2012-10-02 15:47:58 -
By David Moskowitz
By now, the bear story on Questcor Pharmaceuticals (NASDAQ:QCOR) is well
understood, with health insurer Aetna (NYSE:AET) indicating that it will make it
next-to-impossible to get a prescription for the company's lead product - H.P.
Acthar Gel (Acthar) - approved, with other health insurers expected to follow. A
government investigation into the company's marketing practices rubbed salt into
this wound, hence, we now have a stock that I calculate is discounting in Acthar
sales being cut in half (see PropThink's prior story). 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 sell side analysts and
investors ran for the exits given the uncertain outlook, and short-sellers
appear to have strengthened their
view. Our 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% before the Aetna news,
to an estimated 20-25% now, demonstrating that: 1) the huge prior short interest
is likely still there; and 2) it has become much more costly to remain short
from here. And yes, 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 take
the story off-line and simply 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. Of course, such an event would force all investors with short
positions to cover at once on a tender of the company's stock - a bloodbath of
another kind.
Upcoming Aetna Policy Update has little downside, but lots of potential upside.
Getting 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, and 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
patients with multiple sclerosis (MS), nephrotic syndrome (NS), and rheumatology
conditions (polymyositis, dermatomyositis, and others) are likely to pressure
Aetna and other insurance companies to allow access to the drug, particularly
because these 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 and have
been exhibiting meteoric growth. 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.
Interestingly, QCOR can certainly afford to rebate Acthar sales now that
Medicaid will start reimbursing Acthar with only a 23.1% discount, versus the
government's prior 100% discount policy (see that story here). Questcor's
current gross-to-net (the discount between average wholesale price and reported
sales of a drug) on Acthar sales is approximately 20% overall 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 the new Medicaid pricing policy is implemented.
Management may instead choose to keep its gross-to-net at the 20% level by
offering new rebates to private insurance companies, so everyone wins -
patients, insurance providers, and QCOR shareholders. Under any rebate
agreements, insurers may also require that QCOR keep future price increases in
line with industry norms, with sales growth primarily driven by demand going
forward. 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 NS where no other approved therapies
exist; we believe it will be difficult for Aetna to outright refuse to pay for
H.P. Acthar Gel going forward.
Dividend and increased share buyback provide real support. Cash flow generated
by QCOR is huge, (estimated run-rate of ~$270 million annually) with an
estimated cash-flow yield of 24%. Notably, the company's recently announced
decision to increase its share buyback program can change dynamics of the stock
in 2 ways: 1) Shares available to borrow become even more scarce, hence, even
more expensive than noted above and; 2) Cash flow per share increases due to the
buyback, hence 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, after the company established its dividend policy
last week, 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 (NYSE:LLY), Pfizer (NYSE:PFE), Merck (NYSE:MRK),
GlaxoSmithKline (NYSE:GSK), and several other pharmaceutical companies have all
been supported by their dividends for years despite abysmal business conditions.
While some of my colleagues have criticized that management could have kept its
powder dry and used the cash elsewhere, others have noted that 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. I agree, and aim to monitor how aggressively management is buying the
stock back at current levels.
Is a "Take Private" scenario realistic? With the stock trading as if Acthar
revenues are about to get cut in half, it is likely that private equity
investors could see an opportunity if they believe the drug will at least hold
on to its current base of sales. Of course, if Acthar still has growth from
here, then the stock is a steal at current levels. Remember that the other 95%
of the company's business still hasn't changed their reimbursement policy (Aetna
reimburses only 5% of Acthar sales), and many health insurers could wait to see
what Aetna actually implements over time. Given that the government's
investigation into the company's marketing practices and the Aetna reimbursement
bulletin were likely both self-fulfilling prophecies generated by the "noise"
around the stock, it would make sense that QCOR's management and Board are
considering the option of taking the company private.
Long QCOR is the bet we would make given the next set of events. 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. What actually happens from here is still yet to be seen. I
currently like QCOR as a long, given that tension is at a high, and that
potential positives are not priced in. Speculation that AstraZeneca (NYSE: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.
Read this original report at PropThink.com.
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