Are Questcor Pharmaceuticals' Explosive Earnings High Enough to Shoulder the Risk?

While Questcor Pharmaceuticals (NASDAQ: QCOR.DL  ) has been reporting phenomenal sales, growth, and earnings per share, a growing investigation by multiple government agencies should concern any prudent investor.

Results
Questcor Pharmaceuticals reported third-quarter results on Oct. 29. The numbers were nothing short of fantastic. Sales were up 68%, EPS up 73%, and there was a 45% increase in vial shipments of its drug. In light of the results, Questcor raised its dividend by 20% to $0.30 per share, an annual dividend of 2% per year.

Questcor makes and sells a drug called Acthar Gel, which was originally developed to treat infantile spasms, a rare disorder, and sold for $40 a tube. Questcor then bought the rights to it. Questcor steadily boosted up the price to tens of thousands of dollars while also marketing the drug for all sorts of other uses.

Questcor benefits from a grandfather clause in the law that doesn't require the use of clinical trials to prove its marketing claims since the drug was already approved by the Food and Drug Administration in the 1950s. This has allowed sales and profits to skyrocket along with its share price.

The less glamorous side of Questcor
Things are going financially quite well for Questcor. At least for now. Could that change? The company disclosed in September 2012 that it was being investigated by the U.S. Attorney's office in Philadelphia for its promotional practices. Investors had blown this off as the stock continued to escalate to new highs. However, on Oct. 30 in its conference call and 10-Q filing, it disclosed another attorney's office investigation and the SEC joined in an expanded investigation. That doesn't sound good.

Normally you might be tempted to blow off such matters, but examine the language in the 10-Q. The quote you should be particularly concerned with is "the investigation to review our promotional practices and related matters." Two observations.

One, it uses the present tense and not the past tense in regard to promotional practices. This means that if Questcor is found guilty of something, it could be widespread, ongoing, and extremely damaging to its financial situation and reputation.

Two, what is "related matters"? This term is quite vague and could mean anything. Why is the SEC involved? Usually the SEC gets involved only when a company has made an improper claim to the public or illegal insider selling took place.

The worst part is that just a couple of weeks before this revelation, insiders such as CEO Don Bailey were selling millions of dollars worth of stock on the open market. It's not yet known if this was done with knowledge about the expanded investigation. However, the timing seems too coincidental, especially with the disclosure that came with the earnings report.

Should investors be worried?
An example of what could happen to Questcor Pharmaceuticals did happen to shareholders of Avon Products (NYSE: AVP  ) on Halloween. Avon Products has been in trouble with the Department of Justice and the SEC over bribery allegations. Avon offered both organizations a settlement offer, and they both told Avon to take a hike. The risk of sizable financial penalties was enough to cause the stock to get clocked as much as 24% in that single day. Questcor could potentially have a similar fate or worse.

It's possible that part of the problem is that Questcor doesn't even disclose all of the active ingredients in its drug. According to a report by Citron Research, this practice is illegal. Questcor has defended this practice by saying doing so would be like Coca-Cola revealing its secret formula. Of course, Coca-Cola's soda isn't a prescription drug, and Coca-Cola doesn't fall under the same marketing rules.

If the investigation ends up with Questcor being forced to reveal its active ingredients, that could open up the possibility of a cheap generic being developed by a company such as Teva Pharmaceutical Industries (NYSE: TEVA  ) . Teva makes and sells a variety of generic creams and gels that compete with popular brand-name drugs. If Teva were to make a generic copy of Acthar, it would, as new generic drugs tend to do, severely crash Questcor's sales and profits. Teva Pharmaceutical, I'm quite confident, would love to take a large chunk of Questcor's multibillion-dollar business.

Foolish final thoughts
While the numbers out of Questcor make it quite a tempting investment, the risk is too great. Playing the game of hoping nothing comes out of a multi-agency government investigation is like playing the financial version of Russian roulette. I'd avoid Questcor until more details and potential consequences emerge.

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Read/Post Comments (3) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 06, 2013, at 2:21 PM, suchiraman wrote:

    Ignorance is not an excuse to write such lousy articles; you should do your due diligence before you write, and not take a lemon as your source of information.

    Of course, Acthar contains undisclosed ingredients; it is a naturally derived product and has a better response than the synthetic compound, because of this.

    As a naturally derived product ( just like thyroid hormone products), they are not required to give an exact chemical composition. They have to provide standardization of active drug. So, it is NOT like making Coca- Cola, which is a mixture of known ingredients. Also, because of this , Teva cannot just reproduce the drud. The method of manufacture is patented, and any would- be competitor would have to manufacture it by different methods , and obviously since it is not a product of Reverse engineering, the end- product would not be identical. hence, HP Acthar Gel can never have a generic manufacturer. They can have a different product that will have to go through the full FDA New drug application process!

  • Report this Comment On November 06, 2013, at 8:15 PM, drdonrs wrote:

    The author blithely ignores all of the trials underway or about to get underway in some of the most devastating inflammatory autoimmune disorders. Dwells on an area of regulatory procedures that is quite common in the pharma industry. When has regulatory agencies forced a company to reveal the ingredients and or the manufacturing process of a drug. Teva produces generic counterparts of drugs that have come off patent. That is not the case here. The article is an attempt to create an environment of uncertainty using the age old method of scare tactics ala the short community with such notables like the "lemon man" of Citron, Andrew Left. In fact the writer almost seems to be a Citron lackey?????

  • Report this Comment On November 06, 2013, at 10:27 PM, Grayhouse wrote:

    Have you ever heard of Botox?!? No one knows the formula or exact ingredients. It now has 4 or 5 competitors. Non of which are classified as generic. All had to do full clinical trials to gain approval from the FDA. Most of these competitors have only one indication vs Botox's numerous. Botox is still the dominate player by a long shot. These competitors have barely scratched out any market share even though they are priced cheaper.

    Still think this is an issue for Acthar? I think not....

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