What happened

Shares of Mallinckrodt (NYSE:MNK) were tanking by 26.4% as of 10:49 a.m. EDT on Tuesday. The drugmaker announced earlier in the day that it had filed a lawsuit against the U.S. Department of Health and Human Services (HHS) and the Centers for Medicare and Medicaid Services (CMS) in an attempt to set aside a recent CMS decision that the company says would eliminate its net sales of Acthar Gel to Medicaid.

So what

CMS intends to require that Mallinckrodt change the base date average manufacturer price (AMP) that's used to calculate Medicaid drug rebates for Acthar. There's a complicated process involved in establishing drug prices for Medicaid patients using this base date AMP. The bottom line for Mallinckrodt is that the change CMS wants could cause the company to pay as much as $600 million in retroactive rebates plus prospective rebate increases of around 10% of Acthar Gel annual net sales.

Businessman looking at red line going through the floor

Image source: Getty Images.

This CMS decision is a huge blow for Mallinckrodt, especially because it's a surprise. Its executives didn't mention anything about the potential for such an adverse decision in the company's Q1 conference call earlier this month. The company even raised its full-year 2019 earnings guidance, reflecting optimism.

Acthar Gel is Mallinckrodt's top-selling product, currently generating more than 28% of the company's total sales. Any significant hit to Acthar would make a major impact on its top and bottom lines.

The company thinks that it's on solid legal ground in its lawsuit against HHS and CMS, though. Mallinckrodt maintains that CMS "attempts to reverse without explanation the Agency's 2012 express, written approval (on two occasions) of the base date AMP used since 2013." 

Now what

Investors will have to wait and see what happens in the courts. Mallinckrodt doesn't plan to change it full-year 2019 guidance or put aside any reserves related to the Medicaid pricing at this point. 

It's possible that we could see a rebound of sorts with the stock in the coming days and weeks. Some investors could think that today's sell-off is overdone based on the possibility that Mallinckrodt will prevail in its case against HHS and CMS. For now, though, this stock is probably one that's best to watch from the sidelines as the drama unfolds.