***The following is excerpted from the May issue (5/6/15) of Nate’s Notes that was published for subscribers last weekend***

Keeping Things In Perspective

• For neither good nor evil can last forever;
• and so it follows that as evil has lasted a long time,
• good must now be close at hand.

 – from Don Quixote (Miguel de Cervantes Saavedra)

While there is plenty going on in the world that we could talk about this month, I will keep my general commentary fairly short in order to address a lot of the questions and concerns that have been sent in following MannKind’s recent earnings report and subsequent conference call.

In a nutshell, despite all the concerns being expressed by the talking heads on TV and elsewhere that “this is the top,” I want to remind you that while it is possible a top is forming, there actually is no evidence to back up the claim that the current uptrend has run its course.

In fact, as you can see in the Eyebrow Levels table below, all five of the major indices I use to gauge the health of the overall market are still flashing bullish signals, and while it is true that the BTK and SOX indices are both down a bit from where they were last month, both the biotech and semiconductor sectors are long overdue for some profit-taking… and, thus, for the time being, I am not at all concerned or surprised by their slight underperformance.  Yes, at some point it will be time to turn less bullish, but for now, you are encouraged to remain as fully invested as you can comfortably be while still sleeping easily at night.

MannKind Update

I have to admit that I have been unsure about where and how to start addressing all of the emails and questions that have come in regarding MannKind over the past 24 hours.  On the one hand, there really is not that much new to report as we patiently wait for the story to unfold, but, on the other hand, there are a number of you that have asked me to spend some time directly addressing the list of “alarm bells” that appeared in Adam Feuerstein’s latest blog entry regarding MannKind… so, naturally, I feel compelled to devote a fair amount of time to discussing the situation.

For those of you not familiar with him, Adam Feuerstein is a blogger who has been dead wrong with every single prediction he has made about MannKind and Afrezza over the past several years (clinical trial results, etc.), but rather than recognize or acknowledge that he clearly does not understand the story as well as he ought to given the amount of time he has spent on it, he instead continues to write negative column after negative column about the company.  The bad news for us is that his writings clearly influence the stock price over the short-term; the good news for us is that, in the end, the fundamentals of a story always end up winning out over “hype” in the stock market (even if our patience gets tested first).

That being said, I am torn between addressing his most recent column head-on (as some of you have requested, but which, in some ways, would suggest that I find his ideas worthy of discussion in the first place), or simply making some observations about the situation that might help put things in perspective and boost your confidence without giving him more attention than he deserves… and so I’ll probably end up doing a little bit of both in what follows.

First and foremost, I want to remind you that while the stock market is a very efficient pricing mechanism over the long-term (i.e. “the fundamentals always win in the end,” as mentioned above), it can be extremely inefficient over shorter time periods… and this is especially true when it comes to biotech stocks.

In addition, I think it is important to keep in mind that, while a lot of the bears howl about “how badly the stock will tank in response to the dilution” if MannKind ends up needing to raise more money via a secondary stock offering, the fact of the matter is that even if the company did a secondary offering, it would probably be for only 10 or 20 million shares at most… and this is nothing compared to the “extra” 100 million shares (give or take a few million) that have already been dumped on the market by short sellers (folks who borrow the stock in order to “sell high in hopes of buying it back low”).

With a little over 400 million shares outstanding, the roughly 100 million shares that have been sold short represent 25% of the total shares outstanding (talk about “dilution” and additional shares influencing stock price!)… but, unless the stock actually goes to $0, at some point, these shares will need to be repurchased in order for those traders to close out their positions and free the capital up for investment elsewhere.

To be sure, some of them will likely hang on hoping for $0, but once the stock starts to find some traction and begins to head north again (as I believe it will), I suspect the majority of those short sellers will realize their trade has run its course and they will start to cover (i.e. buy back) the shares they have sold short… and so, from a practical perspective, it is like there is a free “stock repurchase plan” in place (and a very sizable one at that!).  No, the covering is not underway yet, but in the same way that flooding the market with an extra 100 million shares has artificially depressed the stock price over the past several quarters, pulling those 100 million shares back out of the market ought to lead to a significantly dramatic move in the other direction as well.

And, speaking of secondary offerings, the company’s cash position, etc., I believe there are a few things to keep in mind on this front as well.

First off, while it is true that the company has a $100 million convertible debt due this summer, the company has suggested that it has a number of options on the table for meeting the obligation.  To be sure, they could be bluffing, but given the circumstances, I have no reason to believe they won’t be able to address the “problem.”  In addition, though management has essentially ruled out the idea of needing to sell more stock to meet the obligation, before you get too worked up over claims from the short camp that “the company is headed for bankruptcy,” I want to remind you that Al Mann has just under $1 billion of his own money tied up in the story, and it is extremely unlikely that he will be willing to watch that investment go to $0 for want of a “mere” $100 million (which he has personally, several times over, I might add).

Secondly, while it is true that the debt that MannKind is accruing as part of the $175 million line of credit that Sanofi has extended as part of profit-loss sharing agreement will have to repaid at some point, I want to remind you that a) if Afrezza is even somewhat successful, this shouldn’t be a problem, and b) should Sanofi ever make an offer for MannKind, that debt would almost certainly simply be absorbed as part of the purchase agreement.

No, I am not suggesting a buyout is imminent (and, in fact, I would rather see MannKind remain independent for as long as possible), but given the circumstances, it is certainly a possibility that we have to keep in mind as we study the cards on the table, especially when one considers the possibility that some of the “confusing” bookkeeping that has taken place with regards to booking milestone payments, etc., has possibly been done with a longer-term exit plan in mind.

As far as the company’s reference to Apple and iPhone sales goes, though Adam naturally chose to mock the comparison, I believe it is actually a far more legitimate comparison than he might want to admit, and I want to encourage you to keep the following in mind as you weigh the circumstances for yourself.

In particular (and in case you didn’t listen to the conference call), management pointed out that total iPhone sales in the first year that product was available barely amounted to a couple of percent of today’s sales of the same product line… thus reminding us that just because something starts small, it does not mean it cannot eventually grow quite large.

In addition (and perhaps more importantly), whereas there was good reason to wonder whether a sizable market would actually develop for a product like the iPhone (early sales numbers for the iPhone were also mocked by skeptics), we already know for a fact that there is a huge (and growing!) market worldwide for prandial (meal-time) insulin… and, while sales have admittedly been slow so far, I believe the benefits provided by Afrezza due to its unique pharmacokinetic profile strongly suggest it will eventually become the meal-time insulin of choice as time goes by.

There are a number of amazing stories from Afrezza users that are starting to pop up in the world of social media, and I have personally heard from a number of my subscribers that they (or a diabetic family member) are very pleasantly surprised at just how well the drug is working for them.  Not only are they achieving “unheard of” levels of control over their blood sugar levels, as pointed out before, as we enter an era when more and more diabetics are starting to track their blood sugars in real-time, they are naturally going to want an insulin that also provides real-time (or very close to it) control of those blood sugar levels… and Afrezza is the only product on the market capable of meeting this demand.

As those of you who listened to (and/or read the transcript of) the conference call already know, despite the nearly unanimous agreement among folks who have tried Afrezza that it is truly a “game changer,” MannKind and Sanofi have identified – and are working to fix – a number of issues that seem to be contributing to the slow adoption of Afrezza.

One of the issues they have identified involves the insurance authorization process associated with obtaining a prescription for Afrezza, and though it would have been nice to have all of the kinks on this front ironed out from the get go, it is not an uncommon problem to encounter when launching a new drug.  While we will have to wait and see how things actually play out, rest assured that Sanofi has a team in place that handles this sort of thing for other drugs on a regular basis, and the odds suggest they will be able to work with insurers to improve the process associated with prescribing (and reimbursing for) Afrezza as well.

Along with a cumbersome approval process for some combinations of doctors’ offices, patients, and insurance companies, MannKind also confessed that the lung test that is required prior to receiving a prescription is also proving to be a meaningful hurdle to adoption due to the fact that a higher than expected number of endocrinologist and diabetes specialist offices do not have their own spirometry machines for performing the test.

Of all the complaints that one could choose to levy against Sanofi and MannKind at this stage of the game, this “surprise” information probably has the most merit; however, as has always been the case for companies intent on achieving success, now that a problem has been identified, rather than sitting on their hands and muttering “it’s not our fault,” they are actively exploring ways to remove the hurdle from the equation (and the good news is that this is probably a fairly easy problem to overcome).

Tying things back to Apple and the iPhone again, in one of my favorite Steve Jobs press conferences of all time, I distinctly remember the absolute frustration and annoyance in his voice as he addressed the “Antennagate” issues associated with the release of the iPhone 4, a model that far and away represented the company’s most ambitious and impressive leap forward at the time.

In the same way that I can only imagine how annoyed Steve Jobs must have been that, after all the effort that had gone into delivering such a revolutionary product, he was forced to utter “fine – everyone gets a free case” in order to keep the product on track for success, I bet Al Mann is probably also thinking the same thing about this issue that appears to be holding back his game-changing Afrezza… and, though it is unlikely we’ll ever hear him say “fine, everyone gets a free spirometer,” it does appear that both Sanofi and MannKind are exploring the possibility of helping to make the test equipment available to doctors as part of their routine sales calls (and this, in turn, will likely be a win:win for all involved, as it will both speed up the prescribing process, as well as give those doctors an extra boost of reimbursement as part of performing the mandated – but very simple – procedure in their own office).

While one can argue whether or not the above two issues should have been identified and fully resolved ahead of time or not, the bottom line is that they are both issues that ought to be fairly easy to address, and thus, I do not consider either of them terribly worrisome as part of our longer-term outlook for the story.

However, just to make sure we’re not chasing windmills after all, I am going to take the same approach I did with Apple during that period after Steve Jobs passed away and people were starting to doubt whether or not Tim Cook did, in fact, have anything coming through the pipeline at Apple (of course, it turned out he did, and the stock has gone on to more than double “against all odds” (sic) since then).

In the same way that I picked an issue by which we needed to see some of the “really innovative products” Tim Cook always talked about (but that had not yet appeared) or we would start to reduce our position regardless of my optimism, I am doing the same thing with MannKind now.

In particular, I am going to use the January 2016 issue as our evaluation point, and over the course of the next eight or nine months, I would like to see at least one of the following events occur in order for us to maintain our current high level of interest in the stock:  a) data showing Afrezza is generating at least 2,000 prescriptions per week (up from the roughly 250 per week that it seems are being reported currently), and b) official public disclosure of at least one of the target drugs currently under consideration for use with the Technosphere platform.

That being said, if the stock was trading at $15, it would be much more difficult to know whether to buy it or sell it; however with it trading down here under $4 – especially when one takes into account the effort that has been put in by those with a bearish slant to bring it down to this price – I believe the risk/reward ratio is extremely skewed towards the reward end of the spectrum (and, in fact, it is telling us we should be buying the stock with both fists)!

Though the trading action we saw today (a “spike down” on much higher than usual volume) suggests to me that a bottom may have finally been put in, there is still a possibility that the real “capitulation” we need to see in order to mark then end of the downtrend may not come until sometime between Monday and Wednesday.

Either way, with the caveat that you should not own more of the stock than you can comfortably sleep with at night, I believe that the time has come for those of you who have been cautiously sitting on the sidelines waiting to either start a position or finally average down on a position you started several months ago to step up to the plate and make a purchase – no, we’re not out of the woods yet, but with such a large disconnect between the share price and the fundamentals of the story, I would be remiss if I was not pounding the table encouraging you to take advantage of the situation while it exists.  Stay tuned!

Top Picks (for new money this month)

All else being equal (i.e. you already own “pretty much everything” in the newsletter), my top picks for you this month are:

Cirrus Logic (CRUS) – Cirrus’ stock has been on a tear lately, and the fact that it is once again setting new muilti-year highs as we go to press suggests there may still be more to come.

Electronic Arts (EA) – EA’s stock has also been on fire for the past several months, and it, too, is breaking out into new high-territory (something that cannot be interpreted as anything but a bullish indicator).

Walt Disney (DIS) – Great relative strength here as well, with the opportunity for more new highs to be set in the weeks ahead if the overall market remains strong.

Outstanding Orders

For the reasons discussed above and below, the Model (Aggressive) Portfolio will sell 100 NXP Semiconductors and 100 Qorvo and will purchase (5,000) Affymetrix, 100 (1,000) Cirrus Logic, (1,000) Electronic Arts, 250 (2,500) Luminex, and 2,500 (35,000) MannKind.  We will use the closing prices on Monday, May 11^th, for all transactions.

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MannKind

I don’t know what else I can tell you about the MannKind story that hasn’t already been said, other than to remind you yet again that has become what I consider to be one of the most extreme examples of an “inefficient market” for a stock in the 26 years I have been doing this.  Also, though it in no way guarantees that the MannKind story will turn out anywhere near as well for us, I want to point out that Celgene’s stock was subject to a lot of the same sorts of irrational skepticism – and tested our patience almost as much – for several years in the late ‘90s before it finally took off for us.  If you’ve thinking about buying some MannKind, now is as good a time as any to get on board.  MNKD is a strong buy under $5 and a buy under $8.