Lannett (NYSEMKT:LCI) stated on its most recent conference call that its "internal investigation" showed no evidence that the company engaged in collusion with its rivals regarding generic drug pricing. No doubt this was in response to the Bloomberg article and the subsequent slide in share price. While the Bloomberg article points out that the authorities have ample reason to examine Digoxin pricing - we have found a few other examples of oddly similar pricing behavior that suggests there may be more to look at over time (to be fair, it's unknown if any of these examples are intertwined in the case mentioned by Bloomberg). In addition to the pending charges we are similarly concerned about the viability of the business model over time, which seems to be a buy and price hike model dependent on drug shortages and the total lack of competition in specific products.
Near Term Risk: DOJ Investigation(s) Into Collusion
Digoxin is the obvious (and well reported) culprit, as you can see below a Wolters Kluwer Price Rx search reveals Impax Labs (NASDAQ:IPXL) matching Lannett's price increase after just a few days. All future entrants in the market also "price match" their WAC to the new high bid, so one has to question where the competition exists in this market.
Now let's look at Levothyroxine, in this case Mylan (NASDAQ:MYL) gets the ball rolling with consecutive price increases in 2013 and 2014 that are both matched within days by LCI and Sandoz. Levothyroxine is not a new product (first synthesized in the 1920's) but because of the cozy pricing relationship displayed by the three generic competitors this remains a multi $100m generics market. Again one has to question the value of competition.
Finally Ursodiol, in this case LCI leads the price higher and Sandoz indexes up a few months later - obviously Mylan is last to the party here but eventually joins ranks at the beginning of 2016.
Our initial conclusion: The DOJ likely has a case against the industry in digoxin - but that there are many other potential targets to discuss. We do no think the status quo is sustainable and the action by the DOJ may break down the final vestiges of "loose" collusion that cause the price matching behavior. Thus we expect to see a steady state of decline in virtually all generic assets over the next few quarters (in addition to the fines associated with the charges we think will be filed).
It's important for us to highlight that we believe the DOJ is highly motivated to get long running cases filed as indictments (this is true for VRX as well). Specifically in cases where large amounts of time and money have been spent. The employees do not know if they are going to want to work for the next administration (in some cases asked to remain in place) or if the next administration will be as aggressive in certain areas as the current one is. Although an incoming AG can "re-task" federal assets in regards to investigative priorities it is much less likely that they re-task resources from current prosecutions.
Long Duration Risk: Increased Generic Approvals Will Damage Price Gougers
We refer to this as "long duration risk" as a bit of a jest - these company's have no long duration assets. However, LCI's business is levered as though they believe the assets have an indefinite lifespan. Over the last year they have established themselves as a serial price raiser in order to keep up with expectations. Most recently the company reported Q3 where virtually all assets experienced a net pricing decrease but in order to save the quarter an Anti-psychotic experienced a 556% price increase.
At the beginning of 2016 Oppenheimer wisely pointed out that LCI enacted a 1,900% price increase for fluphenazine HCL on top of a 220% price increase for terbutaline sulfate.
Final Conclusions: We see LCI as another example of a levered spec pharma company that is dependent on price to continue operations. In addition to the potential fines from the DOJ related to the collusion probe we would expect a corporate integrity agreement to be put in place (which would serve to further hamper the behavior). In addition to that we see the increased pressure from Washington on the FDA to release more generics as a real threat to pricing power over the long haul.
In conclusion LCI represents a very challenged business model that we have warned about in the past. While Concordia International (NASDAQ:CXRX) has very idiosyncratic issues (as does LCI) they are both examples of levered companies playing an old price gouging game in a world that will no longer tolerate it.
Disclosure: I am/we are short LCI, VRX.
Additional disclosure: I am/we are short LCI/VRX. All information for this article was derived from publicly available information. Investors are encouraged to conduct their own due diligence into these factors. Additional disclosure: This article represents the opinion of the author as of the date of this article. The information set forth in this article does not constitute a recommendation to buy or sell any security. This article contains certain "forward-looking statements," which may be identified by the use of such words as "believe," "expect," "anticipate," "should," "planned," "estimated," "potential," "outlook," "forecast," "plan" and other similar terms. All are subject to various factors, any or all of which could cause actual events to differ materially from projected events. This article is based upon information reasonably available to the author and obtained from sources the author believes to be reliable; however, such information and sources cannot be guaranteed as to their accuracy or completeness. The author makes no representation as to the accuracy or completeness of the information set forth in this article and undertakes no duty to update its contents. The author may also cover his/her short position at any point in time without providing notice. The author encourages all readers to do their own due diligence.