Opioids Or Price Gouging- Mallinckrodt Spinoff From Sonorant Will Give You Your Choice Later This Year

With its stock in freefall, Mallinckrodt(MNK) announced plans to move forward with a spinoff announced late last year. Mallinckrodt stock, which traded for over $130 per share in March 2015, was $62.58 when we wrote about it in November 2015, and $18.67 when we discussed it in December 2018.  In the last 6 months, it has fallen another 50%, with recent trading below $9 per share, though it has rebounded in the last week to closer to $10.

Mallinckrodt is a grandchild of Tyco as a spinoff of Tyco spinoff Covidien(see our retrospective of Tyco spins). Later this year, it plans to spinoff its Specialty Generics business. This Tyco great-grandchild will retain the Mallinckrodt name and MNK ticker symbol. Meanwhile, the remaining Specialty Brands business will be renamed Sonorant Therapeutics and is expected to trade under the SRTX ticker symbol. The company has not explained the derivation of the new name, but, for a change, it’s actually a real word in the English language meaning “a speech sound characterized by relatively free air passage through some channel, as a vowel, semivowel, liquid, or nasal.”

In December, Mallinckrodt had planned that constipation drug AMITZA would be included in the spinoff of Specialty Generics, but it has now decided that it will be retained by Specialty Branded due to improved performance in Specialty Generics.

It was previously announced, and reflected in the preliminary registration statement on Form 10 filed by Mallinckrodt Inc. with the U.S. Securities and Exchange Commission (SEC), that the new spun-off company would include AMITIZA (lubiprostone). Given the strong, return-to-growth performance of the Specialty Generics business, it has been determined that the AMITIZA product should remain with the Specialty Brands company.

“When we announced our intent to separate the Specialty Generics business through a spin-off in December 2018, we noted the final allocation of assets between the two companies could change. Our goal from the outset has been to establish two new, appropriately capitalized, independent companies well positioned to unlock and increase value over the long term,” said Mark Trudeau, President and Chief Executive Officer of Mallinckrodt. “We now believe retaining the AMITIZA product will better serve the needs of the Specialty Brands company, providing revenue diversification and stronger cash flows to support our commitment to debt reduction. Importantly, as a result of this change we believe the new Specialty Generics company will emerge with significantly less debt than previously anticipated, and have greater flexibility to pursue growth and investment strategies aligned with its goals.”

Without the AMITIZA product, for the twelve months ended March 29, 2019, the collective net sales from the Specialty Generics business were $722.6 million on an as-reported basis.

Mallinckrodt, the Specialty Generics business, is projected to have $150 million in annual EBITDA.

With approximately 1,600 employees, the newly separated company will include a leading acetaminophen business, a portfolio of both APIs and generic finished dose forms of controlled substances and other drugs, a complex specialty generics development portfolio, and a strong U.S. manufacturing footprint. The Specialty Generics business’ outlook for 2019 is largely driven by volume-based market share recapture. Its pipeline is progressing toward long-term advances with nearly 20 products in development, approximately 70% of which are non-controlled substance molecules, and the branded versions of those products currently aggregate to more than $10 billion of net sales.

Harbaugh said, “We have a diversified revenue base across APIs, contract manufacturing and finished dosage form generics with solid cash flows and a long-standing leadership position in controlled substances. With expected 2019 pro forma, stand-alone adjusted EBITDA of roughly $1502 million, we believe we have a compelling story that investors should find attractive.”

Prior to the spinoff, the new Mallinckrodt business will raise up to $300 million in debt and distribute the money to Sonorant. Mallinckrodt also faces significant potential liability as a manufacturer of opioids. Consider the following disclosure from the company’s recent 10-Q.

Opioid Related Matters
Since 2017, multiple U.S. states, counties, other governmental persons or entities and private plaintiffs have filed lawsuits against certain Mallinckrodt entities, as well as various other manufacturers, distributors, pharmacies, pharmacy benefit managers, individual doctors and/or others, asserting claims relating to defendants’ alleged sales, marketing, distribution, reimbursement, prescribing, dispensing and/or other practices with respect to prescription opioid medications, including certain of the Company’s products. As of May 7, 2019, the cases of which the Company is aware include, but are not limited to, approximately 1,780 cases filed by counties, cities, Native American tribes and/or other government-related persons or entities; approximately 122 cases filed by hospitals, health systems, unions, health and welfare funds or other third-party payers; approximately 27 cases filed by individuals and 7 cases filed by the Attorneys General for New Mexico, Kentucky, Rhode Island, Georgia, Florida, Alaska and New York. Certain of the lawsuits have been filed as putative class actions.
Many of the lawsuits have been coordinated in a federal multi-district litigation (“MDL”) pending in the U.S. District Court for the Northern District of Ohio. The MDL court has issued a series of case management orders permitting motion practice addressing threshold legal issues in certain cases, allowing discovery and setting a trial date in October 2019 for two cases originally filed in the Northern District of Ohio.
Other lawsuits remain pending in various state courts. In some jurisdictions, such as Connecticut, Illinois, New York, Pennsylvania and Texas, certain state court cases have been coordinated for pretrial proceedings before a single court within their respective state court systems. State cases are generally at the pleading and/or discovery stage.
The lawsuits assert a variety of claims, including, but not limited to, public nuisance, negligence, civil conspiracy, fraud, violations of the Racketeer Influenced and Corrupt Organizations Act (“RICO”) or similar state laws, violations of state Controlled Substances Acts or state False Claims Acts, product liability, consumer fraud, unfair or deceptive trade practices, false advertising, insurance fraud, unjust enrichment and other common law and statutory claims arising from defendants’ manufacturing, distribution, marketing and promotion of opioids and seek restitution, damages, injunctive and other relief and attorneys’ fees and costs. The claims generally are based on alleged misrepresentations and/or omissions in connection with the sale and marketing of prescription opioid medications and/or an alleged failure to take adequate steps to prevent abuse and diversion.
The Company intends to vigorously defend itself against these lawsuits and similar lawsuits that may be brought by others. Since these lawsuits are in early stages, the Company is unable to predict outcomes or estimate a range of reasonably possible losses.

In addition to the lawsuits described above, certain Mallinckrodt entities have received subpoenas and civil investigative demands (“CID(s)”) for information concerning the sale, marketing and/or distribution of prescription opioid medications, including from U.S. Department of Justice (“DOJ”) and the Attorneys General for Missouri, New Hampshire, Kentucky, Washington, Alaska, South Carolina, Puerto Rico and New York and the Divisions of Consumer Protection and Occupational and Professional Licensing of the Utah Department of Commerce. The Company has been contacted by the coalition of State Attorneys General investigating the role manufacturers and distributors may have had in contributing to the increased use of opioids in the U.S. On January 27, 2018, the Company received a grand jury subpoena from the U.S. Attorneys’ Office (“USAO”) for the Southern District of Florida for documents related to the distribution, marketing and sale of generic oxymorphone products. On April 17, 2019, the Company received a grand jury subpoena from the USAO for the Eastern District of New York for documents related to the sales and marketing of controlled substances, the policies and procedures regarding controlled substances, and other related documents. The Company is in the process of responding to these subpoenas, CIDs and any informal requests for documents.

On August 2, 2018, Energy and Commerce Committee leaders in the U.S. House of Representatives sent a letter to one of Mallinckrodt’s subsidiaries requesting information about that subsidiary’s efforts to monitor opioid sales for suspicious orders. The subsidiary has responded to this letter.
Similar subpoenas and investigations may be brought by others or the foregoing matters may be expanded or result in litigation. Since these investigations are in early stages, the Company is unable to predict outcomes or estimate a range of reasonably possible losses.
New York State Opioid Stewardship Act. On October 24, 2018, the Company filed suit in the United States District Court for the Southern District of New York against the State of New York, asking the court to declare New York State’s Opioid Stewardship Act (“OSA”) unconstitutional and to enjoin its enforcement. On December 19, 2018, the court declared the OSA unconstitutional and granted the Company’s motion for preliminary injunctive relief. On January 17, 2019, the State of New York appealed the Court’s decision. The Company intends to vigorously assert its position in this matter. In April 2019, the State of New York passed its 2020 budget, which amended the OSA so that it would apply only to the sale or distribution of certain opioids in New York for 2017 and 2018 and, effective July 1, 2019, imposes an excise tax on certain opioids.
This litigation could potentially have a dramatic or even fatal impact on the company and a spinoff is unlikely to absolve Sonorant of responsibility for it.  Sonorant will have its own problems as well. Despite a recent settlement with the DOJ, the company still faces several lawsuits related to Acthar sales practices. Acthar is a rather controversial drug, as we wrote in 2015.

At the time, Acthar was owned by Questcor Pharmaceuticals, which was later purchased by Mallinckrodt.  Acthar had been initially approved by the FDA in 1952, having been developed by the Armour meat company from the adrenal glands of pigs. Before it was purchased by QuestCor in 2001, the drug cost just $40 per vial. Questcor, which paid just $100,000 for the rights to the drug, raised the price aggressively, reaching $28,000 per vial by 2012 and $32,000 in 2014 The cost to manufacture each vial is less than $300. You read that right- by 2012, the company was making more in profit off each patient(who uses multiple vials), than it paid for the rights to the drug. To be fair, the company also pays a royalty of 1% on sales above $10 million to the previous owner.

Questcor also has aggressively pushed additional indications for the drug which had very limited use previously. Because it was approved in 1952, the company is not limited in the indications it can market the drug for.  In 2008, the drug, which had been largely prescribed to infants, was prescribed 202 times for Medicare patients, leading to $7 million in reimbursements. By 2013, ProPublica estimates, Medicare reimbursements reached $220 million. With total 2013 sales of $761 million, Medicare is a major percentage of revenue.

The company is already under multiple investigations, including one regarding its 2013 purchase of a potential competitive drug. As well, 14% of 2013 prescriptions resulted in adverse event reports, and the drug may be linked to over 20 deaths.

Acthar and its owners, Questcor and now Mallinckrodt, have defied gravity longer than anyone might have expected. But at some point this business built on a sand castle will crumble, leaving shareholders grasping for the grains quickly passing through their fingers, to be scattered by the wind.

To be fair, the company did announce positive trial results for Acthar in rheumatoid arthritis yesterday, though it was a relatively small sample(n=259), and investors are advised to note the study limitations outlined in the press release.

Study Limitations

  • Sample bias may exist for the open-label phase of the ongoing study, and patients were aware that they were receiving Acthar Gel.
  • Examiner bias may also exist as the patient had to reach low disease activity in order to enter the second phase of the study.
  • The results cannot be solely attributed to Acthar Gel since patients were on different medications at the start of the trial and no washout periods were undertaken.
We just don’t see what there is to like here, either in the parent or the child. Even after years of declining stock, the risks seem to outweigh the rewards. Investors would be wise to look elsewhere for gains.
The latest Form 10 for the spinoff, from May, can be found here. The company has said it expects to file an updated Form 10 reflecting its latest plans sometime this month.
Disclosure: The author holds no position in any stock mentioned