A Deeper Look At MannKind - Sanofi Deal And Valuation

Aug.13.14 | About: MannKind Corporation (MNKD)

Summary

MannKind shares in 35% of profits and losses.

Sanofi is very experienced in the sector.

The street will begin to assess MannKind valuation.

The excitement of the new deal between MannKind (NASDAQ:MNKD) and Sanofi (NYSE:SNY) has now been absorbed, and the street is now assessing how it feels the deal will impact MannKind. The equity currently trades at a market cap of $2.8 billion.

The first thing that needs to be understood is that getting a deal to commercialize the drug Afrezza is great news. The fact that the launch in now just months away is great news. The fact that MannKind now has "official" Big Pharma validation for its science is big news. Lastly, the fact that consumers will now have a non-injection treatment is great news. That being said, the story of an equity is not all about news.

In my opinion, the biggest challenge for MannKind over the next 6 months is managing the expectations of the street. If expectations get set too high, the equity can suffer. One only has to look at Arena Pharmaceuticals (NASDAQ:ARNA) (market cap of $1 billion) to see what happens when the expectation bar is set too high. Arena's partner Eisai (OTCPK:ESALY) announced sales numbers of $200 million at an Eisai shareholder meeting last Spring and $150 million a few weeks later leading into the launch of Belviq, an anti-obesity pill. The gross sales came in at about $45 million. Needless to say, Arena's stock has suffered along the way, despite seeing sales finally pick up.

With MannKind, the current market cap is $3 billion. There are many that have felt that this number was over-inflated. On the other side of the coin, there are bullish speculators that feel the market cap could go substantially higher. With the announcement of the Sanofi deal, analysts and the street can, for the first time, begin to apply real dates to sales models and consider the 35% share of profits and losses that the deal will bring MannKind.

Is it possible that Afrezza will be a blockbuster? Certainly. Blockbuster status is earned by obtaining $1 billion in gross sales in 1 year. Before you go and tally up $350 million to MannKind, remember, the 35% is on profits or losses. Gross sales do not equate to profits. The companies will divide up a net sales number. If we take a stab at the gross to net ration and simply use 50%, the $1 billion in gross sales would equate to $500 million in net sales. That would give MannKind $175 million (equating to the amount of milestone money that Sanofi fronted MannKind, in addition to the $150 up-front payment).

The purpose of this article is not to rain on the proverbial parade of a new and exciting deal. The purpose is to get you to assess this company with a more critical eye now. The pure speculation is evaporating away, and now it comes down to performance.

Now let me shift gears a bit and look at the $775 million in milestones that was announced as part of the deal. These are potential payments that MannKind can earn when certain regulatory and sales goals are met. When I look at milestones in deals, I often look at it is a very simple manner. The first third of that money is essentially money in the bank. The second third is earned with good success. The last third requires "uber-success" to be earned. Rarely are all targets in a deal like this earned. While very simple, this model has served me very well over the years. In essence, look for $260 million to be easy to obtain, $260 million to be harder to obtain and the last $260 million to be at a level that everyone is swimming in money anyway, and the milestones will be a small part of the excitement.

There is still a lot to digest with this news and still a lot that we simply do not know. I do not recommend rushing to judgment in either direction, but I do think it is very important to begin looking at potential revenue to MannKind vs. the current market cap. I am not trying to be a bear here, but the $3 billion market cap that we have been seeing in the pure speculation phase now needs to begin to stand up to a much stronger fundamental test. The big piece of information we want now is the price point of the product and an understanding of what the insurance industry will be doing. Sanofi has a lot of work to do for the remainder of 2014. Over the next 6 months, there will certainly be debate about revenue models, pricing and expectations. I will close with how I began. MannKind needs to carefully manage expectations.

Disclosure: The author is long ARNA. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have no position in MannKind, Sanofi, or Eisai.