eisai would be between 35% and 41% were those sales reached with incentives on top of that.
Here are Jefferies pro-forma financials for 2018
|Pro-forma Income Statement Valuation from 2018|
|All in 000s|
|2018 Values||6 years @ 10%|
|PPS $2.38 (P/E = 20; Pre-tax)||47.67||26.91|
|PPS $2.11 (P/E = 20 Post-tax)||42.20||23.82|
|Pre-tax Mkt Cap||11,653,300||6,577,984|
By comparison, hard estimates by Wall Street are more reliable
Arena estimates may be very conservative
In 2018, Jefferies points to only $140M for ROW sales. Arena has signed up Ildong Pharma for Korea, and Eisai for Mexico and Brazil. Europe is on-hold until the EMA reports what the issues with the recent Lorcaserin application withdrawal might entail.
By comparison, significant upside exists for Arena.
Tax kickers not meaningful for Arena
While Mr. Rho points out the NOL (net operating loss) would be nice to have, Arena has consistently stated that theirs (while large), is not of major importance - Arena has a tax holiday in Switzerland for 10 years. Any "BP" acquiring either company would have to determine what NOLs might exist post-takeover, but it's not a major issue in the Arena case.
By comparison, the NOL isn't even needed for Arena.
Valuation easier to predict for Arena
Mr. Rho makes the case that the $18B market capitalization for MNKD, with a potential $1B profit and 18 P/E - discounted at 10% would be $11 billion for the company would equate to $27.50 a share.
I will use the post-tax EPS provided by Jefferies of $2.11 and a P/E of 20 = $23.82. The MannKind estimates remind me of these optimistic views of Michael Murphy from June of 2012, in "How good can it get"
Using a 20% discount rate, that $166 price in 2016 is worth $68 today. Using a 15% discount rate, $166 is worth $87 today. Using the 10% discount rate often granted to Big Pharma, the stock is worth $109 today.
Eisai might be sand-bagging
While Eisai guided to $200M in sales for FY2013 (end March 31, 2014), they have provided conflicting future revenues for Belviq. As the fourth largest Japanese pharma company, with a market cap of $12B, they have the same issues with expiring patent on their best selling drug Aricept, and need replacement for the pipeline. Still, they provided guidance for $1B (100B yen) in 2020 from their conference call, which equates to a 22.6% CAGR (compound annual growth rate). (Note: $200M over 42 weeks is $240M for a full year comparison). Conversely, Jefferies has a lower start of $34M in 2013 (annualized $60M in sales for 29 weeks) with a $1.5B estimate for 2018, which equates to 92.5% CAGR.
Eisai's own chart curve suggests their $1B may be low. (see page 12)
Piper Jaffrey posted an alert to clients based on the Eisai sales comment of $200M in FY2014.
Arena Pharma has positive read through from Eisai forecast, says Piper Jaffray
After Arena Pharmaceuticals partner, Eisai, predicted that sales of Arena's Belviq anti-obesity drug could reach $200M in its fiscal year ended in March 2014, Piper thinks its estimate of $22M of Belviq sales in 2013 looks conservative. The firm keeps an Overweight rating on Arena.
With a strong launch, or a suspicion of a strong launch, the take-over price will creep up, and for every $1 in price escalation becomes an extra $250M for the acquirer, plus a premium. If sales are more like Eisai has suggested, shareholders may not be willing to cash out at all.
The time for big pharma to make their move on Arena draws nigh. For MannKind, the opportunity may exist for quite some time.