On April 1, 2014, the Endocrinologic and Metabolic Drugs Advisory Committee ((AdCom)) convened to discuss and vote on whether to recommend the Food & Drug Administration approve MannKind Corporation's (NASDAQ: MNKD) New Drug Application (NDA) to market Afrezza, an innovative inhaled insulin product for the treatment of adult patients with type 1 or type 2 diabetes mellitus (DM). Over the course of roughly nine hours, with time taken off for breaks and lunch, the 15 experts (14 voting and one nonvoting members) appointed by the FDA listened to and interacted with FDA reviewers, MannKind representatives, and interested public advocates, with the latter including patients who had participated in the biotech's clinical trials. At the end of the day, the AdCom members took two votes, the first on whether Afrezza should be approved for the treatment of type 1 and the second on whether it should be approved for patients with type 2. As most investors in MNKD are undoubtedly aware by now, the votes were overwhelmingly in favor of recommending approval, with 13 yeses (to one no) for type 1 and 14 yeses (and zero noes) for type 2. Needless to say, Wall Street responded favorably to the blowout, pushing up the price of the company's stock 74%. The advance on Wednesday helped the shares more than regain all of the territory that had been lost in the previous two sessions, losses that had been triggered by a wave of alarming headlines that spelled gloom and doom for Afrezza at AdCom. So, what are investors supposed to do now? My view is that the vote tallies have myriad positive implications and I haven't sold a single share or warrant. Nor have I closed out any bullish option positions. One of the most significant aspects of the past week, in my opinion, was the incredible flattening of MannKind's risk profile, while simultaneously boosting the rewards potential. With that said, we review the implications for:
… The FDA Decision
Some detractors continue to argue that the FDA will still vote against approving Afrezza. And, as some had suggested, early this morning, the regulators postponed their decision by three months, pushing out the PDUFA date to July 15th. Is the delay all that relevant for long-term investors, though, putting aside the impact on speculators that have purchased options? The answer would be no. MannKind had $62 million in cash at the beginning of the year. The company also has a credit line with Alfred Mann that can be tapped if additional funds are necessary to get to the finish line. Moreover, it has two At-The-Market issuance agreements that can bring in another $50 million. As to a negative outcome, what are the probabilities of this? The answer is probably incredibly low. First, the historical record already tells us that a large majority of NDAs are approved. Second, the latest round of clinical trials were designed in very close consultation with the FDA, with the endpoints essentially set by the regulators, so the odds of approval go up even higher. Throw in the fact that the experts picked by the FDA for the AdCom review overwhelmingly voted for approval, and a positive FDA outcome seems a near certainty. Indeed, a study by the influential consulting concern McKinsey & Company indicates that the FDA will follow its advisory recommendation about 90% of the time. So while a negative decision is possible, it's almost impossible to envision the FDA essentially disregarding both the fact that MannKind had met the objectives that it had set and the recommendations made by the panel of experts it had convened. The delay most likely reflects the FDA's need for time to fine-tune what are undoubtedly complicated labeling issues, considering both a heterogenous population of diabetics and the potentially massive number of people that may use Afrezza for many years.
… Stockholders' Peace of Mind
Until the past week, every objective recommendation of MNKD stock had to include the warning … but the price could drop into the pennies: if the company couldn't raise the money to continue further development two years ago; if phase 3 results didn't meet their respective endpoints last year; and the AdCom votes didn't go well just last week. Indeed, given the huge short interest, the large number of alarming headlines in the prelude to AdCom, the sharp drop in the stock price, and the lowering of the price target to $1.50 by an analyst, it's probably safe to say that even the most optimistic bull went to bed last Monday thinking Tuesday could bring the unraveling of MannKind Corporation. Now, absent some "black swan" event, the warning can probably be put to bed and investors can rest far easier going forward, today's price action notwithstanding, knowing that the floor for the stock price is most certainly higher now than it was a week ago. That floor is also supported by the knowledge that the science behind Afrezza has been validated by the 14 experts on the AdCom committee, which diminishes (but certainly does not eliminate) the importance of having big pharma do so by partnering with the company.
… The Company's Financial Position
In the early days of March, MannKind and Deerfield amended the agreement that had the investment management firm lending $160 million in four equal tranches to allow two things: One, Deerfield was allowed to convert $60 million more of debt into MNKD equity; the agreement originally allowed a total of $40 million. Two, assuming FDA approval, MannKind can borrow $1.50 more for every dollar's worth of debt that was converted into equity, or up to $90 million. So, assuming FDA approval and maximum conversion, the biotech could get up to $130 million in cash in very short order; the total includes the final $40 million tranche that is conditioned on FDA approval.
… Negotiations with Prospective Partners and/or Buyers
As we've discussed in previous articles, MannKind retained investment bank Greenhill last August to help identify and negotiate with companies that could help market Afrezza post approval. To date, all that's been disclosed about this very important issue are as follows: 1) MannKind wants one global partner; 2) There are several regional players that are interested in doing a deal but they have been put on the backburner; 3) Management is happy with the job that Greenhill is doing. Beyond this, there are no indications that the company is preparing to market the product on its own, steps that would include raising more money and slowly developing a sales infrastructure.
All things considered, I'm inclined to believe that most of the negotiations have already been conducted, with the finalization to take place after the FDA has announced its decision. This close to the finish line, there seems little benefit to making any announcement before then. Moreover, as speculated in our initial article on the biotech, titled Pricing A Highly Probable Takeover Of MannKind, I still think a buyout is more likely than a partnership. My reasons are spelled out in the aforementioned article, with further elaboration in a subsequent article, Pricing MannKind Corporation On A Stand-Alone Basis. Updating my thoughts, it's interesting to note that nothing was announced over the past several months. A partnership that had certain contingencies embedded into the agreement could certainly have been announced without being too disruptive. An agreement that included an upfront payment of x dollars, a milestone payment of y dollars, and varying royalty rates, etcetera, could have been digested by investors and had a reasonably measured impact on the stock price. On the other hand, how does a company announce a takeover that's contingent on FDA approval? More important, how would investors accommodate such an announcement? To illustrate the dilemma, with a possibly extreme hypothetical example, what would MNKD shares be worth if the takeover price were $40 a share, contingent on approval, keeping in mind that the deal is being announced pre-AdCom and pre-FDA decision? All that said, this is pure speculation on my part, made easier to do since I strongly believe the stock is very attractive even without the carrot of a buyout.
As to the identity of the possible partner or acquirer, I have refrained thus far from even speculating since there are so many variables and my guesses are going to be little better than anyone else's. Nevertheless, with the days that this guessing game can be played dwindling away rapidly, I am going to throw in my two cents. There are about two dozen possibilities, including the obvious deep-pocketed candidates, Pfizer, Merck, Eli Lilly, Johnson & Johnson, Sanofi, etc. If I had to pick one, though, it would have to be Novo Nordisk, which has deep pockets, a richly valued stock that could be used as currency to help fund a transaction, and probably the most to lose if a rival ended up with Afrezza. As noted in another of my articles, MannKind's Steady Progression Towards FDA Approval Continues Unabated, the Danish concern also had an inhaled insulin development program in place several years ago and thought it was the long-term answer to treating diabetics. Also worth noting is a February 6th Forbes article that states Novo Nordisk has been hiring "reps by the hundred in the U.S." even though it doesn't have a new drug to launch. In any case, whomever the partner or acquirer ends up being, assuming, of course, there is one, the AdCom vote has certainly enhanced MannKind's negotiating position vis-à-vis all prospects.
… The Going It Alone Scenario
Management has made it abundantly clear that it intends to market the product with a partner, and I fully expect that a large healthcare concern will be involved in Afrezza's market launch and commercialization. So, a decision to go it alone would be a surprise and represent the worst-case scenario. Significantly, though, it doesn't appear to be a horrendous prospect anymore. The AdCom vote, for one, has validated Afrezza as a viable treatment for diabetes. The billions of dollars spent by Pfizer, Novo Nordisk, and Eli Lilly on developing inhaled insulin products strongly suggest there is a large market for MannKind's product. All patient and physician surveys, including those conducted by the three large companies, indicate a receptive market place for Afrezza. Moreover, given the money likely coming from Deerfield shortly, plus the prevailing market price for MNKD stock, the funds necessary to self-launch wouldn't result in terrible dilution to current stockholders, notwithstanding the notion that no dilution is good dilution. In fact, a dilution could probably be capped at roughly 15%, hardly a disaster.
The frenzy of selling triggered by the alarming headlines that followed the FDA's posting of AdCom briefing documents on March 28th undoubtedly resulted in some short-covering. The sharply discounted stock price that prevailed last Monday also gave new investors and traders very attractive entry points. The heavy trading volume and slight price retreat last Thursday and Friday suggest some traders quickly took profits, while some short sellers may have increased their positions in order to increase their average selling prices. We won't know for a few days whether the overall short interest declined as the price rose post AdCom; as of mid-March, 63.6 million shares had been sold short, representing a whopping42% of the public float.
The history of individual investors have them selling too early when a stock is going up and selling too late when a stock going down. They invest too much in one stock, follow it too closely, and get too emotionally involved, often resulting in their making poor decisions. Selling decisions are frequently made arbitrarily, with the price alone being the sole consideration. Booking some gains is seldom a bad thing, nor is taking a few dollars off the table when one has put too much money on one stock and is having trouble sleeping. Selling a biotech because it's gone up two points is not a recipe for long-term success, however. Neither is the strategy of assuming huge downside risk, while giving up any prospect of make huge profits, all in the name of "scalping" a point or two. If you're happy to make a dollar or two, you're probably better off trading stocks that are far safer than biotechs, and that probably includes every sector that's not biotech. And while on the subject of what individuals who invest in biotechs probably should not do, I would throw in the use of margin and the use of "stop loss" orders. Margin use will invariably cause severe stress and often result in your having to exit a position at the most inopportune time. Stop loss orders, meantime, often won't keep you from suffering substantial losses when bad news triggers a gap-down in price but could push you out of a stock when a rumor or some other event results in a temporary price drop. MannKind investors are certainly no strangers to temporary drops in price, reflecting a very aggressive and persistent group of short sellers.
As to the question of guesstimates for the stock price pre-FDA decision, post decision, after the announcement of a marketing partner, etc., which is so often the question posed in e-mails, direct messages, and comments following articles, I have no clue. And anyone who suggests otherwise is overestimating his or her capabilities. In the aftermath of the AdCom votes, some have predicted that the price could approximate $5 after the FDA's decision, even if favorable. I wonder if they thought MNKD shares would be near $4 the day before AdCom, or if they anticipated a near-doubling in the price after the vote. All that said, it doesn't require a huge stretch in imagination to see Afrezza becoming a multi-blockbuster drug and the price of MNKD stock being much higher sometime in the not too distant future.
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.