The Idiot's Guide To Why Questcor Is Suspicious

Dec.19.13 | About: Mallinckrodt PLC (MNK)

There's tons of smart people that invest everyday on both sides of every stock on the big boards. Bulls make their arguments and bears make theirs, ultimately driving the price of a stock either up or down depending on which side gathers the most support.

With Questcor (QCOR), I'm baffled. Let me preface by saying I'm not trying to insult anyone here, just laying out my case.

I'm baffled because you don't need a Harvard Business School MBA to figure this one out. You don't need a MBA at all. You don't need a finance degree, you don't even need a college education. You may not even need a high school education. Rather, you just need some street smarts to wrap this case up in one glance. If it seems too good to be true, it generally is - even some of the dimmest and most undereducated of individuals know this.

Questcor stock has gone through the roof in the last few years, yielding enormous paydays to both its investors and its executives. As manic delirium sets in, analysts and bulls seem to have glazed over some of the possible inner workings of the company, for benefit of "if it isn't broke, don't fix it".

Meaning, similar to the hysteria over at Herbalife (NYSE:HLF) - as long as the stock's going up, who cares what's happening behind the scenes? It's a mindset that even the best of investors has been guilty of from time to time - myself included.

But, I've since learned from that, and seem to see Questcor in a clear light.

For more into my previous thoughts on QCOR, you check out the two articles I have published on them (here and here).

I was content with my arguments against Questcor for the time being, until it was announced this morning that Whitney Tilson was short the stock. With this announcement, bulls who have no idea why short selling is vital to a market flipped out, calling him a market manipulator - and I started to do a little more reading into how the Chronic Disease Fund, and it's association with Questcor.

Tilson's e-mail to ValueWalk said the following:

I hadn't gotten around to writing about one of my newest short positions, Questcor Pharmaceuticals Inc ((NASDAQ:QCOR)), so I owe a debt of gratitude to this article in tomorrow's NY Times, which does a nice job of laying out key parts of what I believe is a scam of epic proportions (I've also included the recent Barron's and Seeking Alpha articles that the NYT article links to).

You really can't make this one up. Just over six years ago in Aug. 2007, this stock was at $0.35 - so how did it increase 158x to today's closing price of $55.18, giving this former penny stock a $3.3 billion market cap? Easy: just increase the price of its one product (H.P. Acthar Gel, a 60+ year old drug acquired for $100,000) from $40 to more than $28,000 a vial (that's not a typo - a 700x increase!). Believe it or not, our insane healthcare system allows this, as insurers are paying it - which, of course, means that all of us are.

Questcor Pharmaceuticals Inc ((NASDAQ:QCOR)) has done all sorts of questionable things to juice Acthar sales so various investigators are circling and medical professionals are asking tough questions, so the smart money is betting that this is a house of cards about to collapse (38% of the float is short). But in the meantime, many investors, cheered on by Wall St. "analysts", are drawn to the company's rapid growth, sky-high 40% after-tax margins, and modest valuation (12.7x trailing EPS and 7.2x EV/EBITDA).

The NY Times also posted an article questioning the Chronic Disease Fund's relationship with Questor this morning. In keeping in the vein of things that just sound a little fishy, let's just take a simple review of the CDF and its interactions with Questcor based on the facts that we know.

And, in the interest of giving people the cliff notes and getting all the cards on the table, let's see what doesn't make sense about Questcor, and where some of my doubt stems from. Given, one of these items would be enough to raise a red flag - all of them together? Well, you can lead a horse to water ...

After reading each of these, ask yourself, "Does this make sense?"

1. Questcor's one drug - H.P. Acthar Gel - is a 60 year old drug, that was acquired for $100,000 in 2001 from Aventis - who claimed a "dwindling market for the drug". Questcor raised the price by a factor of 700 from $40 to $28,000 a vial. Questcor is now a 3.5 billion company based on a $100,000 drug. Make sense to you?

2. Questcor's promotional tactics of said drug are under investigation by the FTC, DOJ, SEC and two U.S. Attorney Generals offices. Make sense to you?

3. Questcor's insiders and stockholders have made ungodly amounts of money over exploiting this price raise and making insurance companies foot the bill. Insurance companies could be catching on. Where is the money coming from? Make sense to you?

4. Do you know how the Chronic Disease Fund works? Read this write-up from the New York Times:

As drug prices have soared in recent years and insurers have increased co-payments, a new type of charity has blossomed to fill a vital niche - helping patients pay the steep out-of-pocket costs for their medicines.

But the largest of these co-payment assistance charities, the Chronic Disease Fund, is now in turmoil after questions have arisen about its relationship with a pharmaceutical company that is itself under investigation for its marketing practices.

The practice is casting light on what has long been an open secret: The bulk of the contributions to these charities come from the pharmaceutical companies. The foundations not only help hundreds of thousands of patients a year, they also raise drug company sales and profits.

After all, if a patient cannot afford out-of-pocket costs of $5,000 for a $100,000-a-year drug, the drug company gets nothing. But if the manufacturer or the charity pays the $5,000, the patient gets the drug and the company receives $95,000 from the patient's insurance company or Medicare.

The contributions - which also provide tax deductions to drug makers - are legal as long as a company does not require that the money it donates be used exclusively to pay for its own drugs.

But articles circulating in the investment world have suggested that the Chronic Disease Fund might be showing improper favoritism toward Questcor Pharmaceuticals, which sells an expensive drug for immune diseases. Moreover, the articles noted that the charity was purchasing millions of dollars a year in services from for-profit companies owned by the charity's founder and president, Michael Banigan.

Questcor and the charity have said they are victims of a campaign by short-sellers - investors who benefit from the decline of a stock's price.

Make sense to you? Questcor donates to a charity that provides people with the co-pay necessary for insurance companies to pay the whole amount for the drug. That's like putting a $20 into a change machine and getting $100 in bills back. Who wouldn't stand there and just keep doing it until the well runs dry.

The problem is, the gravy train has to end at some point.

And Questcor is blaming it all on the shorts, like they're the ones conducting Questcor's business. All the shorts are doing is stating their case which, if I do say so myself, makes a lot of sense.

Tilson is, in my opinion, going to be the first in a long line of individuals who will be able to see clearly that something is out of whack here. We may not be able to pinpoint exactly where Questcor is going to find its "death blow", but there are certainly a considerable amount of options on the table. I'm predicting that there's going to be more shorts in QCOR, and it's going to force downward pressure on the stock.

There's enormous risk with Questcor and many other vehicles for investors to go long in - why would you risk it with a company where the pieces don't add up?

I also want to make it clear that I closed my short position on QCOR a little while back, but am considering opening another one. I'm offering that disclosure to divert the myths that come with an article when you're short a stock (generally, conspiracy nuts claiming you're colluding with hedge funds or Seeking Alpha to launch "attacks"). It's not an attack, folks. It's the truth - and those who can see it deserve to profit from making the correct trade. That's just the Darwinism that is the public markets.

Best of luck to all investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.