Questcor Pharmaceuticals: A Short-Seller's Dream

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A short-seller typically looks for three things in a stock: controversy, excessive valuation or volatility, and other short-sellers. Questcor Pharmaceuticals (NASDAQ: QCOR) is a short-seller’s dream, as it’s driven by one product, has traded with both a massive valuation and excessive volatility, and has 51.10% of its float short as of Oct. 15. But will it remain a short-seller’s dream?

For those of you who have never read the story of Questcor Pharmaceuticals, you really should take 10 minutes on its website. The company acquired its lead product, Acthar Gel, for about $100,000, after it was turned down by every large pharma company. The company has since more than doubled sales for each of the last three years and has returned revenue of nearly $425 million during the last 12 months from its one multi-purpose product.

It has been nothing but good fortunes for this company, with its 10,000% gain from June of 2007 to June 2012. However, the stock has traded lower as of late, by more than 50% since September, and fell another 6.48% on Friday as daunting concerns created uneasy investors.

It was a piece from Citron Research that first started the fall of Questcor Pharmaceuticals. The firm identified aggressive marketing practices, competitive threats, and gave reasons for why Questcor would return to single digits. At the time those arguments sounded ludicrous, but after several months, and Aetna limiting coverage and an investigation, the shorts are seeing big profits from this past momentum stock.

Aside from all the rumors, speculation, and uneasy feelings, not much has changed with the company itself. In fact, the company is far better today than it was at $55 per share. Questcor has made an effort to been more proactive; it’s entered into an aggressive buyback program and has implemented a dividend.

The company has stated several times that the drop in coverage will have an effect of only 5% on sales, and most importantly, the company continues to see record monthly prescriptions and revenue growth for Acthar Gel. Now, the company trades with a forward P/E ratio of just 5.76, and from the outside looking in the stock appears very attractive.

With so many positives, why would Quesctor be a short-seller’s dream? The truth lies in perception. Unfortunately, it doesn’t really matter how a company performs when rumors are spreading, especially in a flat and very indecisive marketplace. As of now, investors are scared to invest in this company. It traded with such large five year gains, still more than 1,700% today, that investors were starting to short the stock even before the rumors began to originate.

The company is now strikingly similar to another fast-growing biotechnology company: Spectrum Pharmaceuticals (NASDAQ: SPPI). Spectrum has been one of the most heavily shorted stocks for years, with 60.30% of its float being short as of Oct. 15. The company is growing revenue at “only” 50%, compared to Questcor’s 100%; however, there aren’t any rumors or serious problems with Spectrum.

I think it’s hard to determine the formula that short-sellers use to find stocks. If I were looking for two of the fundamentally strongest companies then I would look to either Questcor or Spectrum, I wouldn’t consider either a good candidate to fall with such low valuations. However, like to short stocks where other shorts are present. Therefore, I am not certain that short-sellers know why they short certain stocks; I think it’s more about following the leader, and chasing trends.

Looking ahead into the next year and beyond, what happens with Questcor? The answer to this question is difficult. When a stock has a large presence of shorts, those who are long get frustrated, and sometimes determine not to invest due to the lack of consistency and the risk of large price swings. However, despite the fact that a company such as Spectrum has been aggressively growing throughout the last year with no movement, I still believe the best way to eliminate shorts is with fundamental performance.

Questcor is making all the right moves: the company is buying back shares to create support, it is paying a dividend, which makes it more costly to be short, and it’s continuing to post market-leading growth. The arguments made on behalf of shorts are still yet to materialize. However, they create a change in perception and an illusion of problems with the company.

Questcor must continue to perform and prove the doubters wrong. As a result, this could mean several months of flat trading, but if the company performs well then eventually its stock will follow. Unfortunately, it takes years to create shareholder value and only days to lose it, so longs must be patient, and if shorts are wrong, then longs will have the last laugh. 

BrianNichols is long SPPI. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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