Questcor Pharmaceuticals And Citron Research: Who Is Correct?

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Vocal short sellers are always a controversial group of investors. Some market followers accuse such investors of being barbarians, intent of distorting the truth for their own personal gain, no matter what it costs innocent companies and their investors. Others see such short sellers as being market vigilantes, doing the work that inept regulators seem unable to do. How you perceive short sellers often depends if they have been involved in a stock you are long or short.

The latest company to come under the short-selling spotlight is Questcor Pharmaceuticals (QCOR), which on Tuesday, July 10 plunged over 20% in response to a scathing report published by Citron Research alleging that the company is destined to wither away. Citron's report was detailed and presented a number of arguments as to why Questcor is a flawed company. However, Questcor has been the subject of short-seller attacks before, and has fought them off (StreetSweeper was the last short-seller to attack Questcor). So who will emerge victorious this time?

As a matter of disclosure, we have no position in either Questcor stock or options, and have never held the shares. This article intends to present both sides of the story, as their are valid points present in the arguments of each camps.

In Defense of Questcor: Old News Need Not Be Repeated and Why Questcor's Market Position is Secure

Analysts were quick to defend Questcor, reiterating their buy rating and price targets. Jefferies, in a research piece discussing this development, maintained its buy rating and $60 target. Jefferies dismisses Citron's concerns, believing that the treat of generic competition is overblown, and that despite Acthar's lack of patent protection, there are may commercial and technical issues that a generic competitor would have to overcome. Jefferies estimates that even if generic competitors to Acthar launched, it would take at least 30 months for them to have a material impact. Furthermore, Jefferies conversations with Watson Pharmaceuticals (WPI) indicate that Watson, one of the leading generic drug companies, has no plans to file for approval of a generic version of Acthar. Oppenheimer agrees. Its comments regarding this situation dismissed the generic threat to Acthar. The firm believes that even though older corticotropin drugs have been approved, they do not present a threat to Acthar. In Oppenheimer's view, any commercialization/approval of a generic competitor to Acthar remains years away and is not a near-term threat to the company.

The allegations raised by Citron Research's report would be even more interesting if it was the first time these questions had been raised about Questcor. But Citron is not the first entity to criticize Questcor. StreetSweeper published several reports in January critical of Questcor. Several issues were raised, including financial relationships with doctors, insider selling, and Acthar's role in the marketplace. Questcor answered these questions, and its stock eventually recovered from the hit it took due to that report. It should be noted that Questcor did not restate any earnings as a result of the StreetSweeper report. Nor was there an SEC investigation, and no executives were dismissed for wrongdoing as a result of that report. It can be argued, therefore, that the Citron report is more of the same, and that in time, Questcor's stock will recover.

We turn now to the matter of insider selling, an argument used in both the StreetSweeper and Citron reports. Both reports criticized the company for allowing insiders to sell huge sums of stock. And as Citron noted, Questcor's continuous share buybacks do little to actually reduce its share count. Given the amount of stock and options that the company's executives receive, Questcor's buyback program simply negates the continuous dilution that is the result of its executive compensation programs. Many investors (in particular readers of Seeking Alpha), view insider selling as a blasphemous act that should only be done in the rarest of circumstances. To them, any insider selling, even if it is one share, represents a lack of confidence in the company and a red flag. In most cases, consistent insider selling is a byproduct of basic human nature. If you are an executive of a company, and you know that your compensation agreement entitles you to X stock options each year, what is the point of waiting to exercise them? Even if in the long run more money can be earned by holding onto them, the lure of immediate money is almost always too great to resist.

In any case, consistent insider selling at Questcor has not done much to destroy shareholder value. Since May 18, 2007, the day before current CEO Don Bailey joined the company as interim president, Questcor's stock price has risen by over 5,100%, as opposed to a drop of over 11% for the S&P 500 (SPY).

Insider selling has been present consistently since 2007, but it has obviously not had a negative impact. Given that the CEO is ultimately responsible for their stock price, this chart shows that CEO Don Bailey has done a good job of rewarding his shareholders.

The defense of Questcor centers on a few key points. Analysts are behind the company, and so far, there is little in the marketplace to suggest that Questcor's position is threatened. Insider selling has had no real impact on the company's stock, and the company has been the subject of short-seller criticism before, and little, if anything, has come from it. So will Questcor emerge unscathed this time? Perhaps. But there are other aspects of Citron's report that need to be addressed.

In Defense of Citron Research: Questions Remain Unanswered

Analysts were quick to defend Questcor's market position and dismiss the threat of generic competition as overblown. However, that was just one of the 9 points that Citron's short thesis was based on. The other 8 points were essentially ignored by analysts, despite the fact that they are material, such as Acthar's insurance coverage.

Given that a vial of Acthar costs $27,000, continuing insurance coverage of the drug is essential if Acthar is to retain and grow its market. And Questcor has been terse in its assessment of insurance coverage for Acthar. Its last non-Form 4 SEC filing was an 8-K filing detailing Acthar sales in June. All that Questcor wrote about its insurance risk was that, "Insurance coverage continued to remain favorable for Acthar during June 2012." Given that insurance coverage is vital for Acthar's success, we find it a bit odd that Questcor does not provide more color regarding its insurance risk. Depending on the condition Acthar is used on, average prescriptions per physician range from 1-1.5 in nephrotic syndrome to 2 in multiple sclerosis. However, there are several signs that indicate that Acthar is written by doctors on an individualized basis, not in wide clinical setting. Questcor itself admits that it cannot answer whether or not Acthar is used in major multiple sclerosis clinics. Interviews conducted by Citron Research indicate that the drug has no presence in clinics.

Because Questcor is required to rebate the 100% of the cost of Acthar to Medicare/Medicaid, the majority of Questcor's revenue comes from private insurance reimbursement, making favorable insurance coverage of Acthar essential to Questcor. While that has been the case in the past, there are indications that this is changing. In early July, Blue Cross/Blue Shield of North Carolina tightened its coverage requirements for Acthar. Beginning in October, the company will only cover Acthar if patients do not respond to other (generic) corticosteroids or have adverse reactions to them. In both cases, Blue Cross/Blue Shield has the right to review a patient's medical history in detail to see if they truly need Acthar. UnitedHealthcare (UNH) and its Oxford unit have also tightened their coverage of Acthar, with the new policy set to take effect on August 1. Its policy is very similar to the new policy at Blue Cross Blue Shield, in that it forces patients to first be treated with other corticosteroids before Acthar can be covered. Neither Questcor or the analysts that cover the company have offered explanations as to why this is not an issue. In addition, Questcor's CEO Don Bailey offers contradictory statements regarding Acthar's position as a second-line therapy. When asked to comment on the failure of generic steroids, Bailey states that, "there are patients who take steroids [generics], who often don't do very well. Those are the patients that doctors use Acthar in." And yet, Bailey has also said that, "the current data really isn't to position Acthar as a second-line therapy for patients who fail on steroid use." His first comment positions Acthar as a second-line therapy, a fallback option for those patients that cannot take corticosteroids, and yet has also stated that Questcor isn't positioning Acthar as a second-line therapy. So which is it? The answer isn't really clear.

Questcor: The Silence Needs to be Broken

There are valid arguments on both sides of the debate over Questcor's future. And so far, we have heard from the analyst community and Citron Research. There is one party that has not yet weighed in though. And that is Questcor. Citron's report was published on July 10, and as of the close of business on July 12, Questcor has not issued any statements regarding this issue. The last major company to see its shares fall as steeply as Questcor's have due to short concerns was Herbalife (HLF). In that case, Herbalife issued a statement just hours after David Einhorn asked questions on its conference call. And 2 days later the company announced that it would buy back hundreds of millions in stock. And 10 days later, Herbalife announced that several of its directors bought thousands of shares of stock. Herbalife did all this even though David Einhorn never said he was shorting Herbalife on the company's earnings conference call. Even as of this writing, David Einhorn has not said that he is short Herbalife. And for Einhorn to not disclose a short would be an unusual departure for him. Herbalife's actions may not have returned the stock to where it was trading before Einhorn raised his questions, but they did halt its decline.

Questcor, on the other hand, has seen its share price slide consistently since Citron's report came out. The company needs to respond to the criticisms of it. Questcor is set to present at a JMP conference on July 13 at 11 eastern time, and the stock rose 3% on July 12 due to rumors that the company will address Citron's report during its presentation. We look forward to hearing what Questcor has to say.


Questcor is certainly one of the more controversial companies out there, and since going public, it has delivered returns of over 1,200% for its investors. However, the ride along the way has been bumpy, and the short thesis presented by Citron Research raises a new set of issues for the company. Can Questcor overcome these issues, as it has past short theses? That remains to be seen, and what the company says in its presentation on Friday will be closely scrutinized.

Disclosure: I am long HLF.

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