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A Worthwhile Long-Shot Bet on MannKind?
Jan 10 2011

We reviewed MannKind Corporation and its AFREZZA inhaled insulin product in great detail in our 10-page December 17, 2010 report. In this article, we analyze the dynamics of speculating on MNKD January $9 calls in the aftermath of the Food & Drug Administration’s roughly four-week delay in announcing its decision on the company’s application to market AFREZZA. The operative word here is “speculate,” because it encapsulates precisely what we do in this article. Indeed, absent a definitive ruling by the FDA, all purchases (or shorting) of MannKind stock or options represent an entirely speculative bet.

 

The January $9 call is, in our view, a relatively cheap way to speculate on an event that could prove extraordinarily profitable. Call options with later expiration dates certainly provide a higher chance of a favorable outcome, but they are more expensive and consequently offer less attractive capital returns potential. That said, readers should also be fully aware that the odds are heavily tilted towards an unfavorable outcome.

 

The profitable purchase of MannKind’s January $9 calls requires three events to occur.

1.   The Food & Drug Administration must announce a decision before the market closes on January 21st.

2.     The FDA’s decision must be the approval of AFREZZA.

3.    MannKind shares have to move above $9 plus the price paid for the option, currently around $0.40.

 

We think there is at least a 50/50 chance that the decision will come out by the 21st. The FDA was presumably well along in the review process when it announced two days before the PDUFA action date that it needed about four more weeks to complete its work. While certainly possible, it’s unlikely that the FDA would have waited until the 11th hour to announce the delay if there were still a lot of work left. Moreover, it’s likely that the regulators asked for more time than would be necessary to avoid having to ask for additional time yet again. It’s also reasonable to assume that the decision will be announced as soon as the review is completed.

 

In our original report, we suggested that AFREZZA would probably be approved, considering its solid efficacy and safety profile, along with its ease of use and likely pricing. The absence of another Complete Response Letter (requesting more data), in late December was probably a slight net positive, bearing in mind that everything would have be fine for FDA approval whereas just one problem would give the FDA cause to reject the NDA (new drug application). So, we would peg the odds of approval to be at least 50/50.

 

As for the third event, the occurrence of events one and two would undoubtedly push the stock beyond $9.40. Indeed, the odds of this outcome following the product’s approval before January 21st is probably close to 100%. In fact, the relatively large short position in MannKind stock, plus the generally negative investor sentiment towards the stock, as underscored by the prevailing prices for the underlying puts and calls, strongly suggests that a positive FDA decision would fuel a substantial rally.

 

This series of speculation suggests that the probability of the $9 calls proving profitable is around 25%. So, if one thinks the stock will rise to around $10, then these options wouldn’t be a good bet. On the other hand, they would represent an attractive bet for speculators envisioning a share price that exceeds $11. At more than $11, the payoff to the apparent one-in-four bet would be greater than five-to-one.” At a stock price of $13, a $400 bet would return approximately $4,000. On the flip side, the speculator would most likely lose his or her entire investment/bet if any of the three events noted above didn’t happen.

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