Post-Valeant, Concordia Healthcare’s business model is in doubt

Having emulated Valeant Pharmaceuticals’ roll-up strategy, this Oakville, Ont.-based drug company is now suffering similar side-effects

 
Medical lab researchers using a microscope
(Michael H/Getty)

As little as a year ago, for a pharmaceutical company to be described as a “mini-Valeant” would have been a compliment. It was an apt characterization of Concordia Healthcare Corp. (TSX: CXR), as the company’s shares posted triple-digit returns. But ever since Valeant Pharmaceuticals International (TSX: VRX) became mired in controversy over drug price hikes and accounting irregularities, the label has become a pejorative. And Concordia is now fighting a battle of its own.

The firm, based in Oakville, Ont., has become a target of short-sellers, Marc Cohodes among them. He’s a retired hedge fund operator who now invests with his own money—and runs a chicken farm in California. He has posted missives about Concordia on his Twitter account (which bears the name of his farm, Alder Lane) and has appeared on BNN. Cohodes is cutting in his assessment of Concordia (“the business model is beyond flawed”) and knows how to win followers. When asked about the details of his short thesis, though, his answer is vague: “People’s eyes will start to glaze over if you push that too much.”

Between January 2014 and August 2015, Concordia’s share price skyrocketed by approximately 1,400% to a high of $110. Since then, it’s shed more than half its value and trades around $32. Concordia followed a playbook similar to Valeant’s—acquisitions, minimal spending on research and development, and at least some reliance on price increases—and its share price has suffered as that strategy fell out of favour. Most analysts who follow the company insist Concordia is likely to bounce back. It has a plan to launch a slate of new drugs over the next three years and enjoys stable cash flow from its existing portfolio. Nine out of the 12 analysts who cover the stock rate it as a Buy, and a few of them have targets exceeding $70. But investors should be aware of the risks inherent in Concordia’s business model.

The company entered public markets in December 2013 through a reverse takeover and has been acquiring pharmaceutical assets ever since. Mark Thompson, the CEO, is a former vice-president at Biovail Corp. (a predecessor to Valeant). The firm’s strategy is to purchase older drugs that have a predictable revenue stream and prescription demand. One point of contention is Concordia’s reliance on price hikes. Raising drug prices is now a controversial strategy—particularly in the United States, where politicians have taken companies like Valeant to task for the practice. Owing to the heightened political scrutiny, making sizable price increases doesn’t appear to be sustainable. “That’s going to come to an end,” says Eugene Melnyk, the founder of Biovail, speaking of the industry generally. “You will not have that flexibility.”

In 2014, Concordia acquired Donnatal, a treatment for irritable bowel syndrome that’s now the company’s biggest seller, representing 10% of revenue. Concordia doubled the price of the drug that year and bumped it up another 11% in 2015. Dimitry Khmelnitsky, an analyst at Veritas Investment Research, reckons that during the first nine months of 2015, Concordia’s organic revenue growth was a “modest” 3% year-over-year. Absent the Donnatal inflation, organic revenue would have declined by 10%. (Khmelnitsky is the lone analyst with a Sell rating on the stock.) Concordia, however, is putting sales resources behind Donnatal this year to drive volume growth. “We continue to hold a somewhat cautious view as it relates to Donnatal,” wrote Scotiabank analyst Alan Ridgeway in a recent note, “but believe that a sustained promotional effort…would be a prudent investment.”

Both the company and analysts view its overseas business as more promising, in any event. In September, Concordia purchased British pharma firm Amdipharm Mercury Co. (AMCo) in a deal valued at US$3.5 billion, adding 190 products to its portfolio. On a conference call to discuss the deal, AMCo CEO John Beighton characterized the U.K. as a “prime market” for “being able to move prices.” The National Health Service (NHS) regulates the cost of branded drugs, but not generics. The thinking goes that competition in the market should keep prices in check. But 88% of the products in AMCo’s portfolio have two or fewer competitors, according to a Concordia slide deck prepared for the acquisition. That allows for steeper price movements. A Financial Times story in May found that AMCo had raised the price of fusidic acid eye drops by approximately 1,290% between May 2013 and April 2016. A review of the NHS drug tariff book reveals other hikes, too. Phenindione, an anticoagulant, shot up by 119% shortly before the sale to Concordia closed.

In response to questions about its pricing strategy, a Concordia spokesperson said in an email that the company offers cheaper alternatives to both the eye drops and anticoagulant. Concordia has also lowered prices on drugs within its portfolio of 340 and says the weighted average selling price for its products in the U.K. is £5.94, below the standard prescription payment of £8.40. Concordia also points out that the generic drug market as a whole results in £13.5 billion in annual savings for the NHS. Khmelnitsky views statements like that as a dodge, since the cost of at least some drugs have increased. “The moment you raise prices on your generic drugs, you’re clearly hitting the U.K. taxpayer’s ability to save,” he says.

Concordia has said that growth in its overseas business will come from equal parts price and volume. Indeed, it now has plans to launch 60 new products over the next three years through AMCo, which analysts say will primarily be reformulations of existing products—a liquid version of a drug previously available only in pill form, for example. “AMCo management has tons of experience,” says Joseph Walewicz, an equity analyst at Laurentian Bank Securities. “Concordia has bought a British company and is saying, ‘Keep doing what you’re doing.’”

The company has been tight-lipped about the specifics of its new products, however. Concordia acquired the global rights to four drugs earlier this year, but declined to identify or describe those products on a recent conference call, citing competitive reasons. That makes assessing the growth prospects challenging. Continued growth is a pressing matter for Concordia, given its $4.4 billion in debt. Annual interest obligations are approximately $230 million on the back of $350 million in cash flow, Khmelnitsky calculates. “My fear is that after growing in the short term, there’s a real risk of the business declining materially,” he says. In his view, major acquisitions are unlikely in light of Concordia’s debt load, and the company has yet to prove its ability to grow organically.

A further complication for investors is that Concordia is in play. The company formed a special committee earlier this year to pursue strategic alternatives, including a sale. Rumours have floated in Bloomberg and the Wall Street Journal that private equity groups are interested. Khmelnitksy sees little chance of a deal happening and contends the drug pricing controversy will dissuade potential buyers.

While Prakash Gowd, an analyst at CIBC, is skeptical that an acquisition will happen at a valuation that Concordia shareholders will accept, he says the company could appeal to buyers for a few reasons. Private equity firms could potentially refinance Concordia’s debt, creating more breathing room to invest in its product portfolio and make acquisitions. Given the increased attention on the sector, a private company would also be subject to less scrutiny, and management would have fewer distractions. “It’s fair to say it’s easier to execute on this plan as a private company,” Gowd says.

For the conservative investor, though, the inflamed politics around pricing, coupled with the uncertainty of Concordia’s strategic review, makes the company a tough pill to swallow.

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