MannKind: Looking Beyond The Short-Term Disappointment

| About: MannKind Corporation (MNKD)


The terms of the marketing partnership is clearly a near-term disappointment.

MannKind couldn't have found a better partner for the long haul, though.

Sanofi optimizes the chances of Afrezza achieving rapid and substantial commercial success.

MannKind Corporation (NASDAQ: MNKD) and France-based Sanofi (NYSE: SNY) announced early yesterday morning (August 11, 2014) that they have entered into a worldwide exclusive licensing agreement for the development and commercialization of Afrezza®, MannKind's recently approved rapid-acting inhaled insulin therapy for adults with type 1 and type 2 diabetes. Under the collaboration and license agreement, Sanofi will be responsible for global commercial, regulatory and development activities. Under a separate supply agreement, MannKind will manufacture Afrezza at its facility in Danbury, Connecticut. In addition, the companies are planning to collaborate to expand manufacturing capacity to meet global demand as necessary. MannKind will receive an upfront payment of $150 million and potential milestone payments of up to $775 million. The milestone payments are dependent upon specific regulatory and development targets, as well as sales thresholds. The two companies will share profits and losses on a global basis, with Sanofi retaining 65% and MannKind receiving 35%. The huge French concern has agreed to advance to MannKind its share of the collaboration's expenses up to a limit of $175 million. The companies plan to launch Afrezza in the United States in the first quarter of 2015.

Sanofi May Just Be the Perfect Partner

Sanofi, which we recommended just yesterday, may be the ideal partner to market MannKind's Afrezza, underscored by both a long-established global presence in the diabetes sector and a complementary portfolio of products. The company has 90 years of experience selling insulin, most notably long-acting basal insulin Lantus, which is not only the best-selling insulin product in the world, with sales likely to approximate $8.7 billion in 2014, but was also used in conjunction with Afrezza in its latest clinical trials. That's not all, it sells diabetes products in some 120 countries, supported by a salesforce that totals about 33,500, including almost 4,770 in the United States where a large percentage of Lantus revenues are generated. Sanofi's impressive record of successfully introducing new products and building sales strongly suggests that its selection has substantially reduced the commercialization risk of Afrezza. Moreover, considering the facts that Lantus loses patent protection next year and Afrezza is the ideal complement to its long-acting insulin, the marketing partner will clearly be strongly motivated to sell MannKind's prandial inhaled insulin.

The Deal Has Strongly Positive Financial Implications

As noted above, the terms of the agreement include an upfront payment of $150 million, which should be received shortly. So, factoring in the $41.2 million cash balance as of June 30, 2014 and the $40.0 million received from Deerfield on July 18th, MannKind will have an atypically large cash cushion going forward. The details of the milestone payments haven't been spelled out yet, but the biotech stands to receive another $75 million for achieving certain development and manufacturing objectives, $50 million for Afrezza getting to market in Japan and Europe, and up to $650 million for reaching certain sales milestones, the first one at $250 million. On the cash outflow side, the most significant is the $100 million in convertible debt that matures August 15, 2015. Given a conversion price ($6.80/share) that's considerably below the prevailing market price, we think there's a strong likelihood that the debt will be converted into some 14.7 million common shares, obviating the need to shell out $100 million. As well, although the company will be responsible for what will undoubtedly be losses stemming from Afrezza's early days on the market, a loan facility (for $175 million) from Sanofi will most likely be sufficient to cover the red ink until profits start to flow. Significantly, too, Sanofi will assume responsibility for conducting additional clinical trials, conducting the post-marketing studies required by the Food & Drug Administration, and making regulatory submissions in all other major markets. All of the above, meanwhile, puts MannKind in a position to focus its growing resources (and management attention) on advancing its other R&D prospects, most certainly including the Technosphere drug delivery platform that has been validated by the Afrezza approval.

Well Positioned for the Long Run

MannKind shares initially gapped up on the announcement of the long-awaited partnership agreement. They spent most of the day giving up a good part of the gains, however, as investors digested the details of the deal. Some stockholders, including the author, were disappointed that the transaction announced wasn't a buyout of the company. Others, no doubt, weren't happy with the relatively small upfront payment, nor with the rather nebulous profit sharing arrangement. Unfortunately also, this angst wasn't alleviated by management during two separate conference calls when executives from both MannKind and Sanofi declined to comment on marketing strategy, pricing, and other variables that would allow analysts to better assess the agreement and construct earnings models, citing either competitive reasons or the existence of some uncertainty on their part.

All that said, management has thus far achieved all of its frequently stated objectives. Most significant, MannKind now has an FDA-approved novel new insulin product that targets the largest therapeutic market in the world. Equally important, the biotech may have secured the perfect partner to sell the new insulin product around the world. One can quibble about the terms of the deal, but it would be difficult to argue with the proposition that Sanofi optimizes Afrezza's chances of achieving substantial and rapid commercial success. MannKind perhaps could have extracted a few hundred million more dollars in upfront money or a slightly better profit sharing split from a different potential partner, but management decided that the deal with Sanofi offered the best long-term possibilities. Interestingly, during one of the conference calls, the company's chief financial officer noted that the 65/35 split equated to a roughly mid-20% royalty rate, a metric that most investors would probably have an easier time understanding and a figure with which they would most likely be content. All in all, expectations and disappointments aside, MannKind seems well positioned for the long haul. The upfront fee is certainly far less than we had anticipated, but the implied royalty rate is in line with expectations. We will update our earnings and share-price projections after the company has published more details of the agreement and provided better guidance on accounting treatment for milestone payments and profits received. For now, we see no reason to change our "buy" recommendation.

Disclosure: The author is long MNKD, SNY. 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.

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