Mallinckrodt

I recently invested in the controversial pharmaceutical company Mallinckrodt Plc (MNK). Mallinckrodt presents a unique opportunity where “headline risk” has caused its valuation to tumble beyond logical rational and has blinded investors from the facts.

My style of investing is inspired by famed Brazilian investor Luiz Alves Paes de Barros, I am looking for bottom of the barrel valuations that have been incorrectly discounted and have the potential for significant upside.

First, I want to address the two Achtar related controversies and present evidence that Mallinckrodt’s financial exposure is limited, and that the headlines are vastly overblown Secondly, I want to assess each of Mallinckrodt’s products and pipeline to determine sales declines and future growth drivers.

The foundation lawsuit – kickback scheme.

The DOJ alleges that from 2010 to 2014 Questcor made payments to a co-pay assistance program the Chronic Disease Fund (CDF) as means to induce sales for Achtar.  For example, Questor could earmark $10,00 through CDF to support a patient’s 10% co-pay and leave Medicaid on the hook the remainder and earn a substantial return.

The effect of the co-pay assistance program on overall sales of Achtar has been greatly exaggerated. Between 2010 to 2014 Questcor donated a total of $23,462,700 which is an average of ~4.6MM/ year. If proceeds were used to fund 10% copays, the maximum amount of revenue generated is $46MM per year on average and the most egregious being in 2013 at 115MM. By the end of 2014 donations fell to $52K per month and almost nil in 2015.

Data presented by the DOJ does not back up the theory that the co-pay assistance program was responsible for supporting most of Mallinckrodt’s Achtar sales. Mallinckrodt terminated their relationship with the co-pay but still managed to generate 1B+ per year from 2015 to 2018.

DOJ Exabit showing payments made to CDF.

Three recent rulings against pharma companies for similar Co-Pay assistance programs

CMS Lawsuit

The second controversy relates to the lawsuit against the US Health and Human Services (HHS) and Centers for Medicare and Medicaid Services (CMS) over a decision to change Medicaid rebates for its Acthar Gel.

CMS recently asked Mallinckrodt to change the drug’s base date average manufacturer price (AMP), which is used to calculate the rebates. This move reverses CMS’ written authorizations of the base date AMP provided in 2012, which has been in use since 2013.

In a worst-case scenario the decision would eliminate Acthar Gel’s 10% Medicaid net sales and lead to non-recurring charges of up to $600m.

Upon review of the evidence, Mallinckrodt has an exceptionally strong case.

In May of 2012 Questcor sent a letter to CMS asking for a new AMP base date after the FDA approved Achtar for use in treating infantile spasms. Questor specifically requested the new base date based on the new indication, and significant revisions to the Acthar label. Not once did Questcor ask for a new base date AMP due to a new NDA number.

In the same letter Questcor presented two options to CMS to approve a new base date AMP. Both options site a label revision as a basis for the revised AMP.

CMS replied to this letter stating that they reviewed the request and that Achtar was eligible because it was approved under a different NDC than the original and later corrected to say because it was approved under a different NDA.

CMS confirms at this stage it reviewed Questcor’s request, so it at this time knew that FDA approved Achtar though a supplement NDA designed for new indications (also known as type 6) – Questor stated multiple time its request for a new base date AMP was on merits of the new indications on the existing drug.

Four full years later in 2016 CMS contradicts their own written approval and asked Mallinckrodt to revert to original NDA, forcing them to retroactively “correct” its base date AMP during a time when the agency was actively encouraging Questcor and Mallinckrodt to use the now-disavowed base date AMP

CMS knew when approving a new base date that the approval for Achtar (new indication) was under a supplemental NDA as this was the reason Questcor requested approval for a new base date AMP.

This suit reflects poorly on CMS and I believe they will be highly motivated not see this case go to trial. Kevin Snell, a relatively in-experienced trial lawyer at the DOJ has been assigned to represent CMS and has little expertise in the subject matter. Expect to see a settlement before the July 24. Mallinckrodt’s concessions in the settlement could cost 10% of Acthar future sales but retroactive rebate payments to CMS is seen as unlikely..

LOE’s and  Pipeline

Mallinckrodt will face LOE’s in the coming years on key drugs but will maintain strong FCF metrics thanks to an underappreciated pipeline and a growing hospital business. The following forecasts conservative revenue estimates for Mallinckrodt and assumes significant declines in INOmax, Achtar, Amizta, Rescule and Ofirmev.

Pipeline sentiment turned drastically negative after VTS-270 and CPP-1X/Sulindac flopped. Despite going 0-2 in the Sucampo acquisition, initial data for Terlipressin and Stratagraft is positive and management is expecting readouts in Q3 or early Q4.

According to Barclays – MNK could receive peak risk-adjusted revenues of $474M in 2025. Hepatorenal Syndrome (HRS) Type 1 is most prevalent in Cirrhosis and Ascites; the more severe Type 1 makes up approximately 30% of Hepatorenal Syndrome cases and is characterized by doubling of serum creatinine levels to over 2.5mg/dl in less than two weeks. Given the severity of the condition, we project approximately 40,000 patients will require treatment for HRS-1 (Figure 2). MNK has the opportunity to capture the entire market since no other FDA approved drugs are available in the US.

Estimated Addressable Terlipressin Market (Source, Barclays)

If Mallinckrodt hits on either Terlipressin or Stratagraft it gives the company exclusivity to two very profitable markets and provides a solid footing for years to come.

Mallinckrodt currently trades at ~1 X 2019 estimated FCF, this valuation level is typically only ascribed to companies with the high likelihood of bankruptcy and I F*ing love it, I live for these opportunities. I am buying the most hated stock on wall street, I am watching short interest balloon and all the while I feel the luminous light at the end of the tunnel. Headlines will pass, debt will shrink, pipeline assets will mature and Teripressin will start “impressin”.

Disclosure: I am/we are long MNK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.