MannKind: Will The Good News Ever Come?

Apr.25.12 | About: MannKind Corporation (MNKD)

In my opinion, biotech stands out as the most difficult industry in which to consistently make money in. Sky-high multiples, billion dollar valuations for companies with no sales, white-knuckle price swings and a plethora of unrealized dreams have been the norm for many years. And what about that tidy 50% gain you have on that stock in your portfolio that you believe will be a 4-bagger after FDA clearance on its new therapeutic? One tepid press release can wipe it out in less than a second.

Two superb examples of the excitement biotech can offer are Human Genome Sciences (HGSI) and Dendreon (NASDAQ:DNDN). Both of these firms skyrocketed from micro cap valuations to $1 billion + based on the healthy prospects from new flagship products. HGSI's share price, for example, rose from a split-adjusted 45 cents in March, 2009, to $35 a year later. In about the same timeframe, DNDN's rose from $2.55 to $58. Biotech is truly the only industry that can deliver these kinds of numbers.

Longs who wanted to "buy and hold" hopefully did not head to the golf course too early, though. The market uptake for both companies' products has been less robust than planned, and the punishment has been harsh. DNDN is now 81% off its peak and HGSI down 80% (before Glaxo's recent bid). Ouch.

These two companies illustrate the common path with biotech on the long side. There is a pre-regulatory run-up followed by a long post-clearance consolidation or, in many cases, a plunge in price due to disappointing market developments. The buying intensity is ALWAYS on the story, not the results. This, of course, represents the core of the risk.

MannKind (NASDAQ:MNKD) is a typical biotech story stock. Its IPO took place in July, 2004. The company's flagship product is AFREZZA, an ultra rapid acting insulin inhaled in powder form into the lungs for absorption.

MannKind's story is compelling. AFREZZA takes effect so quickly (12-14 minutes) that users do not have to time their dose before meals-- they can inhale as they begin eating. Other insulin products are slow acting, so, if the timing is not just right, the glucose-lowering effects will persist post-meal producing a hypoglycemic event. This is annoying for diabetics, not to mention dangerous and even life threatening (in the extreme).

On the demand side, the story could not be more bullish. Obesity continues to expand (sorry, I couldn't resist) throughout the world, as well as the concomitant Type II diabetes. The global diabetes population is well into the 100's of millions. At launch, AFREZZA will be able to address almost the entire adult (18 years +) diabetes market. Product sales could theoretically reach $1 - $2 billion.

Serial entrepreneur Al Mann founded MannKind in the early 1990's. Mr. Mann has a sterling record of accomplishment commercializing technology going back to the 1960s. He is a billionaire who, until this year, was a member of the Forbes 400. Mr. Mann is so bullish on MannKind's prospects that he has invested $1 billion of his own money in the venture. This is an extraordinary level of insider buying.

Like most individual traders, I do my own research on investment candidates. Part of my decision criteria beyond a stock's fundamentals is its chart action, investor sentiment, as well as industry and sector relative strength. In other words, what do the institutions think of my investment candidate and its peers? Since I do not possess the time and resources to "out analyze" the pros, I want my thesis to be consistent with theirs. Swimming against the tide is a great way to lose money.

One way I look at the biotech industry is segmenting companies according to market capitalization. The largest group-- let us call it Group A-- are companies with a minimum valuation of $1 billion. The established players are here, but it also contains the innovators-- firms with little or no sales but with extremely bullish prospects based on a game-changing product that fills a large unmet need. The market is very efficient in identifying these story stocks. It is ludicrous to think that the thousands of investors and analysts around the world are going to overlook a company with blockbuster potential. This enthusiasm almost always results in sky-high valuations for these firms.

Smaller companies with valuations between $500 million up to $1 billion comprise Group B. As a whole, this segment contains those firms with staying power, but with more limited upside potential. In other words, the number of potential market leaders drops precipitously from Group A. There are always a few big winners, but it is a small number-- there ain't much to be had.

Group C contains the largest number of companies. These firms have market caps less than $500 million. The number of big winners emerging from this segment is miniscule, only a small handful each year. It is a bone yard. This is arguably the most difficult investment candidate pool on the planet. Only a very small number of top-flight investment professionals in the world make money here. It is colossally hard to do. Unfortunately, this area attracts many individual investors who think they can find the next Amgen (NASDAQ:AMGN).

So what do the institutions think of MannKind? Its current market capitalization is a paltry $355 million. It is a member of the bone yard group. Could the market be this inefficient? Stock markets typically discount the future 6, 9 or 12 months. Could tens of thousands of the keenest minds on the planet be wrong about the MannKind's prospects? This is a company with a paradigm-changing product addressing a humongous global unmet medical need backed by a successful entrepreneur who has invested $1 billion of his own money in the venture.

Under normal circumstances, MannKind's market cap should be $1 billion or more, even allowing for the market's current "show me the money" mentality. The fact that it is not is the single most important signal that the best place to be for individual investors, at least right now, is on the sidelines.

MannKind will be hosting its Q1 earnings call sometime in mid to late May. There are two major points that need clarity:

1. Funding: The company recently completed a secondary offering that raised $86 million, which significantly diluted current shareholders. This will fund the company's operations into Q4. Mr. Mann originally stated in November that he was pursuing a private debt placement. He apparently could not get the deal done, so the equity offering was his only alternative. He admitted that they had to scramble a bit to get the funding consummated before they ran out of money. Mr. Mann apparently lacks enthusiasm for putting more of his capital into the venture. This is hardly a vote of confidence about the situation.

So what happens in Q4 and beyond? I do not think the prospects of a debt placement will be any better next quarter than they were last quarter, so I believe that there will be much more dilution on the way. MannKind will need a minimum of $150 - $200 million to get it through to AFREZZA approval, so this bodes ill for current shareholders. Its 2012 proxy statement includes an amendment to increase the number of authorized shares from 250 million to 350 million.

2. Distribution Partner: Mr. Mann stated his intent to consummate a global partnership agreement by mid-year. Ideally, this agreement will include a significant funding commitment.

The other area that many conference call attendees will be keenly interested in is the status of the two remaining clinical trials. Enrollment for both is supposed to be complete by June and concluded by year-end.

The company intends to complete AFREZZA's resubmission by mid-2013. This means that regulatory clearance should be granted in early to mid-2014.

So when will the good news come? Maybe Mr. Mann will throw us a bone in May. Until then, I will be watching and holding on to my hard-earned money. MannKind has a long way to go before it is a viable investment candidate.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.