Recent Questcor Short Squeeze Confirmed, Continuation Possible

In anticipation of major movement ahead of Q1 2013 earnings for Questcor Pharmaceuticals (QCOR), a lot of speculative positions were opened on the long and short side of the trade in anticipation of potential surprises in the company’s earnings and revenue. The company had posted record sales for its lead product H.P. Acthar gel for the fourth quarter of 2012, and bulls were generally expecting the momentum to continue into the next quarter while the product saw expansion into a few new indications, although a dip in the usage for the treatment of exacerbations in Multiple Sclerosis in the first two months of the year appeared to drag total Acthar sales low enough to cause a sales revenue decline in Q1 2013 relative to Q4 2012.Although this was exactly what the bears were looking for, the reaction to the Q1 earnings was clearly bullish. After April 30th, when QCOR was trading just north of $30 per share, the stock went on to rally to ~$42.40 per share in two weeks.

This 41% rally, which was made on fairly strong volume, is largely explainable by a big shift in sentiment from the bear side. Going into the earnings with short interest data from April 30th, one can see that about 27.1M shares of QCOR were being sold short. The most recently posted data from May 15th shows that there was a decline of ~2.3M in the total pool of shares short, moving the figure down to 24.9M. This also represented a decline in shares as a percentage of float from 45.5% to 41.8% based on the most recently acknowledged number of total shares outstanding (~59.6M) which may decline as the company’s share repurchase plan still allows the company to acquire another 6.3M shares.

Although much of the rally was fueled by organic buying, it’s now apparent that the short squeeze that many Questcor longs were looking for has finally started to happen. Depending on the price that these QCOR shorts were covered at, we can say that about $70-90M worth of QCOR was purchased as a result of short covering in the first two weeks of May 2013. The market helped absorb this with significantly increased volume in QCOR common stock, although the effects were still quite dramatic.

Going forward it’s not clear whether the remaining 24.9M shares that are short will be phased out to the benefit of QCOR shareholders, but bears may be willing to wait until Q2 2012 results later this summer which could miss our high expectations. The market is expecting an EPS of $.98 and revenues of $167.3M on average (significantly higher than Q1 2013 results) as the company expands Acthar’s marketing into a total of 19 separate indications.

Questcor is more likely to stay rangebound until we see Q2 2012 results in about two months, and I don’t expect too much change in short interest as we head towards this catalyst. Many of the newer short sellers seemed to have bet against the stock in late 2012 and early 2013, and should have covered after Q1 earnings. Many of the “old” short positions should still be in the green, although interest and dividend payments from Questcor to its shareholders (now at a yield of 2.87% per year) continue to whittle away at those gains.

QCOR also has strong fundamentals, with particular robust cash flow and inherent undervaluation, and seems especially attractive as a holding below $40 per share. If Q2 results are in line with the company’s own expectations, I also expect the stock to eventually make an attempt at $50 depending on the reaction of bears that are still heavily shorting the stock. Like mentioned earlier, there are 24.9M shares of QCOR still being sold short, which equates to ~$870M worth of potential buying.

Disclosure: Long via Short Puts