Insys Therapeutics: drug dealers and the Feds. Can the business survive?

Insys Therapeutics (INSY:NASDAQ) is a seller of marijuana based anti-nausea drugs and super-strong opiates (Fentanyl) and nothing much else. Nothing has anything that resembles strong patent protection and their version of sublingual Fentanyl is a relatively new comer to the opiate scene - having only been on the market since early 2013.

Remarkably the market cap is over $1 billion. Here is a description from the last 10K. 

We are a commercial-stage specialty pharmaceutical company that develops and commercializes innovative supportive care products. We have two marketed products: Subsys, a proprietary sublingual fentanyl spray for breakthrough cancer pain, or BTCP, in opioid-tolerant patients and Dronabinol SG Capsule, a generic equivalent to Marinol (dronabinol), an approved second-line treatment of chemotherapy-induced nausea and vomiting, or CINV, and anorexia associated with weight loss in patients with AIDS. We market Subsys through an incentive-based sales model.

Drobinol is just marijuana extract. Subsys is a sublingual spray version of fentanyl - an opiate stronger than but shorter acting than heroin whose only legitimate use is to treat pain so sharp the morphine doesn't cut it.

Subsys - by far their important product - is a me-too product. It is - as the form 10K stated - the fourth Transmucosal Immediate Release Fentanyl (TIRF) product released in recent years. However very rapidly gained sales - indeed far more rapidly than any Fentanyl ever. Again to quote the 10K.

We launched Subsys as a commercial product in March 2012. Subsys is the fourth new branded product in the TIRF market over the last four years. Within the first four weeks of product launch, Subsys realized greater market share than the previous three branded products combined at their respective peak market penetration levels to date according to Source Healthcare Analytics. In December 2013, Subsys was the most prescribed branded TIRF product with 28.3% market share on a prescription basis according to Source Healthcare Analytics. Through our ongoing commercial initiatives, we believe we can continue to grow our market share and net revenue for Subsys. According to Source Healthcare Analytics, in 2013, TIRF products generated $421.2 million in annual U.S. product sales. The physician prescriber base for TIRF products is concentrated with approximately 1,850 physicians writing 90% of all TIRF product prescriptions in 2013, according to Source Healthcare Analytics. As a result, our commercial organization is able to promote Subsys using a highly targeted approach designed to maximize impact with physicians.

Now given that there is not a huge difference between TIRF products it is remarkable that Subsys immediately became the dominant TIRF product with a greater share than the three previous leaders combined. It is not entirely obvious how they did that.

But the key was quoted above - and I underlined it just to make sure you noticed. Insys markets Subsys through "an incentive-based sales model".

Its a little hard to work out what that actually means - but it is the key risk in this business. The 10-K only says this:

We market Subsys through our U.S.-based, field sales force focused on supportive care physicians. We utilize an incentive-based sales model that employs a pay structure where a significant component of the compensation paid to sales representatives is in the form of potential bonuses based on sales performance.

This is not well-described in the form 10-K. They state several times that the sales approach is similar to one used at Sciele Pharma - a company that management were previously associated with. Again to quote:

We commercialize Subsys through a cost-efficient commercial organization utilizing an incentive-based sales model similar to that employed by Sciele Pharma and other companies previously led by members of our board of directors, including our founder and Executive Chairman. We intend to market Dronabinol Oral Solution and other proprietary supportive care products, if approved, using the same approach and our commercial organization. 

Beyond that - and a description of the size of the marketing force - the marketing scheme is not well described. Here is the description of the size and extent of the marketing force. 

As of December 31, 2013, we had 145 full-time sales and marketing personnel. We expect the number of our sales and marketing personnel to increase as we seek to continue to increase our existing product sales and as any subsequently approved products are commercialized. We expect our sales and marketing expenses, along with our research and development expenses, to be our largest categories of operating expenses for the foreseeable future. In addition, because we use an incentive-based compensation model for our sales professionals, we expect our sales and marketing expenses to fluctuate from period to period based on changes in Subsys net revenue. Specifically, we expect our sales and marketing expenses to increase in 2014 to the extent that expected increases in Subsys net revenue are realized.

So, what have we got?

A me-too drug - another sublingual Fentanyl - but with a marketing incentive scheme that works and that encourages people to sign up.

One way is that - like Galena - the company offers free samples. I have cut and paste the offer below:

But the main differentiation for this company is the "incentive-based pay structure" whereby "a significant component of the compensation paid to sales representatives is in the form of potential bonuses based on sales performance". 

Oh, of course the drug is wildly addictive and makes you massively high.

There is one more thing that makes this drug particularly susceptible to rapid but ultimately undesirable growth. I will leave that to later in this post.

This is kind of special - its a business model almost designed for something to go wrong - very wrong.

Very wrong of course is off-label selling and diversion to drug addicts. Worse still is the systematic creation of drug addicts by your sales force who are paid by incentives.

The beginning of the unravelling

On Friday in the late afternoon Insys stock rapidly dropped about 20 percent on no apparent news. Twitter had the story though - a story in a Michigan local paper about a doctor being arrested for allegedly defrauding medicare. 

The money quotes in the paper:

Medicare paid Awerbuch [the allegedly corrupt doctor] $6.9 million from Jan. 1, 2009, through Feb. 6, 2014, for Subsys he prescribed. The next highest amount a U.S. prescriber received was $1.6 million. 

"Awerbuch is responsible for approximately 20.3 percent of the Subsys prescribed to Medicare beneficiaries nationwide during this time," the affidavit stated. 

He wrote 1,283 prescriptions for the drug in five years, while the next closest prescriber wrote 203 prescriptions, the complaint stated.

Now there are something wrong with these dates - because Subsys was only marketed from March 2012 - but - if the paper is to be believed - a single doctor was responsible for over 20 percent of all Medicare Subsys prescriptions. And that doctor is not going to be prescribing any more.

This doctor took to prescribing Subsys very freely and if the story is to be believed contrary to the black-label warnings. He also allegedly defrauded private health care companies - so he is responsible for more of the sales. Allegedly the doctor also prescribed Subsys to the police officer. To quote:

On one visit, an undercover officer asked for a Vicodin prescription and attempted to bribe Awerbuch for the drug with $1,000. The officer told Awerbuch he would sell the drug to coworkers. 

Awerbuch refused the bribe and asked the officer not to sell Vidodin again. He also asked if the officer was a Drug Enforcement Administration for FBI agent. The officer said he was not, and Awerbuch issued him the Vicodin prescription. 

During a later visit, Awerbuch proscribed Subsys to the officer even though the officer had not been diagnosed with cancer.

The affidavit also talks about the doctor giving the "free 30 day trial" to people who are not cancer patients.

Increasing doses

Just in passing the affidavit mentions prescriptions to individual patients. They go up very rapidly consistent with addiction. If you want the bull case for the company that is it. Rapid growth based on addiction.

Diversion

It doesn't take long prowling the internet to work out that there are other issues with Subsys. I am not going to lead you through the underground of drug-diversion websites - but it is not hard on the web to find people who have taken this drug intravenously and some of them report getting distributors to give them the thirty day free samples. Moreover - and this really is an issue - this is a sublingual spray - that is a liquid. The other forms of the drug (lollipops, rice-paper tabs etc) are not liquids. [However if you want a guide to extracting Fentanyl from patches look here... Never underestimate the ingenuity of an addict needing hit.]

It is much easier for a narcotics user to prepare a sterile liquid for IV use than a medicated lollipop. I have a pet suspicion - not proven - that one reason for the very rapid uptake of the spray version is that it is much more suitable for diversion.

Do the Feds close the company?

I am never fond of short-cases where the short seller is reliant on the government to close a business for them (see Herbalife). However this seems as good a candidate as any for government closure.

We have 

(a) easily detectable diversion [indeed we have the prescription of the drug to a police officer without cancer and who previously said that he planned to sell narcotics to his work colleagues],
(b) a drug that seems designed for diversion,
(c) an incentive system for sales people that encourages them to make sales regardless and who - because of their incentives - may be tempted to sell off label,
(d) a single doctor who prescribes a double-digit percentage of the Medicare total for the drug and who is currently under indictment.

Finally we have (e) a drug with perfectly good substitutes such that the loss of the company marketing the drug will mean no real loss to society or patients.  

It seems like an okay short to me. At the minimum the Feds will investigate the sales practices and their link to the Michigan doctor. After all there was someone who was working with patients to get refund approval on many of these prescriptions and there was a salesperson paid a big incentive bonus for these sales.

Oh, and the company is trading at a big multiple of sales and of earnings.

John

Disclosure: unsurprisingly I am short. However I worry about shorting addictive products generally. So take that with a grain of salt.