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Summary

  • MannKind is awaiting FDA approval of its inhalation powdered insulin for diabetes patients.
  • After two previous FDA rejections, capital resources have dwindled.
  • Capital raise could increase already significant dilution from options, warrants and convertible debt.

The clock is ticking for MannKind Corporation (NASDAQ:MNKD) and its application for approval of its AFREZZA powdered inhalation insulin. There have been some setbacks and delays since the company first applied to the Food and Drug Administration (FDA) for approval of this innovative therapy for diabetes sufferers, and the FDA pushed out its deadline date for a decision to July 15, 2014. MannKind shareholders have been waiting on pins and needles for some action from the FDA.

AFREZZA and the inhaler devices that are to be used to deliver the insulin powder have been under development for many years and the company's financial resources are dwindling. Shareholders would rightly be concerned about whether the company has enough financial resources to usher AFREZZA to the market AND what a capital raise might mean for valuation.

Need for More Cash

First, let's take a look at how much financial support MannKind's operations appear to require. (We will use data from MannKind's 2014 10K, a registration statement amendment filed in March 2014 and March 2014 10Q filings with the SEC.) In the twelve months ending March 2014, the company used $133.7 million in cash for operations - mostly administrative and research and development activities. Even though the heavy lifting in the development of AFREZZA is nearly complete, in the March 2014 quarter the fire consuming MannKind's cash seemed to heat up, using $37.0 million. At that rate of spending, the company may need $148 million for the full year 2014.

MannKind reported $35.8 million in cash resources at the end of March 2014. However, the company is required to maintain a minimum of $25.0 million in cash by an agreement with an investor group that has provided a loan facility. The other $10.8 million is probably needed to just meet near-term expenses like the next payroll and rent checks. Thus the company's cash resources are already a bit strained.

Bank account: no excess cash

Tapping the Capital Markets

The company has been relying on two financing facilities as well as the issuance of new shares of common stock to keep the home fires burning. Mann Group, led by MannKind's founder and chief executive officer, Alfred Mann, has provided a loan facility for up to $370 million. Much of the available credit has been used and already converted to common stock by the Mann Group. At the end of March 2014, there was $49.5 million outstanding under the Mann Group facility and the company had about $30 million in available credit. While that is a tidy sum, shareholders should not count on all of this credit to support operations in the near-term as management has already declared that it will rely on at least a portion of the facility to cover capitalized interest.

Mann Group Financing Facility: potential $20 million

The second credit facility made available by the Deerfield private investment group could be a source of additional capital. The original agreement with Deerfield made $200 million available to the company in separate tranches. MannKind has already drawn down the first three tranches and had $98.6 million in senior convertible notes at the end of March 2014, after some of the notes were converted to common stock. A fourth tranche of $40 million remains available, but only if MannKind receives FDA approval of AFREZZA. A recent amendment to the Deerfield facility added another possible tranche that could put another $20 million in the company's bank account even without a favorable FDA decision. However, if AFREZZA is approved this new tranche could be expanded up to $90 million.

Deerfield Funds: potential $20 million without FDA approval of AFREZZA or $130 million with approval of AFREZZA

With the verdict still out on AFREZZA, MannKind has had to make alternative arrangements for additional capital. At the beginning of March 2014, the company secured a new equity-based financing facility for up to $50.0 million. At least through the first week in May 2014, the company had not yet tried to sell shares through the facility.

At-The-Market Equity Facility: $50 million

So far, searching through MannKind's 'corporate sofa cushion' we have found $120 million in available capital without an approval of AFREZZA and $210 million if AFREZZA is approved. If the approval of AFREZZA is not forthcoming by the anticipated July 2014 deadline, it will likely be due to a request by the FDA to provide additional data or clarification. If AFREZZA is approved, the company must complete production capacity at a facility in Danbury, CT and begin a sales and marketing campaign as part of its commercialization effort. Either way, I believe it will be necessary for MannKind to go back to investors for additional capital.

Stock Price is Investor Bet on FDA Decision

In April 2014, an advisory committee voted overwhelmingly for approval of AFREZZA for both Type 2 and Type 2 diabetes suffers. Nonetheless, the FDA elected to take another three months to review data from Phase III studies completed last year. It seems more likely than not that the FDA will finally give MannKind the green light for AFREZZA. Press releases for such events serve as great elixirs for investors, rendering them eager to open their purses and ready to bestow rich valuation multiples against future earnings.

A discussion of valuation multiples of earnings would be beyond the balance sheet theme of this article. However, my review of recent trading patterns in MNKD shares suggests the stock developed considerable upward momentum beginning with the company's first quarter financial report in the first week of May when the decision of the FDA advisory committee was made public. Since then the stock appears to have reached a plateau near the $11.00 price level. However, news of a favorable action by the FDA would certainly have sufficient influence to propel the stock through a price resistance level. I believe the stock could reach the $16.00 price level within a short time just on the news alone.

Balance Sheet Provides Reality Check on Dilution

An even more important question for investors to answer as they listen to the tick, tick, tick of MannKind's clock is what share price is justified by MannKind's balance sheet. The company has completed a number of financing and may need to again dip a bucket into the capital market well. As a part of those financing arrangements, the company has issued a plethora of options and warrants on its common stock, not to mention the conversion features of various debt facilities.

Some of these derivatives have already been exercised, bringing shares outstanding to 388.6 million by early May 2014. In fact, warrant exercises have just in the last year presented an important source of capital. In the year 2013, 66,353 warrants were exercised, bringing in $171.5 million in new capital to MannKind. There are many more options and warrants chucked away in the desk drawers and file cabinets of investors. An approval of AFREZZA will make it more likely than not that all the derivatives would be exercised as they become eligible. A mash-up of data from recent filings with the SEC, suggests the company had already issued derivatives and conversion features that would require MannKind to print up another 69.4 million shares of common stock if everyone comes forward. The good news is that the options and warrants could bring in an estimated $151.1 million in new capital. Granted some of those options are not yet exercisable, so in the near-term only $67.9 million in new capital might be forthcoming.

Derivative Exercise: $99.9 million with another potential $51.2 million in the long term from options that become exercisable later.

Adding the proceeds from options and warrant exercises to the other capital sources the company already has at its disposal begins to bright up the financial picture for MannKind. However, it would bring total shares outstanding to 446.2 million (458.0 million with all options exercised). If the company uses all currently available credit and equity-based financing facilities and its creditors convert debt to common stock would be 11 million shares if AFREZZA remains sidelined at the FDA and 27.4 million shares if AFREZZA is approved. At maximum that could bring total shares outstanding to 491.4 million, a 26% dilution compared to current shares outstanding.

What Dilution Means for Your Trade

From the current share price near $10.00 and a potential 491.4 million shares outstanding sometime in the near future, the company will need to command market value near $10 billion to give shareholders the 'double bagger' reward many require to take a position in a risky biotech. MannKind must capture market share from Novo Nordisk (NYSE:NVO), a producer of injectable insulin. There have been numerous estimates of what those sales might be. EvaluatePharma, a provider of market intelligence on life sciences companies, reports that the consensus sales estimate for AFREZZA is near $600 million per year. That implies a sales multiple of 16.6 to reach a market cap near $10 billion (I am assuming all debt is converted and there is no excess cash). That hardly seems plausible.

Perhaps investors would be satisfied with a valuation near that of Novo Nordisk, which currently trades at 7.9 times sales. That would imply a market value of $4.7 billion ($600 million times 7.9) or $9.56 per share for MannKind, if all financing vehicles are used and all options, warrants and conversion features are exercised ($4.7 billion divided by 491.4 million shares). That hardly seems worth the trouble.

Conclusion:

The clock is ticking for MannKind and an alarm should be sounding for investors who are taking long positions in MannKind without consideration of the dilutive impact of recent capital raising efforts. MNKD shares appear to have the potential for upside from the current price level, but may be more a matter of investor excitement than reasoned evaluation of fundamentals. The company's balance sheet points to so much dilution, that fundamental financial projections may not support a stock price much higher than the current level. Use your own sales or earnings estimates for valuing MNKD, but do not forget to tally up shares outstanding.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

OUTSTANDING DERIVATIVES - MANNKIND

Derivative

Issuable Shares 3/31/14

Average Exercise Price

Potential Capital Raise

Options

Total

23.9 million

$4.35

$103.8 million

Exercisable

12.1 million

$4.36

$52.6 million

Warrants

19.7 million

$2.40

$47.3 million

Senior Notes

Conversion feature

14.7 million

-0-

Make-whole premium

2.0 million

-0-

Restricted stock

9.1 million

-0-

Total*

69.4 million

$151.1 million

*Total shares issuable would be 57.6 million and total capital raised would be $99.9 million excluding those options that are not exercisable.

Source: MannKind 10K and 10Q filings; Crystal Equity Research estimates

HISTORIC BALANCE SHEET VALUES - MANNKIND

Dollars in Thousands

12/31/12

12/31/13

3/31/14

Cash

61,840

70,790

35,759

Current assets

66,810

76,275

39,399

Total assets

251,314

258,646

224,553

Accounts payable

4,555

3,860

3,638

Senior convertible notes, current

114,443

-0-

-0-

Loan facility, current portion

-0-

102,300

25,871

Current liabilities

144,775

127,794

44,515

Senior convertible notes

97,583

98,439

98,662

Loan facility, long-term portion

119,635

49,521

49,521

Total liabilities

361,993

289,359

207,017

Deficit

(110,679)

(30,713)

17,536

Shares outstanding, 000s

377,208

388,615

Source: MannKind 10K and 10Q Reports

Source: MannKind's Clock Is Ticking, But Balance Sheet Sounds An Alarm