MannKind, Front and Center: The Best Product Doesn’t Always Equal the Best Stock

With diabetes on the rise, the drug companies are trying to find the fastest, most effective drugs, while still turning a profit.

MannKind (MNKD -1.68%) is constantly trying to revolutionize the drug market, but is that hurting them, or helping them? Today on Industry Focus, we'll get some insight on when to invest, or when to dump the stock.

A full transcript follows the video.

Michael Douglass: MannKind Corporation; undervalued, or under delivering? This is Industry Focus.

Hi, Fools! Healthcare analyst Michael Douglass from the Motley Fool here and I'm on the phone with Todd Campbell, one of our contributors. Todd, welcome back to the show.

Todd Campbell: I'm glad to be here.

Douglass: Fantastic. So, we got a question. We love getting questions, by the way. Please, fire us a question, the email's [email protected]. Again, that's [email protected]. So, please send us emails. We love getting questions. A lot of questions from Krishna who writes "Listen, I've been following MannKind and astounded at its market cap, despite the approval of their drug and partnership. Would love to get your thoughts on the company."

So, I'm not going to hold anyone in suspense. I'm pretty bearish on MannKind. Todd, I know you are too. But before we get into the reason behind that, let's start with some background on the company. So, MannKind Corporation, I think one of its big selling points, Al Mann, is this really well known -- he's a billionaire, right? Big time investor who has led company after company and just done such a good job of monetizing profit products.

MannKind struggled a little bit more than some of the others though.

Campbell: Yeah. He bit off a lot. There's no getting around it. Basically what MannKind is trying to do is revolutionize treatment. For generations, the treatment regimen is "I go to Metformin, then Metformin doesn't help me with my diabetes any longer, then I go to insulin." And insulin's usually taking either short acting insulins at meal time, and then there's often time a long acting insulin that can be tanked in the evenings. But those are injection based drugs.

Heck, people don't like to inject themselves. So, Al Mann looked at that and said "You know what? We can build a better mouse trap. What if we were to develop something that worked a little bit like an inhaler that an asthmatic would use? But instead of delivering asthma medication, it's delivering insulin directly into the lungs. It works more effectively, works quicker, faster onset, a little bit easier dose, less patient burden, if you will. That's a huge issue in diabetes. You have roughly 40% of people who fail to take their diabetes medications as prescribed. So, essentially what Al Mann was trying to do here was build a better wheel.

Take something that is working right now, which is injected insulin, and make something better that's easier for patients to use.

Douglass: When you think about the opportunity there, if you can -- this really simple, tiny inhaler -- there have been a lot of comparisons to Pfizer's (PFE 1.00%) Exubera which was also an orally delivered mealtime insulin. But the delivery device was clunky, it was large, it was awkward, and it sold atrociously. Something that a lot of folks have done is they've compared Exubera to Afrezza, the MannKind drug. They said "is this just going to be another Exubera?" I think that was one of the big concerns about it.

But with Afrezza, it's a much smaller delivery device, a lot less clunky and weird to carry around.

Campbell: Theoretically it is, indeed, a better treatment option, or potentially a better treatment option for many people and I think that's why so many investors got excited about the prospect for this drug. However, MannKind's path -- Afrezza's path to approval -- was anything but smooth. It was very rocky. As a result the company took on a tremendous amount of debt, and ended up having to find a marketing partner once they did get approval last summer.

That marketing partner is Sanofi (SNY 1.84%), stepped up and gave the $150 million up front for global rights to commercialize Afrezza. They also agreed to pay MannKind $775 million in potential milestone payments that may, or may not ever end up getting paid. MK, as a result, had to give up 65% of whatever profit, or loss, that Afrezza ever ends up generating.

This has been quite a story filled with highs and lows for MannKind investors over the last 10 years.

Douglass: Very much so. I think that's very fair. After two complete response letters which is the FDA's way of saying "no", they did finally get a success, as you pointed out, last summer, and ended up signing with Sanofi, which is a diabetes heavyweight. When you think about potential marketing partners, Sanofi's definitely up there in terms of knowledge in that area.

And you see a lot of smaller biotechs signing on a big marketing partner because frankly, they know the science. This big marketing partner -- in this case, Sanofi -- you want a big partner that's been in the space for a long time that knows how to market, that knows the doctors, and has the sales force already built out. So, that can save you the capex of getting that group together.

Also, trying to build up some expertise when you could just basically leverage somebody else's expertise to go ahead and get your drug out on the market and hopefully winning big. Now, the first quarter for Afrezza did not go very well. A couple caveats. First off, it's the first quarter, and it wasn't even a full first quarter. The launch happened in February and the quarter began in January.

So, it wasn't' even a full first quarter. Of course, in biotech -- and health care across the board -- you're going to see drugs take a while to ramp up. You've all heard the story -- if you've been listening at all to Industry Focus Healthcare -- about Gilead Science's (GILD 0.28%) Sovaldi and how it did $2 billion plus in its first full quarter on the market. But that's not normal at all. Usually you really do see this ramp that takes some time to get up.

€1 million in sales was -- MannKind's management called it "modest, very modest". Definitely lower than they were expecting and lower than a lot of investors were expecting, which is why you've seen their market cap just cut apart over the last couple of months. Even despite the fact that your first quarter should be modest it was lower than a lot of people were expecting.

Campbell: Yeah. Let's lay this out for people. I think this is an important point to drive home. There's a huge market opportunities when you consider the fact that estimates peg the diabetes population growing at 205 million people between now and 2035. So, it will be almost 600 million people on the globe with diabetes that will -- most of which will at some point end up needing some form of insulin.

The market potential there is huge. They've lined up with Sanofi, which is a power house in diabetes. They market Lantus, which is the longa acting insulin, had $7 billion in sales last year. Sanofi knows what it's doing. It knows how to commercialize a drug. So, they go out and they launch this drug after winning approval last summer, they launch the drug in February. It took quite a long time, in my view, to get that drug launched.

Now they're coming back and saying "Okay, how did we do in the first few weeks after the launch?" The temptation for investors is to look at the press release for MannKind, and not dig any deeper. I think this is one situation where you really had to dig a little bit deeper because it was actually in -- I think it was in the Q&A section of the conference call where MannKind's management admitted basically that there was that €1 million out there. They said "Hey, it was $7.1 million in product shipments to Sanofi from MannKind's perspective.

But you have to dig deeper and realize that's $7.1 million includes a lot of free samples that were being given out. It includes some inventory that's going to end up sitting in the channel. So, it's very important for investors as they dig through the future quarterly reports from MannKind to see how sales either progress or not, that they not just look at the press release itself, but actually dig a little deeper and do some more due diligence on that.

Douglass: Yeah. The other thing I would add is, of course Mr. Edstrom, the new CEO of MannKind said "there were a lot of different issues. You had the spirometry scheduling" -- that's a basic lung function test that folks have to take before they can be prescribed Afrezza, there's a box requiring that. "There's managed cares prior authorization process." There's all these various things that are making it difficult for patients to get the drug.

Sanofi and MannKind -- particularly Sanofi of course are the lead -- are working to fix those problems. But to my mind -- and this is where it really gets to the crux of the matter, this is really where MannKind's -- it's a bit of a trend that we've seen with MannKind's management. This is really, I think, more than anything else why I think I'm really not confident in the stock and the company moving forward -- is that you have management under delivering on investor, and to some extent management expectations.

You got the sense throughout the call that management was surprised by how poorly things had gone here, and I'm sure they were surprised when they also got rejected by the FDA twice. Here it's very clear there are these issues with Afrezza that you'd think in that nine month lead up period to the actual launch, that they would have done some solving for. It just doesn't appear that's happened.

Campbell: Exactly. You look at the conference call, you read through there and you come away thinking "I understand it's hard to get an appointment with the doctor, and I understand that most of these doctors that are doing the prescribing don't have this test on site. So, they have to send someone to another facility, then get the test back, then all them up, and then get them started on the 10 day sample, then after that, write them a script."

I understand all those things could be delaying script demand, but really? Shouldn't some of those issue have been contemplated ahead of time? Maybe some solutions put in place? I don't know. I think it's a fair question that investors might want to be asking. They are saying "We think we can address some of these issues." As time goes by we're going to end up getting -- you won't have to worry so much about the preapproval process, we're thinking that maybe we can make this equipment available and help doctors get this equipment into their offices so they won't have to send them off site and we might be able to launch a program as soon as August that helps people do that.

These are all things that the companies are trying to put in place to be able to kick start scrip demand by yearend. But I think it's fair to be able to ask the question "should these really have been surprises?"

Douglass: The other piece -- again, in health care evaluations always kind of problematic because, can you really predict what's going to happen with a drug? But when you look at S&P CapIQ estimates -- they take an average of analyst estimates -- it looks like MannKind, as soon as estimates are correct, which again predicting the future; kind of impossible. But MannKind is trading at a little bit under 200x 2018 earnings based on those CapIQ estimates and its market cap today.

About 100x 2019 earnings. Not cheap. Not at all cheap in health care, particularly given that we're years away from that possible turn toward profitability. You've got cash burn concerns, you've got the fact that the launch -- you get the sense it's not going nearly as smooth as it should be. Goldman Sachs (GS 3.30%) just cuts their Afrezza sales forecast in half because of uptake being so slow and when you think about that -- MannKind gets 35% of profits or losses, the numbers that FiercePharma reports that a lot of analysts are estimating around $600 million or so in peak sales. It's not really that much.

Once you back that into earnings potential it doesn't really look that impressive. So, the really big, open question is, we've got what could be a transformative drug, and a transformative technology. Is MannKind going to be able to monetize it well? Are they going to be able to market -- with Sanofi -- well? Is this really the management team that's going to do an effective job with that?

For me, personally, I am not confident in that. Which is why I've stayed very happily on the sidelines and away from the stock.

Campbell: Yeah. I tried to evaluate biotech stocks based on three criteria. The current products, the future products in the balance sheet, and I'm not sure that MannKind scores well on any of them. It's unproven. So you have Afrezza -- that's the current product -- but we don't know what the peak potential sales could be for that. There are -- you could get the 35%, but you could also get the $775, or the $7.25 million remaining in milestones that you could still get.

But those have no guarantees associated with that. A lot of those are going to be sales based milestones. So, who knows? You can't really consider that. Afrezza is an intriguing drug. It could be a good selling drug, but I'm not convinces necessarily at this point that it's a $1 billion blockbuster. As far as the future is concerned, you could use the technology that they're using for Afrezza for other drugs, and they're researching that. But all that effort they're doing right now is preclinical.

It's too early staged for you to try and stick a number on it and say "This is worth X." Then as far as the balance sheet, it's not rock solid. They had to spend a lot of money on these trials with the CRLs back from the FDA, etcetera. Even if you back out the Sanofi collaboration revenue that's sitting as a liability out there, the company still owes $150 to $200 million. So, I wouldn't say that its balance sheet is overly fantastic either.

Based on those three criteria, it just doesn't pass muster for me.

Douglass: And that is just our two cents on the company. Of course, we don't give investment advice, we just do some research and give our two cents. Before we go, I want to make our listeners aware of a special offer. If you're looking for more Foolish stock ideas, Stock Advisor may be right for you. It is our flagship newsletter started more than 10 years ago by the co-founders Tom and David Gardner, of The Motley Fool. We're offering the lowest price out there for all of our Industry Focus listeners. $98 for two a two year subscription to Stock Advisor.

You will get two stock recs a month with insight from a team of analysts. Go to focus.fool.com to take advantage of that deal. Again that is focus.fool.com. As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against. So, never buy or sell stocks based solely on what you hear. With that said, for The Motley Fool, I'm Michael Douglass. Thanks for listening, and Fool on!