I have been short MannKind shares regularly for many years. This has generally resulted in fantastic profits for my partners and me. It is with some sadness, then, that I write that I believe that MannKind’s existence is nearing an end. With a financial position only Lehman Brothers and MF Global could envy, MannKind is in dire financial and practical straits that I will walk through. I’m short MannKind stock, and believe you should be too. Similarly, I feel there is no reasonable framework whatsoever for being long MannKind stock.
MannKind has one product, Afrezza, a branded inhaled insulin. I think inhaled insulin (including Afrezza) is a bad idea conceptually, with marginal theoretical benefits compared to regular insulin and no actual benefits. The world does not need Afrezza. In a series of letters to the FDA in 2010, I attempted to convince the agency that Afrezza’s clinical trial package was lacking—in fact, I feel every single Phase III trial of Afrezza technically failed to succeed.
Defining success can be a surprisingly difficult thing to do in clinical science. While I won’t bore you with the trial-by-trial analysis I did (my papers to FDA were over 30 pages long!), I will reiterate my main complaint that Afrezza has not performed well enough in its pivotal clinical trials to merit approval – it is a very weakly efficacious antihyperglycemic. There are other issues, such as market size (surprisingly small and shrinking), safety (mostly theoretical concerns that have been addressed) and regulatory (detailed questions on inhaler switches and bridging studies) but I think those are secondary when the main issue is the inferior efficacy of Afrezza.
Thankfully, there is a new and simpler thesis for shorting MannKind: It is out of cash. With $23 million in cash and $45 million remaining in a credit facility with their “principal shareholder,” the company has $68 million in cash available to it as of Q3 2011. Q4 2011 is over, and my guess is the company burned something like $26 million, so it now has $42 million available to it. Well, the next year of operations should cost at least $90 million (I believe the number will be bigger), which means MannKind needs to raise at least $48 million. Let’s see how I arrive at this critical assumption in detail.
Clinical trials are very expensive. There are some general rules of thumb: $50,000 per patient enrolled is a good estimate. Trials where many drugs are given to the patient (the company running the trial pays for these!), or trials where many blood tests and readings must be done, or if there are hospital visits/stays, are more expensive.
My guess is the two Phase III trials MannKind is embarking on, which are enrolling 800 total patients will cost $50,000 per patient or $40 million. My checks with industry experts suggest that would be a bargain price (as many of you have noticed, all of my analytical work builds in a margin of error). Unfortunately there are more costs to clinical trials – you need a regulatory and clinical staff to run a trial and that will usually run you $10 million a year. Call it $2 million for consultants and $8 million for the roughly 60-80 people MannKind has in its clinical and regulatory departments. So we’re talking $50 million now for all research costs (R&D) line. For a reality check, MannKind has never recently spent less than $23 million in a quarter for R&D, so assuming they will get down to a $13 million run-rate is rather conservative!
G&A costs for MannKind have always been around $10 million per quarter. With multiple offices and quite a large finance and legal department, I assume MannKind continues to lower its infrastructure costs and only spends $5 million per quarter, for a $20 million 2012 budget. MannKind has roughly 90 employees in administration, finance, executive, etc. functions, this should cost about $10 million annually. Incredibly, MannKind only leases one of their three sites, the New Jersey office, and this will only cost approximately $1 million. Add in the 90 employees at Danbury (100,000 all-in cost each) and $20 million is about right for infrastructure/non-clinical employee G&A (some will move into R&D). Another $10 million in professional services (legal and consulting) and miscellaneous expenses (perks, T&E, etc.) and we’re at $30 million for non-clinical (adjusted G&A).
The $50 million in R&D and the $30 million in G&A add to our running total of $80 million total burn. Another $10 million in interest expense (it would be $24 million but their “principal” shareholder takes interest payments in the form of stock), and we are at $90 million for 2012. I think the final figure will be larger, and the delta will come from more than expected clinical trial expenses. The CEO insisted that the trials could result in data by year-end 2012, which would imply one of the fastest enrollments in diabetes history.
Remember, the Afrezza studies are 6 month studies, so enrollment would need to be completed by June or July for this to be true. This would cost MannKind at least a little more in fees (enrollment speed is often a function of expense), especially if they plan on doing more customary extensions to the trials (follow-up). I don’t think enrollment is on pace and it would be almost impossible to see clinical data by year-end 2012.
Let’s now turn to the practical part of MannKind’s financial situation. MannKind has been trying to sell senior secured debt (backed by the Danbury and Los Angeles sites and their insulin supply) and ostensibly has failed to do so. While a debt deal may still be reached, it is evident that this senior secured paper needs to be modified into at least a convertible senior secured paper. This means that, similar to one of their other financings, MannKind will have to set up a borrow facility which will allow convertible arbitrage buyers to buy this debt while shorting the stock, locking in no potential loss and receiving a healthy coupon while being backed by MannKind’s assets.
This sort of deal would likely crush MannKind stock, because I don’t think that MannKind’s assets would be worth much more than $40 million in a fire sale. This means that convertible debt investors will likely ask for a conversion feature at a deep discount to MannKind’s current stock price, to ensure that they can execute their hedging short and ultimately collapse/convert their note against the short to remove the need of seizing MannKind’s assets. This might sound like a reasonable way to get out of a liquidity crunch, but recall that the CEO of MannKind has a large equity position in the company.
It remains to be seen if after a dilutive series of financings that this executive will remain interested in this company which addresses a limited market (remember Afrezza is just a mealtime insulin, a smaller market than the basal insulins) which is shrinking due to new (DPPIV inhibitors, GLP-1 agonists) and coming SGLT2 and other drugs. It is hard to personally commit to a company without much upside potential, especially after what may become serial dilution. Meanwhile, I don’t even think the new Phase III trials of Afrezza will work.
In any event, MannKind has been trying to price debt for a long time (based on a September 23, 2011, press release, which has had no follow-up), so I suspect there is a good chance it never happens. If MannKind does a secondary equity offering, the short idea should work due to the dilution and discount secondary price. It appears the principal shareholder is not financing the company further (definition being new money in a new financing), or at least those are the rumors I have heard from people who have met with him. The dilution that a series of financings would come with would remove or lessen the interest, focus and reason for continuing this ill-conceived project of the principal shareholder.
Is bankruptcy the best option for MannKind’s principal shareholder? With the capital structure dynamics at play, MannKind’s largest shareholder (who is a large debtholder as well) may benefit from a bankruptcy, while of course, equity holders would be wiped out. With a staggeringly “upside down” balance sheet of $23 million in cash and $488 million in debt (unheard of from a non-revenue company), eventual bankruptcy is definitely in the cards for MannKind.
Accelerating this process may allow for a re-casting of the Afrezza story and emergence from bankruptcy is likely the healthiest approach, if and only if there is no irreparable harm to the company’s ability to continue its clinical trials. CROs, employees and other vendors don’t look kindly on voluntary bankruptcy filings.
It will be interesting to see how MannKind attempts to dig itself out of its current hole, but no matter what it tries, I am certain there will be substantial dilution, which will cause the share price to plummet, or there will be a bankruptcy filing. Even with very high borrow rate, shorting MannKind in anticipation of their imminent collapse is a wise trade.