MannKind: Managing The Endgame

| About: MannKind Corporation (MNKD)

"Rumors, speculation, profit taking and other exogenous events can certainly influence the trajectory of a stock price, as stockholders in MannKind Corporation (NASDAQ:MNKD) painfully experienced in Tuesday's wild trading session. Ultimately, however, the fundamental driving force for any stock is the company's fundamentals. And in this regard, nothing seems to have changed at MannKind despite the stock's sharp fall in price, on record-setting volume of 37.9 million shares. On the contrary, if anything, the small biotech is inching ever closer to getting its innovative inhaled insulin product, Afrezza, on the market."

The sentences above constituted the opening paragraph of our June 19th article entitled MannKind: Facts and Fundamentals over Fiction and Fear. But for a few minor necessary changes, we probably could (and actually do) use the exact same paragraph to open this article, as the sentiments and description accurately reflect the current state of affairs.

MNKD shares were down 11.3% in the last two days, and were off 17.5% at the lows of yesterday's trading session. There was no company-specific news and there were no obvious developments that might have fueled the sell-off. So what explains the recent volatility? Stockholders are sitting on massive profits, probably on the order of $2 billion, including warrants, and are understandably nervous as the day the company announces make-or-break results of phase 3 trials rapidly approaches. Short sellers, who owe a whopping 46 million shares (30% of the float), as of July 15th, are clearly anxious, too, since the results, which are expected to be announced within a few weeks, could eliminate any hopes of recouping losses that may well exceed $200 million. The combination of actions taken by jittery longs and anxious shorts, along with, perhaps, some hanky-panky perpetrated by market makers and hedge funds looking for better entry points might be contributing factors. Truth be told, it's virtually impossible to know precisely what's drives a stock on a day to day basis. (Well, at least the author of this article doesn't know.)

All that said, in the final analysis, ultimately, the fundamental driving force for any stock is the company's fundamentals. If the results from the phase 3 trials are good and MannKind's flagship Afrezza inhaled insulin is approved by the Food and Drug Administration, it really doesn't matter what short sellers do in the near term and what the stock price is today or tomorrow. Indeed, unless one is trading the stock or speculating with options, the long-term investors shouldn't even care whether there is some profit-taking after the results are announced, as some fear. A school of thought has the shares dropping in price even if results are favorable, but we don't wholly subscribe to this, given the huge short position, the possibility of two other events - partnership or buyout and FDA approval - in the relatively near future, and substantial capital appreciation potential.

As for the company's fundamentals:

1. The pivotal Phase III trials - Affinity 1 and Affinity 2 - have been completed and the results are slated to be announced around mid-August; the expectation among most close observers is that both trials will meet their primary endpoints, and we think the probability of same exceeds 80%.

2. The current timeline has the FDA issuing a decision on a NDA (new drug application) for Afrezza next spring. Assuming the endpoints are met, we think the probability of an approval would approximate 90%, given the trials were designed in very close consultation with the regulators.

3. A recent $160 million deal with Deerfield Management and cash forthcoming from the conversion of warrants into stock later this year, along with the credit line with Alfred Mann, give the company considerable financial flexibility and leverage, vis-à-vis potential marketing partners or prospective acquirers or going it alone.

4. Assuming Afrezza is approved by the FDA, meaning that the inhaled insulin product is at least as good as the current injectable alternatives, convincing diabetics to switch from multiple injections daily to a small and painless (Dreamboat) inhaler is unlikely to be a hard sell. Indeed, the odds are very good that Afrezza will quickly gain market share in the large (and growing) diabetes care market.

All in all, regardless of where the stock is today, tomorrow, or in the days after the results are announced, we think it will be considerably higher by next summer; we argued in two previous articles that the stock price would be north of $25. The average cost basis for our common shares is around $2.50, while the average for our warrants is $0.60. We are short 2014 $7 puts and have a bullish spread, long the 2015 $5 calls and short the 2015 $7 calls. Our entire position in MannKind was relatively small when established last year. We haven't closed out a single share, warrant, or contract, so the total position isn't so small anymore. For whatever the following information is worth to readers, our intentions are to maintain all of the positions through at least the FDA's decision, other than the $7 puts, which expire next January.

The conventional wisdom would have us take some profits off the table or at least buy some protective puts - which we still may. After a lengthy deliberation, though, we decided to deviate from the norm, taking into consideration both the high probability of success and the huge upside potential.

Disclosure: I am long MNKD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.