Where Is The Growth?
Mallinckrodt’s Q2 revenue fell 5% Y/Y. This was a major disappointment in my opinion. Mallinckrodt had been growing revenue by double-digits on the strength of acquisitions, and the market rewarded the company as if the growth was organic. Now that management has tamped down acquisitions, growth has come to a screeching halt.
Acthar, which treats infantile spasms and certain autoimmune conditions, grew by 7% Y/Y; Acthar now represents 39% of total revenue, making the company a one-trick pony. Revenue from “Other Specialty” and Specialty Generics both fell by double-digits. About 28% of revenue is derived from generics which could be problematic long-term given the lack of pricing power within the generic segment. Copy cat drugs and the U.S. government’s concerted efforts to help drive down drug prices could provide headwinds for generics for the foreseeable future.
That said, Acthar is considered one of the most expensive drugs currently being reimbursed by Medicaid. In the past, Citron has questioned whether Acthar is effective for certain indications. Management is currently providing studies to prove Acthar’s effectiveness, yet no conclusion has been reached:
We were also pleased that four new Acthar papers were published in the last several months, which we believe provide additional evidence for payers and prescribers to support the positioning of the product, primarily for refractory patients. Three of the publications report on clinical experience for Acthar in key promoted indications: rheumatoid arthritis, nephrotic syndrome and sarcoidosis, with clinical studies in these patient populations providing further evidence to support the treatment of refractory patients who can benefit from Acthar.
The fourth is a recently published article summarizing the extensive data contained in our Academy of Managed Care Pharmacy, or AMCP, dossier for Acthar … Primarily used with managed care organizations, the dossier contains data on proper use for appropriate patients and the health economic benefits of the drug.
I find it odd that for a drug as expensive and widely used as Acthar, Mallinckrod does not have studies pursuant to its effectiveness at the ready. If Acthar’s effectiveness or pricing gains government scrutiny then Medicaid could cut back on purchases of the drug. In my opinion, this is the single biggest threat to owning MNK at this juncture. Uncertainty hangs over Acthar and the company has been unable to generate organic growth from generic drugs so the stock could be dead money for a while.
The Balance Sheet Is Now In Focus
I would lump Mallinckrodt in the same category as other serial biotech acquirers like Teva (TEVA) and Valeant (VRX). Now that Mallinckrodt has tamped down acquisitions, and price gouging has come under the radar of policymakers, the value of the company’s prior deals and the quality of its balance sheet could become a point of emphasis. The company has engaged in asset sales of over $800 million this year, which I found prudent. Shoring up the balance sheet is key to Mallinckrodt’s long-term survival. It currently has cash on hand of $330 million; EBITDA of $333 million is rather hefty, despite the fact it fell by double-digits Y/Y. Mallinckrodt’s $5.9 billion debt load is at 4.4x run-rate EBITDA – approaching junk levels. If its credit metrics deteriorate then the rating agencies could downgrade the company’s debt, and cause sentiment to sour.
The company has a much stronger balance sheet than Valeant, which I estimate is insolvent. However, any hit to Acthar could hurt Mallinckrodt’s EBITDA, cash flow and credit quality. While liquidity is strong, Mallinckrodt practically has no other assets; $12 billion of its $15 billion asset base is made up of goodwill and intangibles. If Acthar ever receives a competitive threat or real push back from Medicaid, the diminution in Mallinckrodt will likely not be an orderly one.
Mallinkrodt’s revenue and EBITDA are both in decline. Its dependence on Acthar to generate revenue and earnings is a major risk factor. A hit to Acthar could trigger a ratings downgrade and cause MNK to unravel.