By Ivan Deryugin
PropThink has been bullish on Questcor Pharmaceuticals (QCOR) for quite some time, and since our report highlighting the company's prospects late last year, shares have returned over 200% as the short thesis surrounding Questcor has continued to unravel. With solid 2nd quarter results, a platform for further growth, double-digit short interest, and a stock that is still undervalued relative to peers (as we'll demonstrate below), we believe that there's upside for long-term Questcor investors.
Well-Balanced Growth in Q2 2013
Questcor's results for the 2nd quarter of 2013 demonstrated that the company continues to grow Acthar sales across multiple indications in spite of continued criticism of the company's business model (our prior coverage of Questcor has delved into these issues in more detail). Total sales grew by 74% to $196.1 million, resulting in a 96% jump in pro forma EPS. Excluding the impact of $7.528 million BioVectra sales (more on this later), "organic" Questcor sales grew by over 57%, outpacing the 50% increase in vial shipments, from 4,710 in Q2 2012 to 7,050 in Q2 2013. In addition, the company saw solid growth across multiple Acthar indications, as shown in the table below.
We believe that Questcor's impressive growth in Q2 is to be noted given the fact that it was broad-based and EPS growth and sales both outpaced growth in vial shipments. But what matters more is Questcor's growth platform. Although the concerns surrounding Questcor and Acthar have thus far proven to be nothing more, the onus is on the company to demonstrate that it's built a business for the long-term. The 2nd quarter was Questcor's first with its expanded rheumatology sales force, which grew to 55 representatives from 12 this past February. CEO Don Bailey stated on the company's Q2 earnings call that Acthar's rheumatology launch was, in his view, the best Acthar launch in Questcor's history, and as this newly expanded sales force continues to build relationships with rheumatologists across the United States, further prescription growth is likely in Q3 and Q4. Rheumatologists generally prescribe an average of five Acthar vials per event, versus an average of 1.5 in MS relapses and 3.5-4.5 in infantile spasms. Questcor's growing rheumatology business will help the company diversify away from nephrology, which even now accounts for 40% of total Acthar sales (down from around 46% in 2012).
Questcor has been pursuing what is in effect a three-pronged strategy to secure future growth, consisting of expanding Acthar sales for currently approved indications, expanding Acthar's use into new indications, and acquiring select other assets, namely Synacthen and BioVectra.
Expansion via Two Pathways
Although Acthar is FDA-approved across 19 different indications, Questcor does not yet market Acthar across all of them. In mid-July, we covered Questcor's newest marketing effort, Acthar in symptomatic sarcoidosis, which affects 150,000 Americans. Acthar's label also covers its use in the treatment of lupus (technically SLE), however sales from this segment do not yet contribute meaningfully to Questcor. But, with an estimated 250,000 lupus patients in the United States, and with 25% of them failing to respond to existing treatment options, there's a clear need for new approaches. Questcor is currently running a Phase IV trial of Acthar in SLE patients with persistently active disease (NCT01753401). The trial, which will enroll a total of 36 patients, is designed to test Acthar at both a 0.5 mL and 1 mL dose, with a primary endpoint of a decrease in SELENA-SLEDAI scores for arthritis and rash, as well as whether or not patients see worsening in organ systems based on BILAG, another measure of lupus activity. The trial has a primary completion date of April 2014, and on its Q2 call Questcor reiterated that topline data would be available in 2014. With the lupus market to grow to an estimated $2.5 billion by 2017, there's certainly room for Acthar revenue growth in lupus alone, even if Acthar captures only a small portion of the market. Given that Questcor is projected to post sales of less than $723 million this year, even 10% of the 25% of patients that fail to respond to existing therapies equates to $6.25 million in sales based on projected 2017 figures, or the equivalent of almost 9% in incremental growth.
In addition to the SLE trial, Questcor is conducting a Phase IV trial of Acthar in idiopathic membranous nephropathy (also known as IMN) specifically focusing on proteinuria. The trial (NCT01386554), which will enroll 60 patients, has a primary completion date of June 2014 and will compare Acthar against placebo in patients that have failed to respond to existing treatment options, which include ACE inhibitors and statins. Enrollment and patient identification for the study has been poor, particularly given the fact that the study commenced in August 2011. Questcor CSO David Young noted on the company's recent conference call that many physicians have been hesitant to enroll patients given the chance that they'll receive placebo. Although there's nothing that Questcor can do to change that component of the trial, the company did recently alter its trial protocol to include a wider range of patients and now no longer excludes patients with progressive IMN. As with its SLE trial, Questcor expects top-line data in 2014.
Questcor is also conducting trials in two new indications for which Acthar is not already approved. Questcor is now conducting a Phase II trial (NCT01601236) of Acthar in diabetic nephropathy with a primary completion date of December 2013. The trial will include 40 patients, with changes in estimated glomerular filtration rates (eGFR) at week 36 serving as the primary endpoint. Secondary endpoints include changes in eGFR at week 52, as well as the complete or partial remission of proteinuria. With the global diabetic nephropathy market slated to reach annual sales of $2.35 billion by 2017 (we explored the diabetic nephropathy market in detail alongside our coverage of ChemoCentryx), the indication could be a lucrative market for Questcor.
But it's the 2nd label expansion program that we find more interesting. Lou Gehrig's disease, or ALS, is a notoriously difficult disease to treat, and the only FDA-approved therapy for ALS, Sanofi's (SNY) Rilutek, provides little in the way of meaningful benefits. The ALS landscape is littered with drug failures, most recently Biogen Idec's (BIIB) dexpramipexole, which failed in Phase III trials in January 2013. While it's too early to ascribe value to Acthar in ALS, investors might consider this a call option on the stock. If Acthar can show efficacy in treating ALS, the company's growth trajectory will meaningfully accelerate. Acthar is now in a Phase II safety and tolerability trial (NCT01906658) that will enroll 40 ALS patients into four different Acthar dosing arms (from 0.2 mL to 1 mL). The trial's primary endpoint is the proportion of patients that experience adverse events requiring either discontinuation or control with concomitants. Secondary endpoints include changes from baseline across a variety of clinical laboratory measures. Questcor has already submitted a request for orphan drug status to the FDA for Acthar in ALS. The study commenced in July 201. Estimates of the size of the ALS market are difficult to come by, given the fact that there Rilutek is the only approved therapy for ALS and it comes with questionable efficacy. Although Rilutek is estimated to have annual sales of $50 million in the United States, estimates for dexpramipexole sales went as high as $1 billion, and if Questcor can demonstrate that Acthar is both safe and effective in treating ALS, we see no reason that Acthar cannot reach meaningful sales figures. ALS affects about 30,000 people in the United States, and another 30,000 in Europe. Acthar in ALS clearly meets the criteria for orphan drug status (the FDA's threshold is less than 200,000 patients in the United States), and Questcor would have strong pricing power if Acthar is approved for the treatment of ALS.
Non-Acthar Growth Opportunities
In conjunction with solid growth prospects for Acthar, Questcor now has two other products and business lines from which to generate growth. The first is BioVectra, which Questcor acquired in January 2013 for C$50 million. BioVectra is a contract pharmaceutical manufacturer and also happens to be the manufacturer of Acthar. The acquisition of BioVectra will enable Questcor to bring Acthar manufacturing in-house, protecting its trade secrets and giving Questcor a growing pharmaceutical manufacturing business (at the time of the deal's announcement, Questcor stated that BioVectra grew sales by 15% in fiscal 2012 - the year ended August 31, 2012), and in earlier conference calls, stated that there should be a pick-up in BioVectra's revenues in the 2nd half of 2013. We expect more color on BioVectra when the company reports Q3 results in October. Questcor also acquired U.S. and select international rights to Synacthen and Synacthen Depot from Novartis (NVS) in June for $60 million and at least $75 million in additional payouts over the next 3 years. Questcor will also pay Novartis a milestone and royalties payment with FDA approval. Synacthen, a synthetic 24 amino acid melanocortin receptor agonist, is approved in more than 40 countries around the world but has never received approval in the United States. Synacthen is used in several neurological and autoimmune disorders such as ulcerative colitis, Crohn's disease, and rheumatoid arthritis. We expect more color on Synacthen in October given that on its Q2 earnings call, Questcor's management highlighted the need to "reenergize" the Synacthen business and formulate a new approach to managing it for long-term growth, both in the United States and internationally. Synacthen has a pharmacological profile distinct from that of Acthar, and CSO David Young stated on the company's Q2 call that Synacthen may even have therapeutic benefits exceeding that of Acthar in some of Acthar's existing indications. Questcor is now working with Novartis and its global Synacthen distributors to integrate Synacthen's global business into Questcor's.
Growth prospects aside, the bull thesis for Questcor is strengthened by the company's financial condition and valuation, both on an absolute basis and in relation to peers. Questcor ended Q2 2013 with $91.896 million in unrestricted cash & investments (and $75 million in restricted cash tied to its acquisitions) and $16.787 million in debt. With operating cash flow growing by over 46% in the first 6 months of 2013 to almost $123 million, Questcor's balance sheet remains strong. CEO Don Bailey went on record on the company's Q2 call saying that he wants to build the company's cash balances, effectively ruling out further large-scale acquisitions or business development deals in the near term. We note that unlike most biotechnology companies, Questcor pays a dividend of 25 cents per quarter, translating into a yield of 1.53%. Although this is not a significant benefit, most Questcor investors are growth investors, and it can be viewed as an added bonus.
Questcor continues to carry a reasonable valuation despite a rally of more than 144% already in 2013. The company trades at less than 14x estimated 2013 EPS, even though 2013 EPS will grow by over 46%, and almost 21% in 2014. On an absolute basis, Questcor trades at a PEG ratio of less than 0.3, (P/E multiple of 13.46 divided by 2013 growth rate of 46.25%), suggesting that shares remain undervalued.
Most importantly, Questcor remains undervalued when compared to a diverse set of peers, including multiple companies with just one product, as shown in the tables below.
Questcor's P/E multiples are well below peer averages and are even below those of the "Big 4" biotechnology companies, whose earnings growth in 2013 is noticeably lower than that of Questcor. The company also trades at a sharp price-to-sales discount, on both a 2013 and 2014 basis. Our only point of contention relates to Questcor's below-average earnings growth in 2014, when EPS is estimated to grow by less than 21% versus a peer average of 29.7%, excluding Questcor. However, 2014 earnings growth from peers is driven by Gilead (GILD) and Regeneron (REGN), which are coming off of an anemic 2013 (in terms of EPS). And in any case, Questcor currently trades at around 11x 2014 EPS versus an average P/E of over 36 for the group (excluding Questcor). Combined with the fact that almost 17% of Questcor's float is currently short, there's reason to believe that shares of Questcor have room to rise, particularly as the company provides more color on its various growth initiatives.
Even with a triple-digit rally in 2013, Questcor Pharmaceuticals is undervalued on a peer-comparison basis. The company has multiple growth initiatives underway, and a potential ALS indication for Acthar adds what is essentially a free call option to the stock. Backed by a solid balance sheet, high short interest, and a valuation that is well below peers on a variety of metrics, we believe that Questcor is well positioned to deliver upside for long-term shareholders.