Are Questcor Shareholders Getting A Good Deal?

| About: Mallinckrodt PLC (MNK)
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The merger is likely to be completed in August, as the companies have mailed the proxy document.

The costs will be substantial for both companies if the merger falls through.

The combined entity will be a better prospect, as it will give Questcor larger scale and Mallinckrodt will get a lucrative product.

In April, Questcor (QCOR) announced a merger with Mallinckrodt (NYSE:MNK) - effectively, Mallinckrodt will buy Questcor and absorb its product - Mallinckrodt shareholders will remain the majority owners with just over 50% of the common stock, and Questcor shareholders will receive 49.5% of the common stock of the new company. The merger has been through the regulatory process and it is now on the verge of being completed, as both the companies have mailed proxy documents to the shareholders. Yesterday, Questcor filed some documents with the SEC regarding the merger and some insider transactions - let's go through these documents briefly.

For any merger or acquisition, the company needs to submit Form S-4 with the SEC detailing all the material information regarding the merger or acquisition. Mallinckrodt submitted Form S-4 on May 16, 2014 - the participants of the merger or acquisition cannot proceed further until they receive a response from the SEC about Form S-4 - the SEC informed the companies on July 11 that the registration statement was effective, meaning the companies can send proxy statement to their shareholders in order to solicit votes in favor of the merger. Both the companies were waiting for the approval from the SEC to mail the proxy statements, as Mallinckrodt and Questcor have mailed the document to the shareholders and announced the dates and places for meetings.

The structure of a merger usually tells a lot about the expectations of the participants - in an acquisition, the acquiring company will try to offer only cash if it believes the business has big potential, as the acquiring company would usually try to avoid sharing future profits. On the other hand, the company being acquired will push for a stock-based compensation. The transaction here is a mixture of cash and shares of the new entity - which means that both the companies believe that a combined entity will be well-placed to grow.

Mallinckrodt is a specialty drug manufacturer, and the addition of Acthar to its portfolio will give it a highly lucrative asset - on the other hand, Acthar will get a bigger platform and larger scale. Furthermore, Questcor has been expanding through mergers, which results in an increase in cost and cash outflow at the start - the business needs to sacrifice something in the short term in order to achieve long-term synergies. According to the latest 8-k filing of the company, its profit margin and free cash flow should improve over the next three years. The following table shows the liabilities for the next five years.

Source: Questcor 8-K Filing

In the first year, the total obligations are roughly $38.5 million. That is almost equal to half of the company's profit from the first quarter. In the next two years after that, this number further increases to a yearly average of $49.6 million. After three years, its yearly obligations are only $4-5 million. A huge chunk of these expenses are accounted by the payment of its acquisition of Synacthen from Novartis (NYSE:NVS) and settlements of the BioVectra acquisition. However, the costs associated with these acquisitions will be settled within three years. As the costs from previous mergers go down, the profitability of the company should go up.

The merger should be completed in August, if everything goes according to the plan - both the companies have called the shareholder meetings on August 14, 2014, and almost all the hurdles have been cleared. There is a substantial penalty for both companies if the merger falls through. Mallinckrodt will have to pay $131.4 million to Questcor in case the merger fails - Questcor's obligation will be even bigger, and it will have to pay Mallinckrodt $194.4 million if the merger does not go through. Furthermore, Mallinckrodt will be liable to pay Questcor $37.5 million if it fails to win an approval from its shareholders for the merger, and Questcor will have to pay $55.5 million to Mallinckrodt it fails to do the same. So, the cost of failure to carry out the merger will be substantial to both the companies. Mallinckrodt had cash balance of about $335 million at the end of the second quarter this year, so, the company has the ability to meet its penalty obligation if the worst happens and the merger does not go through. On the other hand, Questcor had about $261 million in cash at the end of the last quarter, which gives it enough room to pay the penalty.

There are a number of other important factors that Questcor shareholders should consider and also read the legal document attached to the proxy statement - I would strongly recommend that Questcor shareholders go through this document.

Another document filed with the SEC was regarding the sale of 10,000 shares by Michael H. Mulroy - the shares were sold at just under $91, for a total of $908,900 - Mulroy now owns just over 77,000 shares of the company after the sale. Most of the analysts seem to believe that the Questcor stock has peaked - analysts at Zacks have downgraded it from "outperform" to "neutral", with a price target of $97. Also, Piper Jaffray has downgraded Questcor from "overweight" to "neutral", and now has a price target of $98.

There are still some risks for Questcor which need to be kept in mind - these ricks mainly come from litigation and the regulators. The litigation battle with Retrophin and the investigation led by U.S. Attorney's Office (USAO) remain a concern for the company. The former is an antitrust lawsuit which was filed by Retrophin at the start of the year. The complaint was that Questcor's acquisition of Novartis' Synacthen prevented the competitors such as Retrophin to compete in the market.

The investigation by the USAO is about the company's promotion practices on Acthar gel. After a subpoena from USAO, Questcor found out that the SEC is also running an investigation about the company for its promotional practices. Although this situation is less intense than the aforementioned, still it further increases the risk of the company.


The merger is at an advanced stage, and as the proxy document shows, it should be completed in August. The deal will be a win-win for both parties - Mallinckrodt will get a lucrative product, and Questcor will have a larger scale - the combined entity will be a better prospect, in my opinion. As I mentioned above, there are considerable costs for the companies if the merger falls through, and the parties seem confident in the approval process. There will certainly be fluctuation in both stocks before the merger goes through. However, after the merger, price should stabilize. We believe Questcor shareholders are getting a good deal with the cash-plus-stock offer, and the combined entity will be in a much better position to exploit the potential of Acthar.

Additional Disclosure: This article is for educational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.