November 08, 2010 - 9:31am EST by
2010 2011
Price: 12.84 EPS $0.61 $0.89
Shares Out. (in M): 65 P/E 21.0x 14.0x
Market Cap (in $M): 833 P/FCF 14.0x 10.0x
Net Debt (in $M): -111 EBIT 59 88
TEV ($): 721 TEV/EBIT 11.0x 8.0x

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Questcor Pharmaceuticals is a niche pharmaceutical manufacturer that offers several compelling potential upside opportunities and limited downside risk.  This is a rare pharmaceutical that generates profits and cash flow, has net cash (which it intends to return to shareholders), has enormous revenue upside, has an FDA approved drug, and yet trades at reasonable multiples on current run-rate results.  It is easy to make the case that there is 50-100% upside in QCOR.  Downside risk appears to be 15-20%.

Questcor manufactures and markets one drug, H.P. Acthar Gel.  Acthar is a porcine-based injectable that contains adrenocorticotropic hormone ("ACTH").  ACTH is a key component of the hypothalamic-pituitary-adrenal ("HPA") axis, a complex system that regulates the body's reaction to stress and regulates critical processes for the immune system, digestion, and emotions.  After injection, Acthar operates by stimulating the adrenal cortex to secrete cortisteriods.  Exactly how and why Acthar works is not yet well understood.  Acthar is manufactured through a proprietary process involving the purification and processing of pig pituitary glands.  The exact manufacturing process is a trade secret, and Questcor believes that it is not possible to reverse engineer the process.

Acthar was developed in the 1940s by researchers for treatment of multiple sclerosis flares.  The drug was approved by the FDA in 1952 for the treatment of over 50 conditions including multiple sclerosis ("MS"), nephrotic syndrome ("NS"), rheumatic disorders, respiratory diseases, allergic states, and ophthalmic diseases.  Acthar also came to be used for the treatment of infantile spasm ("IS") even though this was not an approved indication for the drug.  In fact, Acthar became the gold standard for treatment of infantile spasm despite being an off-label treatment and IS became the primary revenue driver for the drug.  The vast majority of revenues are still generated by 2 indications, IS and MS. 

Achtar is a powerful drug and can have serious side effects.  The most common Acthar side effects are similar to those of steroids - weight gain, high blood pressure, and mood change.  There is also increased risk of infection or severe allergic reaction.  With chronic use of Acthar, Cushing's syndrome is a risk.  The drug has been in use for 60 years, but new side effects in treatments of other conditions are possible.

Questcor purchased Acthar in 2001.  The company tried a number of strategies to grow its business that proved unsuccessful until a new strategy was put forward by a new management team in late 2007.  The new team increased the price of Acthar from $1,650 per vial to $23,000 per vial to ensure the viability of the company and to bring pricing of Acthar in line with other drugs treating rare diseases.  In 2008, Questcor submitted another supplemental new drug application ("sNDA") with the FDA to add an IS indication for Acthar.

In 2009, Questcor revamped its sales and marketing effort for MS after previous sales efforts had failed.  The company began to market Acthar as a second or third line treatment for MS rather than a first line treatment.  That effort has proved successful and the company has dramatically increased MS prescriptions.

Recent Developments:
In October 2010, the FDA revised the Acthar label.  IS was added as an indication and the key other indications were kept, including MS and NS.  There are now 19 approved indications for Acthar. 

In late October 2010, four abstracts were posted by the American Society of Nephrology relating to the use of Acthar for NS.  These are the first studies of Acthar for NS.  Though these were small sample size studies (N=21 in one and N=18 in another), they showed tremendous potential for Acthar in treating NS.  In one study of 21 patients with different forms of NS, 10 of the patients with membranous nephropathy ("MN") that had failed an average of 2.3 other treatments, had promising results - complete remission was achieved in 3 cases and partial remission in 4 more cases.  Though small, this 70% response is very encouraging.  Similar response was achieved by the other 11 patients in the study with different forms of NS.  In another study of 18 patients with advanced diabetic nephropathy ("DN"), 69% achieved partial or complete remission over 6 months of treatment with Acthar.  These studies are to be presented at the ASN conference in November with a presentation scheduled November 20, 2010.  The company expects a peer-reviewed journal publication in early 2011.

Segments for Acthar:
IS - the $100m market with significant penetration
IS has historically been the primary use of Acthar accounting for 50% of 2009 revenue.  IS is a very rare form of epilepsy that can be life threatening.  Acthar is considered the gold standard first line treatment for IS although some physicians may try steroids before escalating to Acthar.  In a typical treatment, 4-5 vials of Acthar are needed which generates approximately $80-100k of revenue per patient.  Questcor does not have issues with reimbursement from private payers for IS and has been reimbursed for years.  Medicaid receives 100% rebates for Acthar (i.e., QCOR recognizes $0 of net revenue for Medicaid prescriptions).  Medicaid patients comprise approximately 40% of the infant population and the company estimates 40% of its prescriptions are through Medicaid.  Since IS is extremely rare, exact numbers are not known, but approximately 2,000 patients a year suffer IS.  Of this amount, approximately 75% are symptomatic meaning the total addressable market is 1,500 patients.  If 40% of these are Medicaid, then the revenue generating market potential is 900 patients.  This means that the total market for IS is approximately $80-100m.  Acthar is currently running at approximately 360 paid prescriptions per year (or 40% share).

Since IS was not on the Acthar label until October 15, 2010, Questcor has not been able to market Acthar for IS historically.  The company is now allocating 20% of its sales effort to pediatric neurologists and expects a modest increases in sales from the new IS indication.

MS - growing to a $1+ billion opportunity?
MS flares have been a rapidly growing indication for Acthar.  The company has expanded its sales force 4 times in the last 2 years to market Acthar as a second line treatment for MS flares.  There are approximately 400k patients in the US each year according the National MS society.  85% of these patients have relapsing remitting MS ("RRMS"), which is a condition that causes periods of flares and periods of inactive symptoms.  Patients with RRMS may suffer flares every 12-18 months, so patients average approximately 0.75 flares per year.  Acthar is now marketed and used when prednisone or a corticosteroid fails to stop an MS flare.  No estimate is available for how often other treatments fail - since there are no other treatments for physicians to prescribe.  Management has estimated 10%-30% of treatments fail.  This puts the available flare market at 25-75k patients (400,000 * 0.85 * 0.75 * [10-30%]).  Acthar treatment for MS requires 1-2 vials and averages approximately $40k.  The company estimates that 10% of RRMS prescriptions for Acthar are covered by Medicaid (i.e., QCOR recognizes $0 of net revenue).  This is much lower than for IS since a lesser proportion of the adult population is covered by Medicaid than the infant population.  Adjusting for Medicaid, the revenue generating market potential is 20-60k treatments a year which is a total market for MS of $900m - 2,700m.  Acthar is currently running at approximately 1,300 paid prescriptions per year (or 6% market share using the smallest market size assumption).  Acthar is FDA approved for MS.

NS - a new multi-billion $ opportunity?
Acthar prescriptions for NS have only recently been written and no studies have been published before about the use of Acthar in NS.  The studies to be presented at ASN show significant promise for Acthar and NS could ultimately be the largest revenue opportunity for Acthar.  NS is a kidney condition that causes the kidneys to dump high levels of protein into the urine which generally leads to end stage renal disease  ("ESRD") or kidney failure.  If treatment is not successful for NS patients, dialysis and kidney transplant are eventually required, although patients can go decades before either of these procedures are necessary.  Treatment of NS with Acthar generally requires 9-10 vials and averages approximately $200k.  In treating NS, doctors typically wait before prescribing medication as approximately 1/3 of NS patients spontaneously remit.  If time does not magically heal, patients are generally given a modified Ponticello regimen (alternating treatment of prednisone and cyclophosphamide) or cyclosporine.  This helps some patients, but large percentages of patients with NS will ultimately enter end stage renal disease.  Then the only treatments available are dialysis or transplant.

Estimates for the size of the market for NS are also difficult, but precise numbers are not critical since they are so large.  As long as Acthar proves successful in treating NS, then the opportunity is enormous.  The two largest opportunities are in MN and DN.

The NIH estimates that 2 in 10,000 people suffer MN.  Assuming 300m people in the US, there are approximately 60k patients.  75% of these patients are idiopathic (i.e., unknown cause for the disease).   20% of patients recover without treatment and 20-40% of patients progress to total kidney failure.  Acthar is approved for idiopathic MN, which would equal approximately 9,000-18,000 patients (= 2 / 10,000 * 300m * 75% * [20-40%]).  Assuming that 10% of this population is covered by Medicaid (company estimates) as this disease is more likely to afflict older population (covered by Medicare not Medicaid) and $200k per treatment for paid prescriptions yields $1.8b - $3.6 billion total market size for Acthar.  The abstract to be presented at ASN November 20th showed real promise for Acthar (though on N=10), with 30% total remission and another 40% partial remission for patients who had failed an average of 2.3 other treatments.  Acthar is FDA approved for MN.

Besides MN, the real homerun opportunity for QCOR is diabetic nephropathy.  Here the market is massive.  Diabetic nephropathy accounts for 40% of end stage renal disease or kidney failure.  Approximately 25m in the US have diabetes, another 60m are pre-diabetic, and 1.6m people are diagnosed with diabetes each year.  Of these patients, approximately 200k patients were on chronic dialysis or living with kidney transplant in the US and 50k patients a year are starting on ESRD treatment each year.  Assuming that we just take the patients who are about to undergo ESRD (50k) and assume that 10% are Medicaid, there is a potential market size of 45k patients a year for Acthar and $9,000b of revenue potential.  The market potential would be materially larger if we assumed some of the people living on chronic dialysis were potential Acthar patients (200k) or some of the people not yet at the final stages of ESRD got Acthar treatment.  Diabetic nephropathy is not on the Acthar label, so the company could not actively market this indication.  However, if data continues to show promise as in the preliminary small study abstracts, then there will likely be off label usage as the alternative (dialysis or transplant) is not appealing to patients or insurers.

Approximately 30 Acthar prescriptions are written per year, indicating 0% market share (rounded).

Other treatments
The company has indicated a desire to try to commercialize as many of the 19 FDA approved indications of Acthar as possible.  QCOR is also seeking additional off label potential including traumatic brain injury.  These on and off label opportunities are unknowable at this point and not likely to generate revenue for any relevant period of time.

There are other drugs that treat each of IS, MS, and NS.  Typically, a steroid like prednisone or a cyclosporine is used.  These drugs are a fraction of the cost of Acthar ($1,500 or less per vial vs. $23,000 for Acthar).  However, these drugs have limited success with IS, moderate success with MS, and moderate success with NS and are already used extensively.

Sabril (vigabatrin) has also been approved for IS, however, it comes with a black box warning about vision loss, which Acthar does not have.  This will impede Sabril's ability to gain share.

Synacthen is a synthetic version of ACTH, and while it is similar to Acthar, it is not identical (contains a portion of the Acthar compound).  Synacthen is not FDA approved in the US, and Novartis would need to run trials to get approval for use in NS, IS, or MS.  This seems somewhat unlikely given that Synacthen sells for approximately $1,500 per vial, and an economic case for a trial is difficult at that price unless the market size is proven to be very large - a scenario that would clearly benefit QCOR.

Generic versions of Acthar are possible eventually.  However, Acthar is created through a proprietary process, so discovering the key and relevant components of Acthar will take time.  Also, the low numbers of prescriptions currently filled with Acthar (approximately 7k per year) make the economic case for a generic very difficult.  However, if MS prescriptions grow meaningfully or NS proves to be a large opportunity, then this becomes more likely.  Regardless, it will take years to develop a generic, run trials, and get FDA approval - even if that process were to start today.

Acthar has limited problems with reimbursement.  IS, MS flares, and NS have devastating consequences and affect small numbers of patients.  In the case of IS, Acthar is the accepted treatment, and insurance companies will be hard pressed to deny coverage to infants.  For MS, Acthar is used in cases when other known treatments have failed.  And in NS, the alternative is generally chronic dialysis or kidney transplant which cost hundreds of thousands of dollars.  Medicaid rebate is 100%, but Medicare and private insurance pay claims, and the company reports no problems with collection.

Valuation and Financials:
Questcor's capitalization is straightforward.

The company had $111m ($1.70/share) of net cash and no debt.  With 64.85m shares diluted shares outstanding, the stock has a current market capitalization of $833m and an enterprise value of $721m.

In Q3 2010, the company produced $16.8m of EBIT, $11.5m of net income, $12.7m of free cash flow excluding WC, and $18.7m of free cash flow including WC on $35m of net sales.  The company has 93% gross margins on net sales (adjusting sales for Medicaid rebates).  Annualizing these totals gives $67m of EBIT, $46m of net income, and $51m of FCF excluding WC on $120m of net revenue.

So excluding any growth beyond what was achieved in Q3 - QCOR trades at 10.7x EV/EBIT, 15.6x PE (excluding cash), and 7% FCF yield (excluding cash).

The company has no good alternative uses for its cash and seeks to return capital to shareholders.  It prefers either special dividends or share buybacks, but has been precluded from share repurchase for the last 18 months due to the sNDA application with the FDA.  Now that the application process is finished, the company expects to begin to buy shares again soon.

Inflection point for growth
There is good reason to believe QCOR will now meaningfully increase sales in IS, MS, and NS given recent developments.  In MS, QCOR doubled its salesforce in Q3 2010 to 77.  The extra sales people should help grow MS sales as they become productive in Q4 2010 and Q1 2011.  For IS, QCOR can now market Acthar for the first time to neurologists.  For NS, the studies highlighted above will be presented at the ASN in late November, which should get some doctors to begin prescribing Acthar for nephropathy patients.

Significant Operating Leverage:
What makes QCOR so compelling is its substantial operating leverage.  Assuming gross margins are 93% (conservative since margins are actually much higher for NS and MS given much lower Medicaid populations) and that the company has limited incremental SG&A (assume 5% SG&A growth per $1 of sales growth), incremental margins are approximately 90% (use 88% in this analysis).

For IS, the company currently sells approximately 640 total Rx per year and 360 paid Rx per year.  Each 10% increase in sales (4% market share growth) is worth approximately $3m of EBIT and $2m of net income.  At 10x EV/EBIT and 15x pe, this is approximately $0.50/share.  Given that the FDA label has just been added, 20% of salesforce effort will now be IS dedicated, and that Acthar is the gold standard treatment, at least 10% is achievable in a low case and 30% in a high case - or $0.50 to $1.50/share of upside.

For MS, the company just doubled its salesforce from 38 to 77 for MS in Q3 (80% of sales effort on MS and 20% on IS).  Since the salesforce expansion started in early 2009, the company has averaged 40 new paid Rx per quarter.  Each 160 new paid Rx (~0.7% market share) for MS yields $5.7m of EBIT and $3.7m of net income.  At 10x EV/EBIT and 15x pe, this is approximately $0.90 share.  It is really hard to estimate MS ramp potential.  Assuming that the salesforce continues at its new Rx pace for 2 more years yields $1.80/share of upside and Acthar would have approximately 7% of its available market share (cases where steroids fail) up from its current 6%.  If Acthar can achieve 10% share in its addressable market, it would grow to 2,300 paid Rx per year - or $5.30/share of upside.

For NS, the leverage is greatest.  Each 10 new patients generate approximately $1.6m of EBIT and $1.0m of net income, which is worth $0.25/share at 10x EV/EBIT or 15x pe.  If the new studies drive some trial by physicians of Acthar for MN, DN, or other types of nephropathy, it is easy to see at least 100 Rx per year, or $2.50/share of upside, and market share would still be effectively 0.  If 5% of MN patients (MN is on-label) received Acthar, this would be an incremental 420 Rx or $10/share of upside.  As mentioned above, DN is an even bigger opportunity, but it is also off label.  But even a small amount of clinicians trying Acthar for patients in end state renal disease would generate significant additional upside for QCOR.  QCOR has indicated it is getting significant interest from nephrologists in the ASN abstracts - including 40 nephrologists planning to attend an Acthar key opinion leader dinner at the conference in November.

The upside case is easy to make as described above.  The key is continued MS penetration and/or any success with NS.  Any moderate success with these indications easily yields 50-100% share upside.

Downside risk in the shares would require MS growth to stall, NS to fail to generate any sales, and IS label indication to have no impact.  For this case, take the conservative assumption that all growth stopped in Q3 2010 and the company will have no other success selling Acthar in any indication.  The company should generate an additional $63m of FCF through the end of 2011 (5 quarter run rate of FCF ex WC).  At a 10% FCF yield on $51m of run rate FCF plus $175m of net cash, the stock would be worth $10.50 (18% downside).  Similarly at 11x PE excluding cash, the stock would be worth $10.50 (18% downside).  At 8x EV/EBIT, the stock would be worth $11/share (14% downside). 

Recent salesforce expansion drives sales in MS/IS.  Expansion from 38 to 77 in Q3 should generate sales by Q4 2010 or Q1 2011.

NS conference and new studies drive early trial.  ASN conference presentation is November 20th, and QCOR plans marketing/sales events at the conference.  40 key opinion leaders in nephrology attending QCOR dinner at ASN.  These are the first studies of Acthar for nephrology.

IS label generates incremental sales.  New sales effort started in November 2010.

Share buyback reinitiated.

New analysts pick up coverage.  Currently, only 2 sell-side analysts cover QCOR.  Additional coverage is possible given the label has been effectively re-affirmed by the FDA and the NS studies look promising.

Side effects - it is possible that increased usage of Acthar in newer conditions highlights new risks for the drugs use.

Alternative treatments - new treatments that address the root cause of or symptoms for IS, MS, and NS are possible.  However, even if new advances were made today, we are years away from widespread adoption and use.

Generics - if Acthar is successful in creating significant markets in MS, NS, or a new indication, other drug companies are likely to develop generic substitutes.  Generics for IS are unlikely as it is such a rare disorder.

New branded competition - if QCOR is successful in creating significant markets in MS, NS, or a new indication, drug companies are likely to develop branded competitive products.  However, QCOR is years ahead of competition now, and if competitors do begin these efforts, it is likely only because QCOR is successful.

Medicaid - Questcor is more susceptible to expanded Medicaid coverage since Acthar gets fully rebated to Medicaid.  This would impact IS (~40% of patients currently covered) more than MS or NS (~10% of patients covered).

Timing - It is hard to estimate adoption/penetration rates of Acthar in MS and NS on a forward basis.  The higher the stock price, the higher the expectations for quick ramp in volumes - which can lead to disappointed shareholders.


Salesforce expansion drives MS/IS sales.
NS conference drives new NS sales.
IS label generates expanded use.
Share buyback resumes.
New sell-side coverage launches.
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