June 27th witnessed The US Food and Drugs Administration (FDA) early approval for Mannkind's lead drug, Afrezza, as treatment indicated for both Type 1 and Type 2 diabetes mellitus, marking a monumental event for both shareholders, as well as, million of patients suffering diabetes. Afrezza is the super rapid acting inhaled insulin, being delivered through a small whistle like device called the Dreamboat.
Revolutionary in its ability to mimic the natural action of the human pancreas, Afrezza would be a game changer to eventually gain complete dominance in the $29 billion insulin market, of which $9 billion constitutes the rapid acting analogues (RAA), growing at 12.4 percent annually to reach $45 billion in US sales by 2020.
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Afrezza was not the first inhaled insulin approved by the FDA. In 2006, Exubera was the first inhaled insulin approved by the Agency only to be withdrawn from the market by Pfizer due to poor market sales. It appeared that there's the delusion that Afrezza is similar to Exubera. Unlike Afrezza, Exubera delivered rapid acting insulin through a large bong like apparatus, thus, deterring patients use resulting from the device's associated stigma. In addition, Exubera does not exhibit the super rapid acting pharmacokinetics intrinsic to Afrezza, as well as, having dosing issues. Due to poor sales, Pfizer cut its $2 billion lost on Exubera in 2007.
Nonetheless, It seemed like Mr. Market is still apprehensive that Afrezza might fare similar fate as Exubera, for he is quoting Mannkind significantly undervalued relative to its true potential. In my other articles, I elucidated and dispelled all concerns like those regarding cough and labeling. For the rest of this research, I would embark on the daunting task of appraising a biopharmaceutical.
The valuation of biotechnology compaies is indeed a daunting task, necessitating creativity and research skills beyond fundamental Graham-Dodd analysis. The Graham-Dodd analysis are applicable to companies that are large and well-established, thereby having stable earnings and relatively predictable future cash flows.
Source: Finance Museum
Contrarily, development-stage biopharmaceuticals have generated neither revenue or operational cash flow from drugs sales. After all, these companies are still "developing" their drugs. Accordingly, we excluded free cash flow (FCF), discount cash flow (DCF), or net present value (NPV) from our developmental biotech analysis.
Needless to say, those factors are critical after a biotech firm received FDA approval and commenced their commercialization to when earnings become relatively stable and operational cash flows are easily calculated. Pharmaceuticals either make profits from direct sales or royalty, usually in the range of less than 20 percent.
In seeking better than average accuracy, we emphasized our calculations regarding statistical probability of positive clinical outcomes, FDA approval, market penetration, and more importantly comparative market analysis (CMA).
Comparative market analysis (CMA) is a powerful tool commonly used by realtors to appraise market values for real estate properties. CMA determines the values for a property like a house by comparing how much similar houses in the same neighborhood were sold.
Being cognizant of the limitations of traditional valuation techniques in biopharmaceuticals analysis, we modified CMA to be applicable to the analysis of biotechnology companies. As followed, CMA focused on the market cap per revenues (MCap/Rev) ratio or factor using data from diverse groups of companies within the pharmaceutical industry.
This integration of knowledge from different disciplines enabled CMA to detect the trend proving that smaller (MCap/Rev) ratios exist for for larger pharmaceuticals and vice versa. These ratios or factors are logical both mathematically and economically.
As companies becoming established and generating more sales,the increasing revenues in the denomitor would lower the ratio (MCap/Rev). Furthermore, it's interesing that this factor automatically adjust in accordance to the bull and bear market cycles, thus, removing the need for an analyst to determine when the economic cycle would shift (i.e when recessions or bull market would come).
Hence, CMA enabled the analyst to focus on a company fundamentals and story without wasting fruitless effort in trying to forecast economic cycles. CMA, thus, resembled Peter Lynch and Warren Buffett (Trades, Portfolio) teachings that the intelligent investors should focus on purchasing great companies at discounts rather than trying to undertake the futile task of forecasting economic cycles.
Regarding the data collected from large firms such as Roche, Pfizer, Sanofi, Merck, Novartis, or Lilly, the MCap/Rev ranged from 3 to 5. In contrast, smaller firms including Incy, Salix, Endo, Vivus, Arena, or Teva exhibited much larger MCap/Rev from 9 to 20. Outliers should be discarded as they are not representative of the general data pool, thus, provide no statistical significance and meaning. An example of data outliders was the MCap/Rev of 50 from Arena Pharmaceuticals.
Source: 360 Biotech With Doctor Tran
The Mannkind appraisal employed an ultra conservative factor of 4 (MCap/Rev) to widen the margin of safety. According to The Father of Value Investing, Benjamin Graham, "Margin of safety maybe thought of as the most fundamental quantitative concept in security analysis." By employing wider margin of safety, an analyst allowed more room for mistakes, thus, leading to higher accuracy and precision.
That being said! Beside CMA, we additionally assessed Mannkind statistical probability of positive phase III/IV trials data, FDA approval, competitive advantages, as well as, commercial success for Afrezza. It was a blessing to witness these predictions unfolded with accuracy. As for Afrezza chances of commercialization success, "qualitative" data such as pharmacokinetics, dynamic, biotechmistry, medicine, patients and physicians preferences, and etcetera ... strongly favored Afrezza as the upcoming blockbuster drug.
The first step in this next part was calculating the market size of rapid acting analogues, of which Afrezza would directly compete.
The $9 billion rapid acting analogues (RAAs) market was obtain via calcuations using using revenues from annual reports from the three major pharmaceuticals including Elli Lilly,Novo Nordisk, and Sanofi.
Scenarios #1 assumed Afrezza capturing only 33 percent of the RAA market and the arithmetic showed $35 PS for MNKD.
By capturing 33 percent of the $9 billion RAA market, Afrezza should generate $3 billion sales revenue
$9 billion (Rev from RAA) x 33 percent (Afrezza market shares) = $3 billion
Using comparative market analysis obtain in the table above, the ultra conservative factor of 4 (MCap/Rev) for a small cap biopharmaceutical was multiplied by $3 billion revenues, thus, revealing the striking $12 billion market cap for MNKD. This was significantly higher than Mannkind current market cap of nearly $4 billion (or shares price around $10), representing significant market discounting and not fully comprehending Mannkind intrinsic or true value.
$3 billion (Afrezza Rev) x 4 (MCap/Rev) = $12 billion MCap MNKD
To quantify Mannkind shares price, we applied the calculated $12 billion MNKD market cap and divided it by 388 million shares outstanding, thus, obtained $31 PPS for MNKD.
$12 billion MNKD market cap ÷ 388 million shares outstanding = $31 per share
Scenario II presumed Afrezza gaining 66 percent of the RAA market, and computed $61 PPS for MNKD.
Afrezza would generate $5.94 billion sales revenue under the premise that it would gain 66 percent of the $9 billion RAA market. By multiplying $5.94 billion Afrezza future revenues by the factor of 4 (market cap per revenues), Afrezza would procure $24 billion market capitalization for Mannkind. Subsequentely, we calculated MNKD $61 PPS by dividing $24 billion MNKD market cap by 388 million shares outstanding similar to previous scenario.
$9 billion (Rev from RAA) x 66 percent (Afrezza market penetration) = $5.94 billion
$5.94 billion (Afrezza Rev) x 4 (MCap/Rev) = $24 billion MCap MNKD
$24 billion MNKD market cap ÷ 388 million shares outstanding = $61 per share
Scenario III assumed Afrezza would be achieving complete dominance or 99 percent of diabetes market, yielding the $91 PPS calculated for MNKD
Assuming Afrezza could capture 33 percent of the $9 billion RAA market, Afrezza should generate $3 billion sales revenue. Using CMA, we multiplied the factor 4 (MCap/Rev) by $8.91 billion revenues to arrive at $35.6 billion market cap for MNKD. The $91 PPS was quantified by dividing $41.58 billion market cap by 388 million shares outstanding.
$9 billion (rev from RAA) x 99 percent (Afrezza market shares) = $8.91 billion
$8.9 billion (Afrezza Rev) x 4 (MCap/Rev) = $35.6 billion MCap MNKD
$35.6 billion MNKD market cap ÷ 388 million shares outstanding = $91 per MNKD share
Scenario IV averaged Mannkind PPS from all three prior scenarios, revealing Mannkind true value of $62 per share
Given Afrezza revolutionizing pharmacokinetics and superb technological design, statistic would suggest that Afrezza should overtake much more than 33 percent of the RAA market ($31 PPS for MNKD). The best-case scenario for Afrezza, in which it completely dominate the market, yielding $91 PPS is reasonable due to Afrezza revolutionary edge.
Nonetheless, true valuation usually lies somewhere in between these extremes. Hence, we averaged out the three scenarios above ($31 , $91, and $61) at $62 PPS for Mannkind Corporation. This figure was in the proximity of the $61 PPS calculated in the second scenario that assumed Afrezza penetrating 66 percent of the RAA market.
($31 + $91 + $61) ÷ 3 = $62 PS of MNKD
Scenario V Excluded diabetes patients who also have COPD, a meager 6.1% or (1.3 million patients out of 21 million patients with diabetes) and shown $62 PPS for Mannkind
Researches shown roughly 16 percent patients with COPD also have diabetes. Calculations revealed 4.6 million out of 29 million patients with diabetes not eligible for Afrezza. In applying this exclusion to $62 PPS, the resulted share price would be $52 PPS for MNKD.
29 million x 16% = 4.6 million patient with cormorbid diabetes and COPD
16% x $62 = $9.9 PPS discounted COPD exclusion
$62 - $9.9 = $52 PPS for MNKD
Scenario VI. Mannkind share is worth $45 per shares after excluding patient with diabetes who also smoke and have COPD.
Research showed that 27 percent patients having diabetes and also smoke, which calculated out to be 7.8 million patients. This rate is comparable to the general populations.
To determine how much revenues from Afrezza should be discounting because Afrezza is contraindicated for smokers, I calculated that $14 would be generated from Afrezza revenues from smokers. Since Afrezza is not recommended for patient who smokes, I deducted $14 per share from the aggregate $52 shares price (representing the PPS that already excluded COPD) and arrived at $38 PPS for Mannkind.
27% x 29 million (diabetes and smoked) = 7.8 million patients to-be-excluded.
27% smokers x $52 PPS MNKD (DM both smoker & non-smokers w/o COPD ) = $14 PPS MNKD (Afrezza revenues from DM smokers w/o COPD)
$52 MNKD PPS (Rev composite that exclude COPD) - $14 (Rev. from diabetic smoker) = $38 PPS of MNKD
In complementing the traditional Graham-Dodd valuations models, 360 Biotech employed the intergrated approach focusing on critical catalysts such as the ADCOM votes, Afrezza FDA approval, market competitiveness and more importangly, leveraging on comparative market to gain better than average accuracy in valuating Mannkind Corporation true value.
We calculated Mannkind appraisal based on scenarios when Afrezza was able to capture 33, 66, and 99 percent market dominance corresponding to the share price of $31, $61, and $91, respectively. It's highly reasonable that the true share price lies somewhere the range of these extremes. To be statistically representative, we averaged out these scenarios plus excluding revenues from patients with COPD and/or smokers (not indicated for using Afrezza) and arrived at $38 per share. Even if Afrezza would perform similarly to competitors, Mannkind should enjoy much higher valuations in the future.
It's important to note that investing research is an imperfect science with interweaving elements of arts. Hence, not even Warren Buffett (Trades, Portfolio) could guarantee 100 percent accuracy in research analysis. Regardless, the odd overwhelmingly favored Mannkind as the prudent investment of a lifetime now that Afrezza was FDA approved. In spite of Mannkind stock currrently discounted and heavily shorted at $9.87 PPS, our extensive valuations proved the company should be worth at least $35 in the next year or two as it Afrezza sales would rapidly ramp up.
Peter Lynch also heeded investors to have realistic expectations and that a company's true values would not be unlocked over night. There, investors need to exercise patience and due diligence. In closing, Mannkind endured the decade long of trials and tribulations to take full advantage of the incoming "tide in the affairs of diabetes market," as well as, to deliver increasing values for shareholders.