The bear story on Questcor Pharmaceuticals (QCOR) is well understood, with health insurers expected to follow in the footsteps of Aetna (AET). The insurance company recently indicated that it will make it next-to-impossible to get a prescription for QCOR's lead product - H.P. Acthar Gel (Acthar) - approved. A government investigation into Questcor's marketing practices worsened losses, and we now have a stock that is discounting in Acthar sales being cut in half in the near future. That's a big decline to be baking in considering that last quarter the company revealed unit growth of Acthar at 69% year over year. Nevertheless, most analysts and investors ran for the exits given the uncertain outlook, and short-sellers appear to have strengthened their view. PropThink's checks with traders indicate that the cost of borrowing QCOR shares to create or add to a short position has gone from an interest rate of 0.2% several months ago, to 4-5%, to an estimated 20-25% now, demonstrating that the huge prior short interest is likely still looming, and it has become much more costly to remain short from here. There are potential forces that could make the short interest even more uncomfortable such as major institutional investors refusing to allow their shares to be loaned out, or worse, the company electing to go private. Management has noted in the past that its biggest competitor is "Wall Street", so we wouldn't be surprised if this is being considered. Such an event would force investors with short positions to cover at once on a tender of the company's stock - a bloodbath of another kind.
Going long QCOR now appears to make sense as the next major catalyst is Aetna's anticipated Policy Update on October 13th, which everyone expects will remain negative for QCOR. Perhaps other insurers could announce similar policies as Aetna in the future, but that is widely expected, and again, based on today's valuation, that scenario is largely being priced into the stock. Recall that Aetna is "grandfathering in" patients that have already received approval for Acthar, suggesting that the current base of sales (annualizing at ~$450 million per year) is more stable than the stock is indicating. Nevertheless, QCOR is submitting additional data to Aetna in advance of the policy Update. If this results in any relief related to new patients having better-than-zero access to the drug, QCOR shares could rally hard.
We believe that advocacy groups for on-label indications are likely to pressure Aetna and other insurance companies to allow access to the drug, particularly because they are FDA-approved indications for the therapy, and doctors are willing to go the extra mile to help patients that have no other alternatives. Our view is that Aetna, and perhaps other insurers, have been nervous about Acthar given that annual sales are nearing the half-billion dollar mark. But of course, the best way to a health insurer's heart is to share the wealth, and it may be about time for QCOR to start offering discounts and rebates on the drug to private insurers like Aetna. An indication that QCOR may start to offer rebates on Acthar prescriptions would be great news for the stock.
QCOR can certainly afford to rebate Acthar sales now that Medicaid will start reimbursing Acthar with only a 23.1% discount, compared to the government's prior 100% discount policy. Questcor's current gross-to-net (the discount between average wholesale price and reported sales of a drug) on Acthar sales is approximately 20% because the lack of rebates offered to private insurance companies is averaged with the current 100% Medicaid discount. However, the overall gross-to-net is expected to drop to about 5% on Acthar sales after new Medicaid pricing is implemented. Management may choose to keep its gross-to-net at the 20% level by offering new rebates to private insurance companies. In that scenario, everyone wins. With a broad FDA-approved label, patients benefitting from the drug in on-label indications; physicians backing the drug because it helps patients; and the existence of Orphan populations like Nephrotic Syndrome where no other approved therapies exist; we believe it will be difficult for Aetna to refuse to pay for H.P. Acthar Gel.
Cash flow generated by QCOR is huge, with an estimated run-rate of ~$270 million annually. The company's recently announced decision to increase its share buyback program may change dynamics of the stock in two ways. First, shares available to borrow become even more scarce, and therefore even more expensive than noted above. Also, cash flow per share would increase due to the buyback, offering more support for the newly established dividend. We note that the dividend also increases the cost of being short. Currently, QCOR is trading with a 4.3% dividend yield and the last three years of trading pharmaceutical stocks has evidenced that a dividend yield in the 4% range establishes a nice floor in the stock. Eli-Lilly (LLY), Pfizer (PFE), Merck (MRK), and GlaxoSmithKline (GSK) have all been supported by their dividends for years despite poor business conditions. The stock buyback and dividend are strong signs that the company is truly confident that its business will remain intact and that an investment in QCOR is the best use of cash.
If Acthar still has growth from here, the stock is a steal at current levels. The other 95% of the company's business still has not changed reimbursement policies, and Aetna accounts for only 5% of Acthar sales. Other health insurers may wait to see what Aetna actually implements over time. And, with the stock trading as if Acthar revenues are about to be halved, private equity investors may see an opportunity if they believe the drug will at least hold on to its current base of sales.
The shorts and QCOR have set up a battle of epic proportions. When tension builds like this in a stock, substantial volatility is a given. So far, the shorts can claim a major win, but interestingly, the only major impact to the company thus far has been headline-driven. Given that tension is at a high, and that potential positives are not priced in, we like QCOR as a long. Speculation that AstraZeneca (AZN), a major pharmaceutical company that is desperate for new products, is eyeing QCOR demonstrates that when a stock drops to fire-sale prices, new scenarios appear.
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