On the surface, Retrophin (NASDAQ:RTRX), which according to its most recent 10-K filing is a "fully integrated biopharmaceutical company focused on the development, acquisition and commercialization of therapies for the treatment of serious, catastrophic or rare diseases", seems to be an up-and-coming force in the world of biotech. The company was founded by an apparent wunderkind, the now 31-year-old CEO Martin Shkreli, who graduated from college while a teenager, and worked at several hedge funds prior to founding Retrophin. Numerous bullish articles regarding the company have appeared on various financial websites. In addition, Roth Capital raised its price target in February for Retrophin to an astronomical $51 (since lowered to $39), which would value the company at over $1.25 billion (based on 25,485,339 shares currently outstanding, as per the most recent 10-Q filing).
So, given all of this, what's not to like? Unfortunately, plenty. This article examines numerous red flags regarding Retrophin, which I believe the market has not fully considered given Retrophin's gaudy $350,000,000 market capitalization. While nothing is certain in life (or investing, for that matter), given the many red flags discussed herein, I believe that, at best, a share of Retrophin is a $14 lottery ticket. In addition, for the reasons set forth herein, a price target of $3 per share seems reasonable for the company.
Red Flag #1 - Retrophin was formed via a Reverse Merger with a "Shell" Company
Retrophin was formed via a reverse merger with a shell company, Desert Gateway, Inc., in December 2012. The specifics regarding the reverse merger transaction can be found here. Reverse merger companies are much riskier to invest in than companies that become public through IPOs, because the former receive no vetting by investment banks prior to the sale of their shares to the public. Reverse mergers were the primary vehicles by which numerous Chinese companies, later exposed as frauds, became publicly traded companies in the United States. For a good discussion of this phenomenon, see here. In fact, in 2011, the SEC went so as far as to issue a bulletin to investors warning them of the risks inherent in investing in reverse takeovers (or RTOs). In issuing this release, the SEC stated that "[g]iven the potential risks, investors should be especially careful when considering investing in the stock of reverse merger companies".
Interestingly, a little digging shows that Desert Gateway (the predecessor company to Retrophin) was, as of February 29, 2012, controlled by an entity owned by a certain Ruth Shepley, as evidenced by the following excerpt from Desert Gateway's 2012 10-K filing:
The following table sets forth certain information regarding the beneficial ownership of our common stock as of February 29, 2012 by (1) each person who is known by us to own beneficially more than 10% of our outstanding common stock; (2) each of our officers and directors; and (3) all of our directors and officers as a group. None of the current shareholders have received or will receive any extra or special benefits that were not shared equally (pro-rata) by all holders of shares of our stock.
Name and Address of Beneficial Owner
Amount of Common Stock
Percentage Ownership of
IACE Investments One, Inc. *
All Officers and Directors as a Group (1 person)
* IACE Investments One, Inc. is a Nevada corporation owned by Ruth Shepley
Why is Ruth Shepley's connection to Desert Gateway (and hence Retrophin) important? According to this article from Sharesleuth.com, Shepley has been instrumental in creating various shell companies in the United States that have later been implicated in Chinese RTO frauds. According to the ShareSleuth article, Ms. Shepley helped create the vehicles that became Telestone Technologies Corp. (NASDAQ:TSTC), China Bio-Energy Corp. (CHIO) and CH Lighting International (OTC:CHHN), all of which now trade at pennies on the dollar in the Pink Sheets, or have had their listed status revoked by the SEC.
No evidence has been uncovered that the founders of Retrophin knew of Shepley's background when they decided to do a reverse merger with Desert Gateway. However, the fact that Retrophin was conceived of as a public company through a reverse merger, and in association with someone with a history of being complicit in the facilitation of Chinese RTO frauds, should give investors pause, to say the least.
Red Flag #2 -The Track Record of Retrophin's CEO and CFO is Less Than Reassuring
Retrophin is led by a 31-year-old CEO named Martin Shkreli (see Wiki entry here). Shkreli formerly managed two hedge funds, Elea Capital and MSMB Capital. Notably, prior to Retrophin, Shkreli never worked at a biotech or other pharma company in any capacity, much less having a senior executive position; nor does he have an academic background in medicine or pharmacology (actually, he received a bachelor's in business at Baruch College - see here). He has also never seen a drug through the process of FDA approval. Thus, no track record exists on which investors are able to judge how competent the CEO actually is. It should also be noted that Shkreli and the entities with which he has been associated have been sued on multiple occasions for failure to pay debts and honor contractual obligations (see here, here, here, here, here and here; note that these and further court filings are publicly available via the New York State Supreme Court's website, searchable by index number and party name).
Can Retrophin investors at least take solace in having a seasoned CFO in Marc Panoff? After all, in announcing Panoff's appointment as CFO, Shkreli stated that "Marc has a successful track record as a financial leader in both established public companies and private start-up environments". A closer look at Panoff's track record, however, reveals a pattern of consistent destruction in shareholder value at the public companies for which Panoff has served as CFO. Panoff last held a CFO position at Neurologix, Inc. (OTCPK:NRGXQ), to which he was appointed in January 2006. In 2012, Neurologix filed for bankruptcy, and its shareholders were completely wiped out, with Mr. Panoff resigning as CFO shortly before the company's Chapter 7 filing. Prior to his stint at Neurologix, Panoff was CFO at Nephros, Inc. (OTCQB:NEPH) from 2004 to 2006, during which period Nephros's stock price went from $6 per share upon its IPO in September 2004 to $1.38 per share on January 11, 2006, the date of Panoff's departure, a total decline during his CFO tenure of 77%. Nephros currently languishes in the Pink Sheets, with a market cap under $20 million. Thus, in his prior two stints as a CFO at a public company, Marc Panoff has compiled the following track record:
Red Flag #3 - Retrophin's Liquidity Situation Appears to be Increasingly Strained
Based on recent SEC filings by the company, it appears that Retrophin is running out of cash and could have issues meeting its financial obligations in the foreseeable future, unless it resorts to further equity dilution. The Q1 2014 10-Q states the following in plain English on p. 25:
Management believes that we will continue to incur losses for the foreseeable future. Therefore we will either need additional equity or debt financing, or need to enter into strategic alliances on products in development to sustain our operations until we can achieve profitability and positive cash flows from operating activities, if ever. Our continued operations will depend on whether we can successfully raise additional funds through equity and/or debt financing. Such additional funds may not become available on acceptable terms, if at all, and we cannot assure you that any additional funding we do obtain will be sufficient to meet our needs in the long term.
This statement seems to contradict the CEO's statement in an April press release that "we have no need… to explore a dilutive equity offering unless it is accompanied by an accretive and strategic acquisition", the substance of which was repeated during Retrophin's Q1 2014 earnings call. It should be noted that Retrophin has never issued any institutional debt during its history, so the company's access to debt financing on anything other than onerous terms is unclear.
Retrophin burned through over $40 million in cash in the first fiscal quarter of 2014 alone through operating activities and investing activities, and ended the quarter with just $3.7 million in cash, as shown in the table below. This was on top of the $23 million in cash burned in operating activities and investing activities during 2013. Indeed, the only thing that has kept Retrophin solvent during 2013 and thus far in 2014 has been dilutive equity issuances.
The estimated cash burn for Retrophin for the 12 months ending March 31, 2015 can be calculated as follows:
Note that the company issued updated revenue guidance in May 2014 (itself a replacement of updated guidance issued in April 2014), in which it claimed that revenues for 2014 would now be between $20,000,000 and $22,000,000, instead of between $10,000,000 and $12,000,000 (as asserted on February 12, 2014, when the Manchester acquisition was announced). This updated guidance, however, should be viewed with a grain of salt, in light of the fact that the company generated a mere $27,900 in revenue in Q1 2014. Regardless, even if the updated guidance at the high end proves to be accurate, Retrophin's cash deficit at March 31, 2015 would still be well in excess of $50 million, assuming the company does not raise additional funds during the period and/or greatly slash its expenses (which obviously would delay the development of its pipeline).
As a consequence of Retrophin's liquidity situation, Retrophin's auditor included the following cautionary language in the 2013 10-K:
[Retrophin] is a development stage enterprise with no revenues, historical losses and limited capital resources. The Company, as a development stage enterprise, is subject to risks and uncertainties as to whether it will be able to raise capital and commence its planned operations. These conditions raise substantial doubt about the Company's ability to continue as a going concern.
Indeed, just to fund its anticipated operations through the end of Q2 2014 (a mere month away), Retrophin needs to raise substantial additional cash and/or issue debt. Retrophin will need to fund an $11 million installment payment for the Manchester acquisition by the end of June. R&D and G&A expenses for the quarter should be approximately $7 million (per the above chart); and other expenses may amount to an additional $7 million (also per the above chart). With just $5 million in cash and marketable securities on hand as of March 31st, and the level of revenue during the quarter unclear (as further discussed below, Manchester's assets generated only $1.25 million in revenue during Q1), Retrophin has left largely unexplained specifically how it plans to close the approximately $15-20 million projected cash deficit by the end of the current fiscal quarter, other than stating on the most recent earnings call that it could sell treasury shares on the open market.
Red Flag #4 - Large Investor Sold Most of its Retrophin Shares Shortly After Disclosing its Position
On April 2, 2014, one of Retrophin's largest shareholders, SAC Capital, sold over 75% of its position in Retrophin, reducing its holdings from 1,291,474 shares to 307,490 shares, which position was originally disclosed in January 2014 - see here and here for the relevant SEC filings. Apparently this large holder of Retrophin did not have much conviction regarding the company as a long-term investment.
Red Flag #5 - Disclosure of Material Weaknesses; Failure to Report Material Litigation in SEC Filings
Retrophin disclosed the following in its Q1 2014 10-Q, p. 28:
As of March 31, 2014, we had identified certain matters that constituted material weaknesses in our internal controls over financial reporting, specific material weaknesses include the fact that we *i* have experienced difficulty in generating data in a form and format that facilitates the timely analysis of information needed to produce accurate financial reports, *ii* have experienced difficulty in applying complex accounting and financial reporting and disclosure rules required under GAAP and the SEC reporting regulations, and *iii* have limited segregation of duties.
Indeed, in its brief history, Retrophin has already had to restate its financial statements to correct improper recording of the costs of warrant issuances, overstating consulting expenses and failing to disclose the payment of liquidated damages owed to investors under a prior registration statement (see the most recent 10-Q, pp. 9-10, for further details).
In addition, it appears that Retrophin has not reported material pending litigation in its recent SEC filings in accordance with Regulation S-K, Item 103. This Item states that a company must:
Describe briefly any material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the registrant or any of its subsidiaries is a party or of which any of their property is the subject.
In Retrophin's most recent 10-Q filing, the company stated that no material pending legal proceedings existed concerning the company. However, a lawsuit by Guggenheim Securities, LLC against Retrophin exists (see the complaint linked above), which appears to have been pending on March 31, 2014 (the balance sheet date) and May 15, 2014 (the date of filing of the 10-Q). The complaint demands the payment of $746,739, which is an amount greater than 10% of Retrophin's current assets as of March 31, 2014. Per Item 103, best practices dictate that any litigation regarding an amount in dispute above 10% of a registrant's current assets should be reported as "material" (i.e., a fact that a reasonable investor would want to know). It should also be noted that the Guggenheim litigation existed on the date the 2013 10-K was filed (March 28, 2014), and was not reported therein either.
In addition, Retrophin filed an antitrust lawsuit against Questcor in January 2014 (see here), which is also not disclosed or discussed in either the 2013 10-K or the Q1 2014 10-Q. Certainly, one could reasonably believe that such a lawsuit would be considered "material" to an investor, and therefore, should be disclosed in Retrophin's SEC filings.
Red Flag #6- Repurchasing Shares Ahead of Equity Issuance
During December 2013, Retrophin repurchased 222,851 shares of its stock, just ahead of its January 2014 equity issuance. See the following excerpt from the 2013 10-K:
The total volume of all Retrophin shares traded during December was 3,134,400, meaning that Retrophin was responsible for buying in excess of 7% of the total volume during that month. Was Retrophin attempting to support its stock price ahead of its January 2014 equity issuance, thus enabling it to issue shares to investors at a higher price than would otherwise be the case? In this Twitter post, Shkreli asserted the following regarding the buyback:
We did do a small buyback as noted. The buyback rules are designed to prohibit "gaming" the stock. The immaterial amount of our buyback relative to value-traded of the stock should be telling.
However, buying over 7% of the total volume of shares traded during the month of December does not seem to be an "immaterial" amount. In addition, why didn't the company publicly announce, in advance of repurchasing shares, that its board of directors had approved a share repurchase program? All Retrophin had to do was file an 8-K at the time, disclosing the fact. It should further be noted that the above disclosure in the 10-K regarding share repurchases in Retrophin's 10-K filing seems to fail to fully comply with the requirements of Item 703 of Regulation S-K, which states that an issuer must disclose the maximum number of shares (or approximate dollar value) that may yet be repurchased under the company's repurchase program. Retrophin simply leaves this item blank in the table above.
Red Flag #7 - Friday Night Disclosure of the Firing of Marcum LLP, Retrophin's Auditor
Retrophin fired its auditor, Marcum LLP, as of March 31, 2014, without any explanation (see here). Retrophin disclosed the fact after market hours on a Friday evening (April 4th). Why did Retrophin feel the need to dismiss Marcum? Marcum had only been on the job as Retrophin's auditor for a brief period, which makes the abrupt dismissal all the more curious.
Red Flag #8 - Retrophin Saddled Itself with a Large Amount of Debt in Buying Manchester Pharmaceuticals, a Company Generating Very Little Revenue
Retrophin acquired Manchester Pharmaceuticals in February 2014 (details may be found here). Retrophin has thus far revealed minimal financial data regarding Manchester, providing only the following information in its Q1 2014 10-Q:
|Three months ended March 31,
(In thousands, except per share data)
|Net loss per common share, basic and diluted||$||(3.00)||$||(0.71)|
Thus, Retrophin paid a fulsome 12.5 times Manchester's annual sales (based on the Q1 revenue run rate) for the company. As discussed above, the acquisition also saddled Retrophin with $33 million in debt that will need to be paid off during the next seven months ($11 million is due in three remaining installments, at the end of June, the end of September and the end of December, respectively). Although Retrophin claimed in its most recent earnings call it will be "cash break-even" during the remainder of 2014, based on its revenue guidance and projected spending disclosed in its SEC filings, this does not appear to include the required installment payments on the Manchester debt. The first installment payment on the debt is due in approximately 30 days.
Red Flag #9 - Additional Red Flags Exist
If the foregoing red flags are not enough to make a reasonable person at least slightly skeptical about Retrophin as an investment at the current market capitalization, it should be noted that many more red flags are revealed in Retrophin's SEC filings. In-depth discussion of these is beyond the scope of this article, but the following should be noted:
- Questionable Related-Party Transactions - Approximately $3 million of Retrophin shareholder money was used to settle and extinguish legal liabilities of the MSMB Capital entities (and indirectly the CEO). How can this possibly benefit Retrophin shareholders (other than the CEO)? See pp. 59 and F-21 of the 2013 10-K for details.
- Unnamed Consultants Have Received Large Amounts of Stock - Retrophin has given hundreds of thousands of shares of Retrophin stock to certain unnamed and presumably part-time "consultants", thereby diluting its shareholders. For example, one such consultant received 200,000 shares of stock in March 2014 (valued at $3.75 million on the date of issuance). Who are these consultants, what are they doing on behalf of the company and why is their identity not revealed? See p. 64 of the 2013 10-K for details.
- Exorbitant Compensation for the CEO - The CEO received compensation over the last 2 years totaling over $17,000,000, including over $2,300,000 in cash and/or debt forgiveness. See p. 21 of Retrophin's 2014 Proxy Statement for details. In light of the company's cash burn and liquidity situation, how can $2,300,000 in cash compensation and/or debt forgiveness possibly be justified? The 2014 Proxy does provide any rationale justifying the level of the CEO's compensation, especially the 2013 bonus amount.
- No "Adult Supervision" of Management by the Board of Directors - Page 9 of the 2014 Proxy Statement reveals that Retrophin currently has no Chairman of the Board. Indeed, based on the disclosure in the proxy, it is actually the CEO who controls and runs the board, without any oversight by a board chairman: "Our Chief Executive Officer, Mr. Shkreli, facilitates communications between members of our board of directors and works with our senior management in the preparation of the agenda for each board meeting."
- Share Creep Continues Unabated - Per Retrophin's 2013 10-K filing, shares outstanding as of March 19, 2014 were 24,262,716. The Q1 2014 10-Q states that shares outstanding as of May 15, 2014 were 25,485,339, an increase of over 1,220,000 shares (or 5% of the total outstanding) in a mere two months.
Conclusion - Retrophin is Currently Extremely Overvalued; Price Target Set At $3/Share
In its brief history as a public company, Retrophin has enjoyed a meteoric rise, with its market capitalization zooming up from approximately $26 million upon completion of the Desert Gateway reverse merger to an enormous $575 million as of April 2, 2014. However, since the stock topped out at $23.75 per share on that date, it has fallen approximately 40% to around $14 recently.
At its current market cap of $350,000,000, and in light of the numerous red flags described above, Retrophin still appears to be significantly overvalued and an attractive short candidate. Most of its drug pipeline is highly speculative and likely years away from being monetized, if ever (for a discussion, see here); the company's cash position has dwindled recently, and its expenses are exploding upwards, as revealed on pp. 21-22 of the most recent 10-Q filing; and its only currently marketable drugs are likely to bring in revenue equal to only $10-12 million this year (or, if you accept Retrophin's revised guidance, $20-22 million), indicating that more dilution is in store for shareholders.
Strictly for the option value on its pipeline, in a vacuum, Retrophin might be worth up to $4-6 per share as a speculation. However, any serious investor insists on a comfortable margin of safety before buying. In light of the numerous red flags discussed above, a price target of $3 per share appears to be appropriate (or 50% below the high end of the option value). At any price above $3, I believe that a long position in Retrophin is simply not a gamble worth taking.
Disclosure: I am short RTRX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.