I believe Mallinckrodt (NYSE:MNK) has not been transparent with investors and its volume growth may not be as strong as investors expect. My belief is supported by evidence suggesting the price of Acthar has been raised, screenshots showing Mallinckrodt changed its Acthar Support and Access Program websites, and other irregularities.
Price of Acthar (Hint: It may be higher than you think)
It's no secret that Acthar is an expensive drug. Many reports suggest the cost of Acthar is $38,000 and I have found no evidence in SEC filings or elsewhere that Mallinckrodt indicated otherwise. Also, Mallinckrodt has made statements suggesting that price hikes for Acthar are minimal. For example, a December 2016 New York Times article states, "Mr. Yunger [a Mallinckrodt spokesperson] said, 'Under Mallinckrodt, price increases on Acthar have averaged in the low single digits.'" This claim is mirrored by Mallinckrodt CEO Mark Trudeau's November 2015 CNBC appearance:
However, publicly available posts from Facebook, Twitter, and Cafepharma suggest that the price of Acthar has risen from $38,000 to roughly $45,000 during April 2016-January 2017. Below are the posts I found:
To me, this evidence from multiple sources suggests that the price of Acthar was raised from $38,000 to $44,000+ (15.8%+). If true, the alleged price hike seems to contradict CEO Trudeau's assertion of a 5% annual Acthar price hike and Mallinckrodt spokesman's recent claim that, "price increases on Acthar have averaged in the low-single digits."
This alleged price hike is plausible because Mallinckrodt does not disclose the price or volume of Acthar. Mallinckrodt only discloses Acthar net sales. Increases in the net sales could be due to organic growth of Acthar, increase in the price of Acthar, or a mix of both. Because Mallinckrodt does not disclose the price of Acthar and only gives general guidance (e.g., "price increases on Acthar have averaged in the low-single digits") investors are left to estimate organic growth. If Mallinckrodt did increase the price of Acthar more than investors believed, then their organic growth assumptions will be wrong and the whole Acthar story will need to be re-evaluated. If price goes up 16% and net sales are up 12%... you can do the math. It's not that simple because there was also a hike from $34,000 to $38,000, and not all Acthar sales for the year were done at the newly hiked price, but you get the point. With the downfall of Valeant (NYSE:VRX) and rise of President Trump, the era of aggressive price increases is ending - and investors rightfully value organic growth over price hikes.
Acthar Support and Access Program (A.S.A.P.) Website Changes
In my last article I wrote,
"What is the Acthar Support and Access Program? Search Mallinckrodt's most recent 10-K and you won't find anything. I have not seen the Acthar Support and Access Program mentioned in any Mallinckrodt SEC filing, analyst call, or investor presentation. However, it seems that the Acthar Support and Access Program plays a large role in patient procurement of Acthar."
I used the dollar amounts of Acthar listed on Mallinckrodt websites to estimate A.S.A.P.'s size. Following my article, Mallinckrodt removed the dollar amounts of Acthar provided through A.S.A.P. from its websites.
(Source: A.S.A.P. Website)
(Source: Acthar Website)
Why would Mallinckrodt remove the amount of Acthar it "donated" to patients? I suspect there is more to this story. Again, the Acthar Support and Access Program is not specifically mentioned once in Mallinckrodt's 141-page 10-K. So investors are left with very circumstantial information about the program. However, based on a patient form, it appears that the Acthar Support and Access Program is operated by United BioSource Corporation - which is owned by Express Scripts (ESRX). Please note that "United BioSource" does not appear in any Mallinckrodt SEC filings.
(Source: Acthar form) August 2016 form
Furthermore, according to Mallinckrodt's 10-K, the specialty pharmacy distributor CuraScript accounted for 38% of net sales in 2016. Like United BioSource, CuraScript is also owned by Express Scripts.
(Source: Page 18 of Mallinckrodt 10-K)
In Questcor's 10-K it said, "We utilize CuraScript, a third party specialty distributor, to distribute Acthar. We rely on CuraScript for all of our proceeds from sales of Acthar in the United States."
After Mallinckrodt acquired Questcor, the following language appeared in its 2014 10-K, "CuraScript Specialty Distributor distributes Acthar and is expected to account for more than 10% of our total net sales in fiscal 2015." This language about CuraScript distributing Acthar did not appear in the 2015 or 2016 10-Ks, but based on how CuraScript's revenue closely approximates the net sales of Acthar (Acthar was 34% of Mallinckrodt net sales in 2016 and 35% of net sales in 2015), I believe it is likely that CuraScript still distributes Acthar.
On CNBC, when asked about Mallinckrodt's reliance on specialty pharmacies, Mark Trudeau said,
"Specialty pharmacy channel is a well-established channel that's been in practice for many, many years. We do use specialty pharmacies, we don't own those specialty pharmacies, we don't control those specialty pharmacies. They are third party contractual relationship. We actually use a multitude of specialty pharmacies; these are typically owned by large companies--publicly traded companies. Their economics is completely separate from anything we do."
If CuraScript does distribute Acthar, then my interpretation of this data leads me to believe that the economics of the specialty pharmacy, CuraScript, is not completely separate from anything Mallinckrodt does (i.e., A.S.A.P. program). This seems to conflict with Mark Trudeau's answer that "their economics is completely separate from anything we do."
I find the lack of specific disclosure regarding the Acthar Support and Access Program, the lack of specific disclosure regarding United BioSource, and the lack of clarity of the Mallinckrodt-Express Scripts relationship troubling. I cannot think of a legitimate reason to remove the amount of Acthar you "donate" to patients at no cost. Unfortunately, this lack of transparency seems to extend beyond the Acthar Support and Access Program.
Acthar Ambassador Program
The Acthar Ambassador program appears to be a program soliciting Acthar users to share their Acthar stories to other patients. The program is mentioned in some old Mallinckrodt material, including the website below:
(Source: Acthar Website)
If you click on the learn more tab, you are redirected to actharamabassador.com, which appears to be defunct as of January 1, 2014:
(Source: Acthar Ambassador website)
I believe most people would assume that this program with no SEC disclosure and no website would have simply been discontinued. However, a quick search of public Facebook posts suggests that, as of March 2016, patients are still active in the program:
(Source: public Facebook post)
On its own, the Acthar Ambassador program does not seem like a big deal, but when viewed in context with other actions of Mallinckrodt, its lack of disclosure and website merit an explanation from management.
Mallinckrodt is a tough company to value. Not only is it difficult for an individual investor to evaluate a pharmaceutical company, but Mallinckrodt's acquisitions, sales, change of fiscal year, and negative tax rate all add additional complexity. I feel many investors give Mallinckrodt the benefit of the doubt, but clear independent thought will prove useful.
In fiscal 2016, Mallinckrodt's pre-tax earnings were $233 million. In GAAP accounting, Mallinckrodt's tax rate was negative 120%. Clearly, this is ridiculous. If we just apply a 5% tax rate, after-tax earnings fall to $221 million. Mallinckrodt has a market cap of $5.2 billion, which results in a P/E of 24.
Another way to value Mallinckrodt would be to look at the cash flow. In 2016, Mallinckrodt's revenue was $3.38 billion. Cost of revenue was $1.52 billion, which leaves a $1.86 billion gross profit. SG&A was $925 million and R&D was $262 million (less than 3% of Mallinckrodt enterprise value). This leaves about $670 million in operating income. Note this figure does not include any interest expense. Mallinckrodt's current debt load is $6.1 billion. This plus a $5.2 billion market cap leaves an enterprise value of $11.3 billion. EV/operating income is 16.9. An acquirer would need to pay about $17 for every dollar of operating income - not cheap.
First, Mallinckrodt is the exact type of company Donald Trump hates. Mallinckrodt relies on price hikes, uses a foreign domicile to avoid taxes, and invests very little in the U.S. Acthar is not alone in its staggering price increase. Mallinckrodt raised the price of Ofirmev (its second largest drug by revenue) over 100% within three months of acquiring it. Despite making and selling most of its products in the U.S., Mallinckrodt was domiciled in Ireland and recently moved to the U.K. And, as said before, Mallinckrodt's R&D is less than a third of its SG&A and less than 3% of its enterprise value. Mallinckrodt is just one tweet away from disaster.
Second, Acthar is a very large portion of Mallinckrodt's net income and may face increasing competition in the near future, but don't take my word for it. In a recent New York Times article, "Daniel Yunger, a Mallinckrodt spokesman, noted, Acthar is not a drug with no immediate competition." One source of competition could be the result of Mallinckrodt's $100 million FTC settlement. Although the $100 million grabbed the headline, an equally important result is that Synacthen Depot, a potential Acthar competitor, will be licensed to a competing company.
(Source: FTC Settlement)
In my last article, I explained why I thought upwards of 80% of Mallinckrodt's net income comes from Acthar. If Acthar faces competition or pricing pressure, Mallinckrodt could lose a large portion of its income.
Third, Mallinckrodt is facing many other investigations beyond the FTC. According to page 112 of its 10- K, "In September 2012, Questcor received a subpoena from the USAO for the Eastern District of Pennsylvania for information relating to its promotional practices related to Acthar", "In March 2014, the USAO for the Eastern District of Pennsylvania requested the production of documents related to an investigation of the U.S. promotion of Therakos' immunotherapy drug/device system UVADEX/UVAR XTS and UVADEX/CELLEX for indications not approved by the FDA …", and "In November 2014, the Company received a CID from the Civil Medicaid Fraud Division of the Texas Attorney General's Office. According to the CID, the Attorney General's office is investigating the possibility of false reporting of information by the Company regarding the prices of certain of its drugs used by Texas Medicaid to establish reimbursement rates for pharmacies that dispensed the Company's drugs to Texas Medicaid recipients." If the FTC investigation went largely unnoticed, what else is the market missing?
Fourth, much of Mallinckrodt's debt is short term. About $3.2 billion of Mallinckrodt's debt is due within the next five years. Much of Mallinckrodt's debt has coupons in the 4-5% range. Now, after Valeant and the pharma slump, and with Mallinckrodt's debt in excess of its market cap and with a rising rate environment, investors will likely demand a higher interest rate if new bonds are issued. A 2% rate increase in Mallinckrodt's $6.1 billion debt load would result in $122 million in additional interest expense (over half of Mallinckrodt's pre-tax earnings).
Fifth, 12 of the 13 analysts covering Mallinckrodt have buy ratings.
The sell-side's love of Mallinckrodt mirrors its love of another large drug company that was aggressive with drug pricing. One indication that the sell-side might be cooling is the constant price downgrades and the big price target drop by Mizuho on February 3rd. Once a few analysts downgrade the stock, the group will likely follow. Any of the issues discussed earlier could serve as a potential spark for downgrades.
The issues in this report raise important questions for Mallinckrodt shareholders. Did Mallinckrodt increase the price of Acthar more than "low-single digits" over the last 12 months? What is the growth of Acthar volume, if any, from 2015 to 2016? Why is the Acthar Support and Access Program not specifically disclosed in any Mallinckrodt SEC filing and what does this program do? What is the Acthar Ambassador program, is it ongoing, and why is it not specifically disclosed in any SEC filing? What is Mallinckrodt's relationship with United BioSource and CuraScript, and how do each of these entities make money?
Mallinckrodt's fearless price increases, daring website changes, and spirited opacity can only be described as, what's the best word… valiant.
In the world of business, bad news often surfaces serially. - Warren Buffett
Disclosure: I am/we are short MNK, VIA PUT OPTIONS.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.