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MagicDiligence (< 20)

MFI Stock Review: Questcor Pharmaceuticals (QCOR)



September 25, 2009 – Comments (1)

Questcor Pharmaceuticals (QCOR) produces and markets for all practical purposes a single product: H.P. Acthar Gel. Acthar is an injectable treatment for inflammatory disorders, particularly multiple sclerosis (MS) and infantile spasms (IS) in children. The company also markets Doral for insomnia, but Acthar contributes about 99% of all revenues, making an analysis of Questcor equivalent to an analysis of the outlook for sales of Acthar.

The drug, and its relationship with this company, have an interesting history. Acthar is not a new drug - it was first synthesized way back in the 1940's from pig pituitary glands. Eventually the drug was owned by Aventis, which nearly discontinued production in the mid-1990's due to poor sales. However, pediatricians objected, as there were few choices for treating IS, and Acthar was (and still is) the first option for treatment. Questcor acquired the rights to Acthar in 2001. With such low volumes and a low price, Acthar did not provide many benefits to Questcor. The company continued to be unprofitable.

In 2007, new management decided to change the direction of the company and focus solely on Acthar. Other pharmaceutical interests were divested. Management implemented a massive 14x increase in the price of Acthar, from $1,650 a vial to over $23,000 a vial in mid-2007. Immediately, Questcor's fortunes did a 180 degree turn. Revenues are up 900% since then. Operating margins today are a nearly unheard-of 60%. Free cash flow margins are right around the same levels. The balance sheet is squeaky clean, with $70 million in cash and no debt. Management is aggressively buying back shares. Simply put, right now Questcor is one of the most profitable companies MagicDiligence has ever analyzed... and results show no immediate signs of weakening.

The key question on Questcor is simple: how long can the company ride Acthar at current price levels? Surprisingly, the chances are pretty good. For one, the addressable market for conditions treated by Acthar is very small - only a few thousand prescriptions per year. Insurance companies have reimbursed the drug at nearly 90%, even with the massive price increase, although some have required stronger evidence of need. One reason for this is the low volume - most insurance companies may have to cover one or two cases a year, making the higher price statistically insignificant. A second is that it is one of the only treatments for IS, which can irreversibly affect a child's development if left untreated, making the drug virtually non-discretionary for these cases. The low volumes also make it less likely that a large competitor will target the market. Lastly, Questcor has filed to make Acthar an approved treatment for IS with the FDA (currently it is prescribed off-label). If approved, the company would be granted a 7-year exclusivity period and could also actively market the product as an IS treatment, which it cannot do today.

However, this is a very "high-risk" stock. High healthcare costs are squarely in the government's cross-hairs, and a firm pulling 60% operating margins puts a big target reading "price gouger" on its back. There are alternatives for IS, the most obvious being Vigabatrin, which is the treatment of choice in most other countries and now under review by the FDA for approval in the United States. There are no typical pharmaceutical moat factors around Acthar, either. The drug is old, has no patent protections, and can easily be produced by generics makers and sold at lower prices. Ganaxolone is another potential competitor aimed specifically at IS, in Phase IIb studes by Marinus Pharmaceuticals. Seeing as 60% of Acthar's sales come from IS indications, any of these competitive factors could very well damage Questcor's golden goose.

Questcor also has no backup plan if Acthar fails. The pipeline has but one single candidate, and the company has all but abandoned development of it. The growth strategy is to get Acthar approval for IS and to expand the salesforce for MS.

Questcor is unbelievably profitable and stands a decent chance of maintaining that profitability at least for a few years. The earnings yield is nearly 20%, significantly discounting the potential effects of margin erosion due to competition, specifically Vigabatrin. But all the eggs are in one basket here. If Questcor cannot maintain high pricing for Acthar, the entire business strategy is moot. There are so many things that can go wrong here. While MagicDiligence believes the odds are with the company over the short term, and is putting a tentatively positive outlook on the stock, it is much too risky for most investors and the Top Buys portfolio.

Steve owns no position in any stocks discussed in this article.

1 Comments – Post Your Own

#1) On September 29, 2009 at 11:05 AM, MagicDiligence (< 20) wrote:

Just to follow up with some recent information missed in the stock review:

Vigabatrin (marketed as Sabril in the U.S. by Lundbeck) was approved by the FDA at the end of August and became commercially available September 21. It is the first officially approved FDA treatment for IS.


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