MannKind: An Enticing Short

| About: MannKind Corporation (MNKD)

Summary

MNKD has recently doubled in price.

Based on the company's history and its risk factors, the current price is completely unwarranted.

I set an ultimate stock price target well below $0.50, i.e. well below an enterprise value of $250M.

The saga of MannKind's (NASDAQ:MNKD) attempts to develop and sell its inhalable insulin drug, brand named Afrezza, has been fascinating. Bulls and bears have had strong opinions both on whether Afrezza would be approved and whether or not an approved drug would be commercially viable. To get a taste of how furious the debate has been, see the SA archive (which doesn't even include PRO articles).

I personally have been short the stock a few times, but for the most part, have simply been a spectator, as I don't like being involved in crowded shorts with potential news catalysts.

Today, however, the situation is different. While MNKD still has a large short interest, the story has been played out, and what is left of the company is trading at such a high valuation that it's hard to see a big run up from here, while an eventual drop is almost assured.

I will go into the valuation aspect below, but in this case, I think the trading opportunity can be best made by using an annotated chart to show the developments at MNKD, and why today's price is nothing but a "dead-cat" bounce, i.e. there are no new positives to explain the recent doubling in price. My general commentary can be verified by going to MNKD's press release archive, but I've also included links to specific references.

Click to enlarge

(original source, with author's annotations)

Chart location 1 - MNKD does several road shows to sell the stock, and it completes its Phase 3 trials for both type 1 and type 2 diabetes.

Chart location 2 - MNKD releases positive data from the type 1 and type 2 diabetes studies, but the results aren't nearly as good as the market is expecting.

Chart location 3 - MNKD receives FDA approval to market its inhaled insulin for the treatment of diabetes. Hope reigns supreme.

Chart location 4 - MNKD enters a worldwide licensing partnership with Sanofi (NYSE:SNY). Commercial launch in the US is slated for the first quarter of 2015. The deal includes a $150M upfront payment to MNKD which is received on Sep. 29, 2014.

Chart location 5 - MNKD announces that Afrezza is available in the US.

Chart location/range 6 - Afrezza sales are incredibly disappointing, even for those not expecting big initial sales.

Chart location 7 - In the wake of the disastrous sales results, MNKD's President and CEO, Hakan Edstrom, steps down.

Chart location 8 - Sanofi terminates its license and collaboration agreement with MNKD. The termination will be effective in its entirety by July 4, 2016.

Chart location 9 - MNKD files its 10-K. Stock doubles in valuation.

The fall of MNKD's stock price is entirely unsurprising given the events outlined above. The one incongruity is the recent doubling of price (chart location 9). That raises two questions: (1) had MNKD's stock fallen too far such that it actually became undervalued? and (2) did the 10-K reveal new positive information? These questions are somewhat inter-related, so I'll tackle both of them in the following section.

MNKD's Valuation and 10-K details

Valuation

As of the close on Thursday March 24th, here are the valuation and balance sheet metrics as presented by Yahoo!:

MNKD sports a billion dollar enterprise value, yet its only product has been returned to it as an abject failure with essentially no sales (Sanofi reported a miniscule 7M euros of total annual Afrezza sales after all its effort). Moreover, its balance sheet is atrocious with a current ratio of 0.27 suggesting imminent and substantial dilution. Undervaluation certainly doesn't explain the bounce from $1, and the metrics scream "over-valuation" at today's price.

10-K

So what about the 10-K? Are there positive nuggets hidden within it?

In response, here's a sampling of what I found (from worst to least bad):

We will need to raise additional capital to fund our operations, and our inability to do so could raise substantial doubt about our ability to continue as a going concern.

We will need to raise additional capital, whether through the sale of equity or debt securities, additional strategic business collaborations, the establishment of other funding facilities, licensing arrangements, asset sales or other means, in order to support our ongoing activities including the commercialization of AFREZZA and the development of other product candidates and to avoid defaulting under the covenant in our facility agreement with Deerfield Private Design Fund II, L.P. ("Deerfield Private Design Fund") and Deerfield Private Design International II, L.P. (collectively, "Deerfield") dated July 1, 2013 (as amended, the "Facility Agreement") that requires us to maintain at least $25.0 million in cash and cash equivalents or available borrowings under the loan arrangement, dated as of October 2, 2007, between us and The Mann Group LLC (as amended, restated, or otherwise modified as of the date hereof, "The Mann Group Loan Arrangement"), as of the last day of each fiscal quarter. It may be difficult for us to raise additional funds on favorable terms, or at all.

Potential dilution is the biggest catalyst for an imminent and substantial stock price drop. It's only made worse by the next risk factor (my underline):

We have a substantial amount of debt pursuant to the 2018 notes, 2019 notes, Tranche B notes, The Mann Group Loan Arrangement and the Sanofi Loan Facility, and we may incur additional indebtedness under The Mann Group Loan Arrangement and we may be unable to make required payments of interest and principal as they become due.

As of February 22, 2016, we had $219.6 million principal amount of outstanding debt, consisting of:

[…]

There can be no assurance that we will have sufficient resources to make any required repayments of principal under the terms of our indebtedness when required. Further, if we undergo a fundamental change, as that term is defined in the indentures governing the terms of the 2018 notes, or certain Major Transactions as defined in the Facility Agreement in respect of the 2019 notes and the Tranche B notes, the holders of the respective debt securities will have the option to require us to repurchase all or any portion of such debt securities at a repurchase price of 100% of the principal amount of such debt securities to be repurchased plus accrued and unpaid interest, if any. The 2018 notes bear interest at the rate of 5.75% per year on the outstanding principal amount, payable in cash semiannually in arrears on February 15 and August 15 of each year. The 2019 notes bear interest at the rate of 9.75% per year on the outstanding principal amount and the Tranche B notes bear interest at the rate of 8.75% on the outstanding principal amount, with accrued interest on each payable in cash quarterly in arrears on the last business day of March, June, September and December of each year. Loans under the Sanofi Loan Facility bear interest at a rate of 8.5% per annum, paid-in-kind on a quarterly basis (2.06% per quarter compounded). Loans under The Mann Group Loan Arrangement accrue interest at a rate of 5.84% per annum, due and payable quarterly in arrears on the first day of each calendar quarter for the preceding quarter, or at such other time as we and The Mann Group mutually agree. While we have been able to timely make our required interest payments to date, we cannot guarantee that we will be able to do so in the future. If we fail to pay interest on the 2018 notes, 2019 notes, Tranche B notes, or on the loans under the Sanofi Loan Facility, or if we fail to repay or repurchase the 2018 notes, 2019 notes, Tranche B notes, or the loans under the Sanofi Loan Facility when required, we will be in default under the indenture governing the terms of the 2018 notes, the Facility Agreement or other applicable instrument for such debt securities or loans, and may also suffer an event of default under the terms of other borrowing arrangements that we may enter into from time to time. Any of these events could have a material adverse effect on our business, results of operations, and financial condition, up to and including the note holders initiating bankruptcy proceedings or causing us to cease operations altogether.

The death of Alfred Mann is also a negative, and is reflected in this risk factor:

As a result of the death of Alfred Mann, the stock that he previously controlled is currently controlled by various trusts, and we cannot assure you of the manner in which the trustees will manage the holdings.

At December 31, 2015, Alfred E. Mann beneficially owned approximately 35.7% of our outstanding shares of capital stock, including shares held in the Alfred E. Mann Living Trust, Mann Group LLC, Mannco LLC, Biomed Partners, LLC and Biomed Partners II, LLC.

I won't belabor the other financial risk factors, suffice it to say they are all in the same vein as above. I'll only cite one more negative: "As of December 31, 2015, we had 192 full-time employees." This means that the cash burn will continue to be heavy, and yet as shown on the balance sheet, the company is cash-starved with $76.6M in current assets versus $268.3M in current liabilities as of Dec. 31, 2015.

Conclusion

Nothing in the 10-K or elsewhere leads me to believe that the recent doubling of MNKD's stock price - to an enterprise value of $1B - is anything but an unwarranted dead-cat bounce. As a result, I'm short the stock (or proxies of the stock) with anticipation that its price will once again drop below $1 and ultimately well below $0.50 (which would still represent an enterprise value of $250M).

Disclosure: I am/we are short MNKD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I actively trade around core positions.