Mallinckrodt plc Takes a Big Swing for Growth

In buying Questcor, Mallinckrodt is acquiring exceptional potential for earnings, controversy, and disappointment

Apr 8, 2014 at 9:30AM

Facing declining market share in its core generic controlled substance (painkillers) market and holding the valuable asset of an Irish tax domicile, Mallinckrodt plc (NYSE:MNK) has aggressively put its balance sheet to work. First the company announced a $1.3 billion deal for Cadence Pharmaceuticals (NASDAQ:CADX) and its hospital-centered Ofirmev product (injected acetamenophen). Now the company is taking an even bigger swing – announcing a $5.6 billion deal for controversial Questcor (NASDAQ:QCOR) and its lead drug Achtar.

If Mallinckrodt can steer Questcor past the rocks that short sellers have been loudly claiming are in the company's path, this deal could double Mallinckrodt's earnings in relatively short order. If the short sellers are proven right about the many and varied problems of Questcor and Achtar, Mallinckrodt's shareholders will pay the price.

The deal to be
Mallinckrodt and Questcor announced Monday morning that they had reached an agreement on a $5.6 billion cash-and-stock deal. This deal values Questcor at $86.10 as of the deal announcement, a 27% premium to Friday's close and very nearly matching the 52-week high for a stock that is up over 150% over the past year. Questcor shareholders will receive $30 in cash per share, as well as 0.897 shares of Mallinckrodt, making them 49.5% owners of the combined company.

What Mallinckrodt is getting
In buying Questcor, Mallinckrodt is acquiring almost $800 million in revenue, $440 million in operating income and $334 million in 2013 free cash flow. Revenue, earnings, and cash flow have been growing at a rapid clip at Questcor in recent years, with a three-year revenue CAGR of 90% and a 100% growth rate for operating income.

Virtually all (95%) of Questcor's revenue comes from the highly controversial compound Acthar Gel (or Acthar). This injected drug is a complex mix of adrenocorticotropic hormone (or ACTH) and other peptides that has 19 FDA-approved indications. Acthar is used to treat exacerbations of multiple sclerosis, infantile spasms, and nephrotic syndrome and has more recently seen growing use in rheumatology indications like rheumatoid arthritis and lupus.

I could fill a week's worth of articles detailing the controversies over and about Acthar. For starters, there is not a lot of clinical data supporting many of the indicated uses, and payers (Aetna most notably) have tried to use that to deny reimbursement. A far bigger row concerns the price of the drug – once sold for about $50/vial, Questcor now charges around $32,000/vial (though rebates can reduce the effective price). Questcor argues that the drug is difficult to manufacture (and that's certainly true to a point), but this has become "Exhibit A" for many activists arguing that the government needs to step in and restrain drug prices.

Those aren't the only issues. The DOJ is investigating Questcor for the company's promotional practices, and similar investigations have led to large financial settlements from other drug companies in the past. Potentially more damning, but far less proven, short sellers have claimed that their evaluations of the drug have shown little-to-no active ingredient (ACTH) in Acthar.

The DOJ investigation looms as a real threat, and one where I doubt Mallinckrodt has any particular insight (it is not as though they could call the DOJ and ask about the investigation). Insofar as the real contents of Acthar go, though, I would imagine that Mallinckrodt has already evaluated this potential claim, as it is not a particularly difficult issue to confirm (though Acthar contains a complicated mix of peptides that alter the PK profile).

What this could mean for Mallinckrodt
Retrophin is working on its own version of ACTH (RE-034), but I doubt that any new entrants would be eager to seriously disrupt the pricing that Acthar Gel presently enjoys. Likewise, moves from payers or legislators to impact pricing would be difficult at best.

Assuming that the deal goes through, Mallinckrodt will be able to reap meaningful back-office synergies from this deal and run those rich Acthar income streams through its lower Irish tax basis. Based on current expectations for Questcor, modest synergy assumptions, and the tax differences, I estimate that Questcor could add 85% to 100% to Mallinckrodt earnings in 2015 and 2016.

That's incredible leverage from an M&A transaction, but investors should demand exceptional returns for the risks involved. The ramifications of that DOJ investigation are still unknown and while the future sales of Acthar are in question, the reality of debt payments to fund this deal will be very real.

The Bottom Line
Mallinckrodt was a fairly sleepy company split between generic pain medications and medical imaging. Cadence should add a little extra oomph to its hospital sales efforts, while Questcor brings in a very large (if controversial) specialty drug with multiple potential growth indications still in the future. With this deal, though, Mallinckrodt becomes a much riskier company with substantial debt. That's a big change in its basic nature, and one that may lead shareholders to consider whether the upside potential from the Questcor deal is worth the added risk and leverage.

6 stock picks poised for incredible growth
They said it couldn't be done. But David Gardner has proved them wrong time, and time, and time again with stock returns like 926%, 2,239%, and 4,371%. In fact, just recently one of his favorite stocks became a 100-bagger. And he's ready to do it again. You can uncover his scientific approach to crushing the market and his carefully chosen six picks for ultimate growth instantly, because he's making this premium report free for you today. Click here now for access.

Stephen D. Simpson, CFA has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information