Description

I.                   General Background

Horizon Pharmaceuticals is a drug manufacturer based out of Lake Forest, Illinois with domicile in Ireland. Because of Ireland’s favorable tax structure, Horizon was able acquire fully taxed drug revenues and put them onto their tax-free platform. From 2013 to today, Horizon acquired nine drugs in addition the their two legacy drugs. Horizon also implemented a Valeant-like strategy which targeted drugs with price increase potential. The strategy is illustrated well with the three drugs in Horizon’s primary care division: Duexis, Vimovo and Pennsaid. In each case, Horizon increased prices ~10x just months after acquiring the IP. As a result, the Primary care division now represents 60% of Horizon’s revenue and ~90% of their EBITDA, based on my estimates.

Duexis, Vimovo and Pennsaid are interesting case studies because they don’t contain any practical intellectual property but are still protected by US intellectual property laws.

Let’s take Duexis as an example….

Duexis is quite literally a crushed Ibuprofen tablet + a crushed Famotidine tablet stuffed into one capsule. Many people know Ibuprofen as an old reliable generic pain medicine. Famotidine is very similar, but protects patients from acid reflux and can be found in Pepcid AC. The medications are often prescribed together, because Ibuprofen will sometimes cause stomach pains in older patients. The cost of 60 tablets of ibuprofen + famotidine is ~$15[1]. at any local pharmacy. The cost of 60 tablets of Duexis is $2,312[2] at that same pharmacy, a 1,541% premium. Again the drug is chemically the exact same as Ibuprofen and Famotidine. An extremely similar relationship exists with Vimovo and Pennsaid.

You may be wondering why doctors would ever choose Duexis over the cheaper equivalents? The answer is that 99%[3] of them refuse to write Duexis scripts. But there exists a small subset of doctors (~1%) who are willing to prescribe drugs like Duexis in return for speaking engagements and other perks which the Horizon’s S&M budget can provide. Horizon spends almost 50% of their revenue each year in S&M vs. 3% on R&D. This is one of the highest marketing budget of any other player in their space. In fact, this is 2x the marketing budget (as a % of revenue) vs. branded pharmaceutical players like Valeant and Shire who seems to have commercials on every TV break. Horizon would argue that their drug relieves doctors from writing 2 prescriptions and ensures that patient takes both medicines. I think their argument is questionable( at best), but the value-add claim doesn’t seem to warrant a sustainable 15x premium.

But, shouldn’t the insurance companies refuse to pay for it? Almost all insurance Companies and PBM’s have put Horizon’s drugs on their exclusion list[4]. Horizon has been able to avoid losing coverage by maneuvering around the payor rules. For example, patients are able to get the drug covered if they have a special note from their doctor (addressed above) and are willing to pay a large co-pay[5]. HorizonCares was a program set up by the Company which covers almost 100% of any co-pay that a patient may receive from an insurance company. The copay’s are usually about $350[6], which is a small percentage of the $2,500 retail price that eventually flows back to Horizon. Valeant was eventually prosecuted for patient assistance program, and as of March 2016, the US Attorney’s Office opened a case against Horizon. I think that Horizon’s patient assistance programs are likely to be subverted by the US government or payors themselves. As a result, I expect to see large decreases in the volume of sales.

But how can our legal system protect these patents? The Horizon story is fairly new and the validity of Horizon’s patents is currently under review from both regulatory and litigation perspectives. Each of Horizon’s Primary Care drugs has approved generic ANDA’s as well, which are being held up in court. In fact, Horizon is being sued by non-profit entities for the absurdity of their patents. In 2015, Texas investor Kyle Bass set up The Coalition for Affordable Drugs to attack Horizon’s IP based on the idea that they had mistakenly been given intellectual property. If any one of Horizon’s three primary care drugs loses its exclusivity Horizon will be affected dramatically because of their earnings exposure.

From a regulatory perspective, the current administration has articulated pharmaceutical prices as a subject of their agenda. Since the change in administration there has been a specific focus on pharmaceutical prices and an ensuing deflationary effect on drug prices. By contrast, Horizon prices hit their all-time high as of February 2017. Horizon’s drugs could be the subject of a pharmaceutical regulatory law because of the questionable status of their patents.

II.                 Thesis

Horizon currently has approximately 90% of their EBITDA concentrated in 3 price gouged drugs and 4.0x turns of leverage. The exact same medicine is available for almost 200x less in any retail pharmacy. Horizon has been able to convince a small subset of patients/payors/doctors to support their drugs through questionable business practices, which I think have now been terminated.

As a result, I think Horizon may have to reduce their prices by up to 90% to stay competitive. If this happens, earnings potential of their business will not be able to satisfy the debt obligation and the Company will be forced to apply for bankruptcy. At relatively low short interest and a 14x EV/EBITDA multiple, I think Horizon gives investors an exciting opportunity to bet against a Company that has high bankruptcy risk.

Catalyst

• No more Copay assistance

• New agreements with PBM’s at a new price levels