Afrezza’s Market Potential and the Future Value of MannKind

by: KLLJ Investments

It has been a long, rough year for MannKind (NASDAQ:MNKD) longs. We’ve experienced a disappointing delay with the January Prescription Drug User Fee Act (PDUFA), only to end up with a complete response letter (CRL). Even though the CRL was about as good as we could have hoped for, the shorts won out and did a number on the share price.

The face-to-face, end-of-review meeting with the FDA took longer to happen then we'd anticipated. The good news behind that delay was that the FDA had 22 people representing five divisions participating in the meeting. Although I'd never heard of anything like that before, I don’t believe even one analyst commented on it. That meeting was followed by a quick resubmission of the updated NDA, which included the new Dreamboat inhaler -- yet the share price has continued to be under pressure.

MNKD entered a very creative financing arrangement with Seaside88 and another generous arrangement with the Mann Foundation to swap debt for equity. Yet the share price has remained under pressure. In addition, a lawsuit that we consider to be meritless was included in the last 10-Q report. That lawsuit had zero impact on the stock price until The Street wrote an article about it several days later, simultaneous to a bear research note from Oppenheimer, which coincided with a large volume increase.

Coincidental? Perhaps, but this brought on the latest wave of pressure on the stock. Here we are after a tough year, less than seven weeks after Afrezza’s new PDUFA, and the stock is still under $6.

Since the last PDUFA came and went, we have more proof that Afrezza is a superior treatment for diabetes, a promising oncology program hitting its next phase and multiple Big Pharma partners wanting to market Afrezza. On one hand, I’d like the stock to be at $10-12 at this point; on the other hand, it has given me the opportunity to add to my MNKD position at prices I didn’t think I’d see again.

So why is the stock price so low? I think there are two primary reasons. First, the street is still concerned the FDA won’t approve Afrezza, perhaps because the FDA hasn’t required an Advisory Committee or because the FDA has become overly risk-averse. I find the AdCom argument puzzling since Afrezza really doesn’t meet the underlying requirements to warrant an Advisory Committee. It isn’t a new compound and there are no safety signals that came out of the trials -- encompassing 5,000 patients -- to bring about a risk vs. benefit discussion.

In terms of the FDA’s risk aversion, where is the risk with Afrezza? It causes a 1.7% reduction in lung function (Dreamboat may be as low as 0.5%), which is well within guidelines. It doesn’t cause cancer or increase cardiovascular risk. The only real side effect is a mild, transient cough in some patients (only 3% stop using it because of this).

Second, many on the street don’t think Afrezza will be a success in the market due to the failure of Exubera. This is, I believe, the primary reason for the depressed share price. Still, I cannot believe how wrong the analysts are -- and here's why.

Afrezza will cause a paradigm shift in how diabetes is treated. I won’t spend time discussing the differences between Exubera and Afrezza because that has been covered in great detail elsewhere. Since we are talking a new paradigm shift in diabetes treatment, you cannot use the current $5 billion Rapid-Acting Insulin market to value Afrezza. The market for RAA (Prandial) insulin therapy today is limited because it typically isn’t prescribed until later in the disease progression -- generally, when it absolutely needs to be.

This is much different to how Afrezza will eventually be prescribed. It will take some time, but perhaps far less than we might think, once Endo’s and Primary Care Physicians get comfortable with it and understand the impact that ultra-rapid kinetics can have in postprandial glucose excursions and reduction in hypoglycemia events.

Afrezza could quadruple the $5 billion RAA market that exists today, through the earlier adoption of Prandial insulin therapy. That is what the analysts just don’t get yet -- or if they do, they're keeping it to themselves. No analyst from an investment bank is going to put his job on the line by making a bold statement about Afrezza being a mega-blockbuster and game-changer when it comes to diabetes management.

Modern society is faced with its two biggest pandemics in healthcare: Obesity and Diabetes. Until the obesity pandemic is under control, we will be faced with the continued explosion of diabetes across the world. There are already over 28 million diabetics in the U.S., 95% of whom are Type II, with 56 million pre-diabetics just a few more pounds away from becoming full-blown. Unless things change, over the next few decades we could be faced with one-third of the U.S. population, and 500 million people worldwide, being diabetic.

Outside of the treatment of obesity, this is the biggest market in the world, with a huge unmet need for better treatment options. We have "Rapid-Acting" insulin that is too slow to act, Basal insulin that is prescribed too high from baseline for fear of hypoglycemia, and GLP-1 injectables that may actually accelerate the degradation of the pancreas. Until we have a cure for diabetes, ultra-rapid insulin therapy that mimics a normal person’s insulin response to a meal will be shown to be the best therapy for patients.

So let’s explore what the market for Afrezza might look like. Rather than compare it to the $5 billion RAA market, I’ll just run some numbers for overall penetration to the current population of diabetics. We know MNKD and its yet-to-be-named partner will launch in the second half of 2011 with enough capacity for 400,000 patients, which equals $800 million in revenue (at $2,000 per patient). Given that one small country overseas wants $200 million worth of Afrezza for itself, I think we will quickly reach demand to support plant expansion.

It will take about $100 million in capital expenditure to increase capacity to 12 production lines to support about 2 million patients, resulting in $4 billion in revenue. If Afrezza is accepted by the market -- and I think it will be, given its superior kinetics and clear medical superiority over existing options -- it could reach full production capacity by 2015. Still, that is only a 10% penetration of the U.S.-diabetic market.

Here is a likely timeline:

2011: Launch. I expect 200,000 patients by the end of 2011.

2012: 400,000 patients, $800 million in gross sales, plant expansions underway.

2013: 800,000 patients, $1.6 billion in gross sales.

2014: 1.2 million patients, $2.4 billion in gross sales.

2015: 2 million patients, $4 billion in gross sales.

2016: Perhaps a new E.U.-based factory underway, along with insulin production.

Again, this is only a 10% market penetration in just the U.S. Think about 15%, 20%, 25% penetration, and the numbers get more ridiculous.

So how do you take numbers like these and come up with a value for Afrezza and MannKind? Rather than try to run a net present value model based on earnings, I’ll look to potential market cap based upon my expected revenues. We don’t know what the split with a partner will look like, or where MannKind’s Cancer Immunotherapy programs will be at in 2015, so this seems to be the easiest method to come up with a rough valuation.

Here are valuations of five other biotechs that I think are good comparisons for these purposes:

Company / Revenues (‘09) / Market Cap / Multiple

Celgene (NASDAQ:CELG) / $2.7B / $28.75B / 10X

Genzyme (GENZ) / $4.5B / $18B / 4X

Amgen (NASDAQ:AMGN) / $15B / $51B / 3.5X

Human Genome Sciences (HGSI) / $0($1.5B est) / $4.7B / 5X (with 50% split with GSK)

Dendreon (NASDAQ:DNDN) / $0($1B est) / $5.2B / 5X

Since the market cap of these fall between 3.5 and 10 times revenues, I’ll use a 4X expected Afrezza revenue to calculate the market cap (this does not account for revenue splits with a partner). At full U.S. factory capacity in 2015 ($4 billion per year), that gives us an expected market cap of $16 billion. This is, again, just for U.S. revenues of Afrezza and equals a 10% penetration of the current diabetic population. You can triple these numbers to account for the rest of the world, which gets us to Amgen (AMGN) territory for revenues, or a $50 billion market cap.

Before you dismiss those valuation numbers as crazy, consider this:

  • CELG: In 1998, Celgene (CELG) traded at $0.50. In 2000, the share price was the same as what MNKD trades at today; five years later, it was at $30 after splitting (3-1, then 2-1) for a split adjusted price of $180. Now that one share is worth $360.
  • GENZ: In 1994, the share price of Genzyme (GENZ) was about the same as MNKD today. In 2005, one share traded for a split-adjusted price of over $200. Now that one share is worth $280.
  • AMGN: In 1994/95, the share price was also about the same as MNKD today. In 2000, that one share was worth a split-adjusted $480. Today, it is about the same, worth $450 or so.
  • HGSI: Human Genome Sciences (HGSI) is dear to my heart, since I owned it at $2.50 just last year. I’ve since sold it, but it is now worth 10X what it was last year, or over $25 ($4.7 billion market cap).
  • DNDN: Many biotech investors know Dendreon (DNDN)’s story well. Two years ago it was trading where MNKD is now, and after approval it went into the $50’s; it's currently trading at $36 ($5.2 billion market cap).

So will MNKD be the next biotech success story? I think so. It might not happen right after approval, but it will happen after partnership and successful market acceptance. The street doesn’t understand the potential for Afrezza. but MNKD CEO and chairman Al Mann does -- and so do I.

I’m also betting that Big Pharma gets it, which is supported by the fact that a dozen or more inquired about partnering with Afrezza, and MNKD has narrowed that list down to three. Partnership will be the major catalyst for share price appreciation in my opinion -- even greater than just approval. Once a Big Pharma (with market credibility) steps up and says it thinks Afrezza is a game-changer -- and will do $2-4 billion a year in revenue -- then the market will have no choice but to re-evaluate MNKD’s valuation.

With those types of expected revenues, a near-term valuation on MNKD of $5 billion-plus is very reasonable. Once Afrezza is launched and showing good market acceptance, then you’ll see that market cap double or more, perhaps by as early as 2013 or 2014.

Al Mann is one of the most unheralded geniuses of our time. He’s proven himself time and time again, yet the street still doubts him. He’s helped the military when nobody else could, powered the space program and advanced medicine, bringing a better quality of life to millions of Americans. Those who have invested alongside him in the past reaped the rewards when he sold his companies for a combined $8 billion.

Why would he back MNKD with his estate and invest almost $1 billion of his own money in it? Because he knows that Afrezza will change the course of diabetes management and, as he has stated, it could be one of the most valuable medical products of all time.

Once Afrezza has proven itself in the market, I fully expect MNKD to be bought up by a Big Pharma -- but the price for it will be more than all of Al Mann’s previous companies combined. A product doing $4 billion a year, with additional demand across the world and a huge barrier to entry, could be worth $20 billion or more. Mann’s 40%+ ownership of MNKD will reward him greatly for his investment, and the good news for us is that 90% of his estate will go to philanthropy. That generosity will fund the next generation of scientists and products that can make a difference to millions of lives across the world. (To hear Mann speak about his previous accomplishments, an outstanding presentation that he gave at Yale a few months ago can be found here.)

As an investor, I’m glad I’ve invested alongside Al in MNKD (at a price far less than his average share price) and I look forward to making a lot of money with Afrezza’s success. As an American, I’m in awe of his accomplishments and thankful for all of the good he has done and continues to do. I hope to meet him one day and personally thank him for his dedication to helping make the world a better place.

Disclosure: Long MNKD

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