The recent growth of Questcor Pharmaceuticals (NASDAQ: QCOR) has been nothing short of stellar.
In the first quarter of 2014, Questcor reported Acthar gel revenue of $209.8 million relative to $126.8 million in the first quarter of 2013 (a 65% increase.) Gross profit rose from $118.9 million to $205.7 million (a 73% increase).
While the company's financial strength caused Questcor shares to double throughout the last year, bears still believe that the company is a house of cards that could topple at any moment.
Why?
Questcor has a number of lawsuits pending, two of which -- the Retrophin lawsuit and an investigation by the United States Attorney's Office (or USAO) particularly concern me.
The Retrophin litigation refers to the antitrust lawsuit that was filed by rival company Retrophin in January of 2014, when the company complained that Questcor's sudden $135 million acquisition of Novartis' Synacthen allowed the company to prevent competitors like Retrophin from competing with it in the market.
Although Synacthen is both cheap and widely available in Europe, US insurers are forced to pay a very high price to Questcor for a naturally occurring version of the product that has been around for over 60 years -- and it didn't even used to be that expensive. When Questcor acquired Acthar in 2001, it was selling for $40 a vial. In 2007, it raised the price to $23,000 per vial. Retrophin was looking to disrupt this situation by acquiring Synacthen from Novartis for $16 million with the intent of developing it in the United States.
The United States Attorney's Office (USAO) investigation is also very problematic because it is centered around Questcor's promotional practices relating to Acthar gel. After receiving a subpoena from the USAO, Questcor learned that the SEC also started an investigation of Questcor's marketing practices. While this litigation is more opaque, I tend to be more leery of companies under investigation.
Why merge with Mallinckrodt?
In April 2014, Questcor and Dublin-based Mallinckrodt Pharmaceuticals announced a definitive merger agreement that gives every Questcor shareholder $30 in cash and .897 shares of Mallinckrodt (MNK). As per CEO Mark Trudeau's comments, the merger will "provide a strong and sustainable platform for future revenue and earnings growth."
Anyone who is familiar with corporate tax can quickly point out the merger is just a cost-effective strategy for Questcor to move its headquarters the tax shelter of Ireland. This has become an increasingly popular strategy for corporations who want to avoid America's 35% tax rates.
Although Mallinckrodt does add diversification to Questcor's business model, it doesn't add any immediate advantages to Questcor shareholders other than Ireland's tax benefits. Although Mallinckrodt is also a manufacturer, it's unlikely that they could make much of a dent in Questcor's high gross margin (over 90%) on its products.
Is Questcor/Mallinckrodt a good investment?
Financially speaking, nobody would deny that Questcor is an absolute powerhouse. But the sustainability of its business model is still the main issue.
While Questcor made its monopoly stronger with the finalized acquisition of Synacthen, court decisions still threaten to undermine Questcor's $5.6 billion valuation.
Because the legal threats to the company's business model are totally unpredictable at this point, I do not view Questcor as a suitable investment for anyone who values long-term sustainability in a stock. Despite the merger agreement with Mallinckrodt, a lot of Questcor/Mallinckrodt's valuation will still be largely based on the performance of H.P. Acthar – which has a lot of uncertainty built in due to the legal and patent issues mentioned above.
