"Insanity - doing the same thing over and over again expecting different results."
Questcor Pharmaceuticals (NASDAQ:QCOR)
Questcor is a biopharmaceutical company focused on therapies for patients with serious difficult-to-treat autoimmune and inflammatory disorders. Their primary product is H.P. Acthar Gel (repository corticotropin injection), an injectable drug with 19 indications, approved by the U.S. Food and Drug Administration (FDA).
Of these 19 FDA-approved indications, the company currently generates the majority of its revenue from the following areas: Infantile Spasms (IS), Multiple Sclerosis (MS), Nephrology, and Rheumatology.
The History of Acthar and How a Drug Bought for $100,000 Built a Billion Dollar Company
Questcor Pharmaceuticals derives nearly all of its revenue from its main marketed drug Acthar (ACTH is the main ingredient in Acthar). ACTH was first obtained by Mayo Clinic, a division of Armour and Company, in 1948. Scientists, studying rheumatoid arthritis, first discovered ACTH in the pituitary glands of pigs, as they investigated by-product development using by-products from their meat-packaging service. An early problem that was discovered, however, was that ACTH had a half life of only ten minutes, making widespread use difficult, if not impossible. In 1952, Armour was granted FDA approval to produce H.P. Acthar Gel (Acthar), a slow-release injectable form of ACTH. Starting in 1958, Acthar was used off-label for the treatment of infantile spasms.
"H.P. Acthar Gel is a highly purified sterile preparation of the adrenocorticotropic hormone in 16% gelatin to provide a prolonged release after intramuscular or subcutaneous injection. Also contains 0.5% phenol, not more than 0.1% cysteine (added), sodium hydroxide and/or acetic acid to adjust pH and water for injection. ACTH is a 39 amino acid peptide." (rxlist)
The rights to Acthar were later obtained by Rhone-Poulenc, which then became Aventis and now Sanofi. By 2001, Aventis had lost several million dollars per year on sales of only $500,000 producing Acthar. When Questcor came along in 2001, Aventis was more than happy to sell the rights to Acthar for $100,000 plus a royalty rate on sales over 10 million. With such low volumes and a low price, Acthar did not provide many initial benefits to Questcor upon acquisition. Either way, Questcor invested in a drug with great potential for a small price. Through marketing and price increases, Questcor was able to turn the potential of that one money-losing drug into an idea worth billions.
Protecting the Trade Secrets of Acthar from Generic Competition
One of the key risks that constantly faces Questcor is the threat of generic competition. Following the 2012 attack by Citron Research, concerns came onto the front page about threats of generic competition to Acthar. Bears claimed that Synacthen, a drug with slightly similar traits to Acthar, would shut down Questcor's business overnight if it was able to be marketed in the United States. Unfortunately for Bears, the opportunity for Synacthen to cause long-term headaches completely evaporated, following Questcor's acquisition of Synacthen. Concerns were not to be abated, however, as in 2013 new fears arose over a competitor drug from Retrophin (OTC:RTRX). Retrophin claimed to have created a drug with similar properties as Acthar and launched a lawsuit against Questcor, when they were outbid by Questcor for the rights to Synacthen.
In an excellent article by Andrew Colburn, Retrophin - A Peek Under The Veneer Of 2 Recent Additions, Mr. Colburn succinctly states why Retrophin offers very little if any threat to Acthar. (Seeking Alpha)
"On January 2, 2013, Questcor agreed to acquire Biovectra Inc. for fifty million Canadian dollars. It has been Questcor's manufacturing partner for the API in Questcor's H.P. Acthar® Gel (repository corticotropin injection) for nearly a decade. The acquisition will enable Questcor to further secure the manufacturing process trade secrets surrounding Acthar." (Questcor)
BioVectra was essentially a vertical integration play by Questcor. Questcor still holds the original trade secrets of how to make Acthar which they purchased from Aventis. BioVectra has been the sole producer of Acthar for Questcor for nearly a decade. By acquiring the only company that has the knowledge to produce Acthar outside of Questcor, they have ensured that any competition to create generic Acthar would be very difficult to accomplish.
"On June 11, 2013, Questcor announced that it had acquired rights to develop Synacthen® and Synacthen Depot in the U.S. from Novartis Pharma AG and Novartis AG. Synacthen is a synthetic 24 amino acid melanocortin receptor agonist. Synacthen Depot is a depot formulation of Synacthen. The products are approved outside the U.S. for certain autoimmune and inflammatory conditions, but have never been developed or approved for patients in the U.S.
Synacthen and Synacthen Depot are available in more than forty countries to treat a number of conditions including some rheumatoid diseases, ulcerative colitis, chronic skin conditions responsive to corticosteroids, nephrotic syndrome, acute exacerbations in patients suffering from multiple sclerosis or retrobulbar neuritis. Synacthen and Synacthen Depot are also used as a diagnostic test for adrenal insufficiency. Synacthen and Synacthen Depot are not approved in the U.S." (Questcor)
The ACTH polypeptide is made up of a 39 amino acid sequence which has been known since 1960. The problem is, however, that this is only the primary structure of the molecule. Polypeptides also have a secondary structure (which is often a helix), which is then folded into a tertiary, 3-dimensional structure. So far, no one has been able to deduce the formation of the 3-dimensional aspects of the molecule which is necessary for complementary configuration with membrane binding sites. The closest anyone has been able to come is with a synthetic form consisting of the first 24 native amino acid analogs, known as Synacthen, which are not as effective as ACTH.
Many short sellers had used the existence of Synacthen as a potential competitor to Acthar, since it was approved coverage of many similar indications as Acthar at only a fraction of the cost. Rather than face a potentially costly expansion overseas, as many shorts had hoped, CEO Don Bailey instead opted to purchase Synacthen outright and eliminate that potential problem once and for all.
The Controversy of Questcor
Questcor's parabolic move from under $.50 a share to a recent high of $80.00 has drawn many short sellers into the picture. Coupled with only one major drug on the market, many critics jumped on the company claiming that it was far overvalued and "too good to be true". The most notable critic of Questcor, from the short side, has been Citron Research which is ran by Mr. Andrew Left. Citron has been very critical of Questcor since 2012, originally claiming that the company was about to lose coverage on many of its indications by some of the major healthcare insurance companies such as Aetna. More recently, Citron has claimed that through independent lab testing that ACTH, the main ingredient in Acthar, has degraded in vials to the point that it provided no medical benefit.
In addition to criticism from short sellers, Questcor is also in the midst of an ongoing Federal investigation by the U.S. Attorney's Office, regarding their promotional practices. They have also been brought into the spotlight for large donations to the Chronic Disease Fund (CDF), which covers Acthar as one of the treatments for its patients.
"Credibility is like virginity; once you lose it, you never get it back."
- Andrew Left, Founder of Citron Research January 24th, 2008 (Citron)
On February 27, 2014, Citron Research released a newly updated attack on Questcor Pharmaceuticals. Citron has had a long history with Questcor dating back to some of their first attacks in 2012, and ultimately leading to a 48% loss on October 19, 2012. While every point that Citron has brought up so far has been managed to be refuted, they still carry a heavy weight.
Citron's most recent piece can be summed into several main parts:
A drug this good wouldn't be bought for $100,000.
Since Questcor doesn't have a patent on ACTH, it is at risk from a competitor who could synthesize a similar compound for much less.
The response to ACTH is just a placebo effect.
First, a drug can be bought for only a few hundred thousand if the seller does not realize the value of the drug. In this case, Aventis was eager to get Acthar off its hands. Questcor, understanding the potential of Acthar, was happy to oblige. Through numerous trials and studies, Questcor has been able to grow the Acthar's potential market from under a million with Aventis to estimates of several billion today. As they say, "one man's trash is another man's treasure."
Second, as previously stated in a prior section, fears of production of a generic Acthar are widely overblown. With Questcor's acquisition of Synacthen and BioVectra, they have solidified their holding on Acthar and eliminated most concerns over generic competition.
Third, in order for Citron to call Acthar a placebo, they produce evidence showing that Acthar provides no medical benefit and that any benefit seen would only come from patients believing they were receiving the real drug. However, this hypothesis breaks apart in several ways. One of Acthar's main treatments is for Infantile Spasms, dealing with children between the ages of four to eight months. Since the placebo effect is a psychological effect, it would be almost impossible for young children to go through this, meaning that any benefits seen are most likely the result of the drug itself. Also, if the drug was in fact a placebo, doctors and patients would have most likely raised that issue first, since they would have seen this issue first hand. Most patients seem too satisfied with their treatment and Acthar continues to be prescribed by more than 3,000 doctors.
FED Investigation of Questcor
On September 24, 2012, Questcor announced that it was being investigated by the U.S. Attorney's Office (USAO) for the Eastern District of Pennsylvania regarding their promotional practices of their flagship drug Acthar. At the time, ThinkEquity analyst Jim Molloy thought that the investigation was most likely centered around possible kick-back payments to doctors. (Reuters)
On October 30, 2013, Questcor released, during their 3rd Quarter Results, that the U.S. Attorney's Office for the Southern District of New York and the Los Angeles SEC branch had joined the investigation.
While investors may be afraid of these developments right now, it is important to understand that such investigations can take time to play out. Also, some might assume that more agencies mean more trouble for Questcor but with the timing of the government shutdown and budget cuts which puts more pressure on any one agency, it is possible that more agencies were needed to continue the investigation. It is important not to forget, however, that the investigation, now in its second year, has yet to release anything of note regarding illegal practices by Acthar.
"When we look into the history of unlawful promotional practices (usually off label marketing) and fines, here is what has been discovered:
First, from 2010-2012: There were 21 pharma settlements for unlawful promotional practices, total settlements of $5.35 billion. The average fine appeared to be about: $250 million.
Second, from 2010-2012: There were approximately 18 pharma settlements for unlawful promotional practices, total fines of $2.45 billion. Note: this model eliminates the three largest fines, each of which was negotiated with a global pharma and for a multi-year track record of off label marketing and kickbacks often covering more than one drug product--which is probably not QCOR's category. Average fine is estimated at $136 million." (Seeking Alpha)
Based on estimates ranging from $136 million to $250 million (using the estimates provided above) at most the fine would be a slap on the wrist for Questcor, provided they are even found guilty of any charges. Based on the current fully diluted share count of around 62 million, this would be worth about $4.00 of Questcor's current share price, using a $250 million fine.
Chronic Disease Fund Worries
One of the biggest issues to arise in the Questcor debate is the association between Questcor and the Chronic Disease Fund (CDF). Shorts have made the argument that Questcor is a major donor of the CDF and in return the CDF promotes Questcor's drug Acthar over competitors, an illegal activity punishable up to a fine of $50,000 and five years in jail. Shorts then further postulate that if Questcor has to cease all connections with the CDF, its core business will take a serious hit that it could not recover from.
"The Chronic Disease Fund® is an independent 501(c)(3) non-profit charitable organization that helps patients with chronic disease, cancer and other life-altering conditions to obtain the life-saving medications they need." (cdfund)
While it is true that Questcor has donated money to the CDF at the tune of nearly $12 million a year, this is less than a tenth of what the CDF brings in and certainly not what would constitute being a major funder of the CDF. Additionally, as a whole, the revenue that comes from the CDF contributes less than a quarter of the total sales of Questcor.
Questcor - An Unparalleled Opportunity
Growth of Acthar Indications
Acthar is currently approved for 19 indications, with the majority of their sales coming from only four areas so far. Clearly this drug has the potential to be a complete blockbuster, if it isn't already one. It also brings up the choice of which is better: 19 different drugs each approved for one indication, or one drug approved for 19 different indications.
Just to reinforce this point, any company that was theoretically able to produce a compound with the exact same effect as Acthar would still face great difficulty bringing it to market. They would need to launch clinical trials and get approved for every single indication Acthar is currently approved for, a feat that could take tens of billions of dollars and many years to do.
Questcor is also in trials for five new indications for Questcor:
IDIOPATHIC MEMBRANOUS NEPHROPATHY (Phase 4)
SYSTEMIC LUPUS ERYTHEMATOSUS (Phase 4)
DIABETIC NEPHROPATHY (Phase 2)
AMYOTROPHIC LATERAL SCLEROSIS (Phase 2)
ACUTE RESPIRATORY DISTRESS SYNDROME (Phase 2)
Orphan Drug Status
When Questcor bought Acthar from Aventis back in 2001, Acthar was considered a normal drug, that is to say, it wasn't cleared as an orphan drug. In 2003, however, this all changed. Acthar was granted orphan drug status due to its lifesaving capabilities for Infantile Spasms and Multiple Sclerosis. Companies that develop an orphan drug (a drug for a disorder affecting fewer than 200,000 people in the United States) may sell it without competition for seven years, and may get clinical trial tax incentives.
This allowed Questcor to significantly raise the price to close to $23,000 a vial, due to the incentives that the FDA allows for drugs that have achieved orphan drug status. With the price per vial currently around $30,000, and pricing continuing to increase by about 5% per year, there is significant opportunity for improving pricing. Because the orphan drug status applies to Acthar as a whole and not just for the treatment of one indication, Questcor is able to charge that rate through all of its indications it is approved for, not just the original ones; Infantile Spasms and Multiple Sclerosis. This also allows Questcor to remain relatively insulated even if competitors do manage to break into one of Questcor's indications.
Continued Coverage by Insurers
In late 2012, Questcor said that Acthar was eligible for lower Medicaid reimbursement rates. Given that many bears on the company considered Acthar to be no better than snake oil, this was a huge validation. It is also worthy to note that Medicaid is typically considered the most stringent of medical reimbursers, so this was a massive win for the Questcor bulls. Where Questcor typically had to give away vials for free to Medicaid patients, it would now only have to waive 23.1% of the cost. This opened up a significant new revenue opportunity without having to recruit a new sales force or having new indications approved. Other insurers have continued to cover Acthar with no drop in coverage.
Large Short Interest
Short Interest has stayed highly elevated for many years now. This stems from the belief that any hiccup in this company could send it spiraling lower. As of February 14, 2014, 18.4 million shares were sold short. This relates to over one-quarter of the outstanding float being sold short. (Nasdaq.com)
Due to the recent price drop amid allegations by Citron Research, this number will probably increase quite dramatically. However, given that Questcor was at all-time highs two weeks ago, many of the short sellers are underwater on their position. This could create a quite powerful move to the upside, if the share price starts to recover. This is also known as a short squeeze. An example of this can be seen following Citron's hit piece in 2012, when the price rallied from around $20.00 a share to over $60.00 a share.
Stellar Financial Performance
Questcor offers a unique opportunity within the healthcare sector. It offers the potential of being insulated from competitors with a large potential market, all while already having a drug on market and being consistently profitable.
For the 2013 fiscal year, Questcor shipped 28,112 vials, an increase of 36% over 2012. The firm also finished with $798.9 million in sales, an increase of 56% over the prior year. This has translated into $4.76 GAAP Earnings per share.
Questcor has managed to do this without sacrificing its margins. During 2013, its margins stood at:
Gross Margin of 90.7%
Operating Margin of 55.15%
Profit Margin of 38.4%
These are incredible numbers by any standard, providing the basis for Questcor to deliver great shareholder value to investors over the long term. Equally impressive is the long-term growth rate which calls for Questcor to grow its earnings at around 30% a year for the next five years. This would give Questcor a very low PEG ratio of 0.51. Coupled with the terrific margins, Questcor offers a tremendous value opportunity solely based on its financial metrics.
Shareholder Friendly Management
Questcor shareholders have benefited immensely from a shareholder-friendly management. In 2012, management initiated a dividend initially at around 2%. This has since been increased to be about 20% of annual profits, according to management.
Questcor has also been steadily buying back their shares which now number around 62 million shares outstanding, down from 68 million in 2008. In the fourth quarter alone, Questcor bought back nearly one million shares. Questcor still has approximately 5.3 million shares authorized for buyback, or 12% of the current fully diluted share count.
The most important news to reach investors from management over the last few months is management's willingness to either go private in a leveraged buyout or to establish themselves in a more tax-friendly nation such as Ireland. According to CEO Don Bailey, Questcor formed an advisory committee to decide what to do with the firm's free cash flow, which was running at more than $100 million a year. Bailey said they were open to anything including going private or making a tax-saving acquisition that would relocate the firm in Ireland, as has been popular in specialty pharma as of late. This set Twitter abuzz as Questcor has usually sunk its cash into share buybacks and Acthar expansion.
Questcor Pharmaceuticals is a firm that continues to grow its sales at a rapid pace without forcing its margins to suffer. They have also actively taken steps to ensure that the production of their main drug Acthar stays safe in company hands and that overseas competition, such as Synacthen, has been bought out. Questcor has also mentioned that they are open to relocating the business to a more business-friendly country or even taking the company private.
Although Questcor's position remains positive, the firm continues to face significant criticism from short sellers, mainly Citron Research, saying that Questcor is massively overvalued. Because of this, shares remain quite volatile, and because of only having one drug on the market, albeit with 19 different indications, Questcor typically trades at valuations lower than its peers. This offers great opportunity to investors as management takes steps to improve shareholder value, all while trading for lower valuations than its peers.