- Two potentially high-impact events are rapidly approaching.
- These shares remain very attractively priced.
- A huge short interest and the second event suggest investors should avoid the temptation to trade the first event.
In two articles published by Seeking Alpha last summer, entitled "Pricing a Highly Probable Takeover of MannKind" and "Pricing MannKind Corporation on a Stand-Alone Basis," we laid out in considerable detail the four possible scenarios that could unfold for the development-stage biotechnology concern in the year ahead. As articles geared towards investors, our primary objective was to assess the attractiveness of MannKind (NASDAQ:MNKD) stock as an investment. Accordingly, we generated price targets for each of the four possibilities, after all, what's more important in evaluating an investment opportunity than its appreciation potential. The second of the two articles was written after a strong run-up in the stock price, and was prepared to help both ourselves and others in their buy, sell, or hold deliberations. (A disclosure may be appropriate at this point: We, as in 3DimensionalResearch.com, recommended MannKind shares and warrants to our clients as a speculative Special Situation on July 20, 2012, when they were trading at $2.62 and $0.70, respectively. Moreover, we recommended the stock to our clients again as a standard Stock Recommendation on September 2013, at a price of $6.05, after the company had reported Phase III results and the shares no longer seemed that speculative. We own both the stock and warrants and have bullish options positions - calls and spreads.) Other than recently closing out a short position in the January 2015 $15 puts, we haven't closed, or reduced, any of our bullish positions.
This article, too, is motivated by the need to review the state of affairs considering both the recent vigor in the stock (up 69.1% in the past five weeks) and two, probably, rapidly approaching potentially high-impact events. Truth be told, it's also inspired by the latest spate of bearish articles that, like all the previous waves, seem largely devoid of substance, objective analysis, or responsible investment advice. Before getting to our primary objective, we will briefly discuss the latter so that investors can dismiss the noise and focus on the fundamentals that matter.
The Short-Sellers' Latest Tactics
As stated in previous articles, we have no problems with short sellers. They generally serve a useful function - exposing corporate malfeasance and highlighting overvalued equities, etcetera - and deserve respect, since they are assuming considerable risk (and theoretically unlimited losses) to back their convictions. Indeed, we're all for their making a public case for why a particular stock may be overvalued, since good information is almost always useful information. That said, the seemingly never-ending bearish articles on MannKind from authors, all of whom claim not to have a position, have, with few exceptions, been scurrilous and irresponsible, written largely, in our view, to misinform, mislead, obscure, and frighten investors. We've detailed the shorts' tactics in the past, in "Follow the Smart Money," for example, and won't repeat here beyond noting that they've been right about virtually nothing for three years and are currently sitting on hundreds of millions of dollars in losses.
In their latest efforts to instill fear and fuel selling, the shorts almost uniformly recommend shorting MNKD stock after the FDA (Food and Drug Administration) approves the company's drug, suggesting Afrezza's maker will suffer the same fate as Arena Pharmaceuticals and Vivus Inc., neither of which has fared well since their respective weight-loss products were okayed for marketing. Their recommendation has at least the following five shortcomings:
- Nobody knows what the price of MNKD stock is going to be after the likely FDA approval. How does one responsibly advise a specific course of action several weeks in advance without having such a critical piece of information?
- The authors make absolutely no attempt to value the stock or assess its upside potential. How does one responsibly advise a specific course of action without having any sense of what some asset is worth?
- It's generally accepted that MannKind will announce either a marketing partner or a buyout soon after FDA approval, either of which would probably trigger a further price run-up. Given this possibility, how does one responsibly advise shorting the stock?
- The recommendation ignores the fact that the short interest is already huge, at 68 million shares as of May 15th, which could be the source of a potentially massive rally if the FDA's approval comes with very few strings attached.
- The FDA has approved literally thousands of drugs in its history, some of which have done fabulously well and made investors in their makers very wealthy. But for some unexplained reason, all of the authors of the bearish articles decided, presumably independently, that Arena and Vivus and their weight-loss drugs, with their questionable efficacy and safety profiles, were the best comparators for MannKind.
A Brief Review
As we saw last summer, the future held four possible paths for MannKind. The first, and shortest, had Afrezza failing to meet its objectives in clinical trials and MNKD stock dropping to penny stock status. The other three had the inhaled insulin product achieving success in the trials, leading to MannKind being acquired; securing a marketing partner; or deciding to commercialize on its own. As detailed in the two articles mentioned above, the takeover scenario suggested a 12-month buyout price of $27.50 a share; the partnership $28.00, and going it alone $27.42.
The Current Situation
With the benefit of hindsight, we know that the first path was not taken. Given the FDA's three-month delay in making a decision on Afrezza, however, we don't know yet which of the other three scenarios will eventuate. That said, management's many comments (and lack of action) over the past several months very strongly suggest that we can rule out the possibility that the company will be going it alone. In its latest comments at a Goldman Sachs Healthcare Conference, the company indicated that it was in negotiations with multiple prospective partners and that a deal could be finalized within six to eight weeks of the FDA's decision. Moreover, it noted that cash on hand and a credit facility with the Mann Group afforded ample resources to get it to the finish line. The lack of action in terms of raising additional funds and building a marketing infrastructure also underscores management's confidence that it will not be going it alone; it is busy hiring people for its manufacturing operations, though, including employees to work weekends. This leaves only the buyout and partnership options.
Pricing the Buyout and Partnership Options
In the 12 months since we priced the shares, the outlook has improved on multiple fronts. On a company-specific basis, MannKind completed two Phase III clinical trials, reported solid results, received rave reviews from the FDA's Advisory Committee, garnering 27 out of 28 possible votes, and is now poised to get the long-awaited permission to commercialize Afrezza. Significantly, too, management recently indicated that it has received inquiries from several parties about its technosphere drug delivery platform, which has numerous potential applications and could be very attractive to both pharmaceutical and biotechnology concerns. The already huge diabetes market, meantime, continues to expand. According to the latest Diabetes Statistics Report, released on June 10, 2014, there were 29.1 million Americans with diabetes in 2012, or 9.3% of the population. This is 12.8% higher than the figure in 2010. The total cost of the disease in 2012 was $245 billion, consisting of $176 billion for direct medical costs and $69 billion in reduced productivity. Worldwide, the number of diabetics has climbed to 400 million, rising at a roughly comparable rate as in the United States. Importantly also, the pace of M&A activity in the drug sector has intensified dramatically of late, reflecting several realities at Big Pharma: maturing product portfolios that need to be replenished; unproductive internal R&D programs despite the investment of tens of billions of dollars; bulging coffers and cheap money. In February, Actavis plc agreed to pay $25 billion for Forest Labs. More recently, in a move that cost short sellers some $330 million, Merck announced last week that it would be acquiring Identix Pharmaceuticals for $3.85 billion.
The $25-billion price tag for Forest Labs values the specialty drugs maker at 5.4 times prospective 12-month revenues and 25.0 times earnings. As for Identix, although the small biotech has three products in clinical trials, two in Phase II and one in Phase I, all targeting the treatment of hepatitis C, any possible product launch is at least two or three years away. Moreover, it would undoubtedly enter an intensely competitive marketplace, one that would include Gilead's huge blockbuster, Sovaldi, and AbbVie's triple-combination product, which will probably be introduced towards the end of this year. (The $3.85-billion price tag for Identix clearly puts the bears' suggestion that MannKind is overvalued at around $4 billion into better perspective.) Novo Nordisk, meanwhile, the closest thing to a pure play in the diabetes arena, is trading at 7.2 times estimated year-ahead sales and 23.6 times estimated earnings. Given all of the favorable developments of the past 12 months, plus the realities detailed above, we certainly see no reason to lower our price targets. That said, in the interest of conservatism, we have decided not to raise them either. All things considered, including the fact that it has appreciated more than four-fold since our initial recommendation, we think MannKind shares still look very attractive.