Market Overview

PropThink: Borrow On QCOR Shares A Coiled Spring, Stock Could Snap Back Hard


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. 

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