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Obesity-focused companies Arena Pharmaceuticals (NASDAQ:ARNA), Orexigen Therapeutics (NASDAQ:OREX), and Vivus (NASDAQ:VVUS) were the big biotech success stories during the first 6 months of 2012 as both Arena and Vivus received positive AdCom votes followed by FDA approval. Orexigen received a boost as a clinical path forward became clear for the company's obesity candidate, Contrave. The share prices reacted accordingly with renewed investor interest. Recently though, VVUS shares have been pressured, losing nearly 65% of their value from the July highs (FDA approval on July 17) as the EMA rejected Qsymia and the launch of the drug has not met expectations. Indeed, VVUS's recent quarterly call confirmed many initial commercialization fears. With Qsymia becoming first available on September 17, 2012, only $41,000 in net product revenues were recorded in the period between 9/17/12 and 9/30/12. Analyst expected revenue of $310,000. Additionally, from the conference call transcript:

"In the following 4 weeks of October, up to, and including week of 10/26, an additional 4,904 Qsymia prescriptions were shipped to patients, bringing the total actual Qsymia prescriptions shipped to patients since launch to 5,560. These total prescriptions represent 3,504 unique patients on Qsymia to date. We are now seeing refill prescriptions in the last 2 weeks of our pharmacy beta."

With a net price of approximately $160/month, it is clear with prescription numbers of ~5000/month that revenue will be in the neighborhood of $2.4 - $3.0 MM and most likely not much higher in Q4 2012. Analyst expectations of $300 MM for sales in 2013 imply a nearly impossible and dramatic ramp up of new patients along with significant patient refills.

These recent developments have significant implications for ARNA and the upcoming launch of Belviq in Q1 2013 (following DEA scheduling later this year). In light of the disappointing VVUS launch, Arena pharmaceuticals is a compelling short play for reasons centered in three main areas: clinical, commercial, and financial.

Clinical Risks - Even though Arena's Belviq has received FDA approval, clinical risks remain. The large clinical program conducted by ARNA demonstrated a clean overall safety profile for Belviq, but many doctors will be interested in combining Belviq with phentermine, which is approved for the short term treatment of obesity. Phentermine was "phen" component of "fen-phen," and ARNA has not yet studied Belviq in combination with phentermine. Indeed, as many investors in the obesity space are no doubt aware, "fen-phen" was pulled from the market 1997 for heart-valve problems (valvulopathy). Arena designed a selective 2C receptor agonist to overcome this issue, and in clinical trials of 1-year duration, 2.4% of patients receiving BELVIQ and 2.0% of patients receiving placebo developed echocardiographic criteria for valvular regurgitation at one year, and none were symptomatic (prescribing info). With greater numbers of patients exposed and possible combination with phentermine, a statistically significant trend of valvulopathy may appear and doom commercialization efforts. Orexigen currently is awaiting FDA approval, but has been moving closer and closer to commercialization as the LIGHT trial has enrolled quicker than expected. An interim analysis and subsequent approval may come as early as Q4 2013 if all continues to go well. Clinical and regulatory risk still remain with Orexigen though, as they await the interim analysis demonstrating that Contrave does not unacceptably raise cardiovascular outcomes and ultimate FDA evaluation. Like Arena's Belviq, Vivus' Qsymia causes serious side effects in small numbers of patients, including the well-documented teratogenic risk associated with topirimate (one of the two main components of Qsymia).

Efficacy however, is the main cause for concern among ARNA investors. Tabulated below are the relevant data gathered from FDA Adcom presentations and the full prescribing information. Even though each company has conducted a slightly different clinical program, there are enough similarities in patient characteristics, trial duration, and placebo response to extract general efficacy trends in both non-diabetic and diabetic populations.

Of the three major candidates, Arena's drug resulted in the smallest amount of weight loss. This trend also held in patients with type 2 diabetes. As shown above, patients only lost 3.3% more weight relative to placebo in a modified intent to treat analysis (last observation carried forward). While some patients of course respond more than others and will likely stay on the drug as they continue to lose weight, only 22.4% of active arm patients on Belviq lost more than 10% of their body weight. It should also be noted that improvements in other indicators other than weight loss were notable and statistically significant. Furthermore, a substantial percentage of randomized subjects withdrew from each study prior to week 52, and this is an important indicator in subsequent commercialization efforts. It is difficult to achieve high market penetration when patients discontinue treatment. If patients are not losing a significant amount of weight, it is doubtful they will continue filling prescriptions. VVUS demonstrated the strongest efficacy at the approved mid-dose and top-dose, and also the lowest dropout rate in its clinical trials. At the mid-dose and top-dose, 37.3% and 47.6% of patients respectively lost 10% or more of their body weight. This bodes well for commercialization. Furthermore, given the clinical dropout rates and its correlation to market penetration, I find it difficult to believe that ARNA will achieve launch success where VVUS has not. VVUS also has the advantage of once-daily dosing, compared to twice a day for Belviq.

Commercialization Hurdles - Arena and Vivus are engaging in very different commercialization strategies. Currently, VVUS is marketing and selling the drug with their own sales force of ~150 territory representatives targeting approximately 25,000 high prescribing physicians. Most of these (~80%) are primary care physicians (PCPs) and approximately 8% are endocrinologists with the remaining being other specialists. Per the recent conference call/earnings release, most of the physicians have been called on at least once by the sales force. Because of the REMS program in place, VVUS currently sells Qsymia through mail-order pharmacies following proper documentation faxed over from the physician's office. There is a 15-20 training exercise that the prescribing physician must participate in before prescribing Qsymia. VVUS is currently trying to expand distribution to include some retail pharmacies, and is working with the FDA to make this possible. VVUS bulls point out that we only have 6 weeks of data and the initial physician training and distribution hurdles have hindered uptake, and that doctors are writing only a few initial prescriptions and seeing what happens before putting large numbers of patients on Qsymia. These are valid points, and only time will tell, but other troubling facts emerged from the call. An estimated 30% of patients who received a prescription for Qsymia did not fill it, presumably balking at the ~$160 price tag for a month's supply. Furthermore, 80% of the customers are cash-pay, demonstrating the significant elastic nature of demand. While VVUS is trying to get insurers and payors on board, this will be a difficult task for all obesity companies. Even with the strongest efficacy data and additional data demonstrating a much slower progression of patients to type 2 diabetes, VVUS's challenges do not bode well for ARNA's market penetration and sales.

On the other hand, Arena pharmaceuticals signed a partnership with Eisai (ESALF,PK) in which ARNA retains ex-North and South American rights and Eisai markets and sells the drug in North and South America. Arena is responsible for manufacturing the drug, and Eisai will purchase the drug for amounts based on net sales (see Financials and Valuation below for details). Eisai plans on launching with approximately 200 representatives, comparable to VVUS. Unlike VVUS however, ARNA is not restricted by a REMS, and may see slightly higher initial patient uptake. However, given a similar monthly price tag and worse efficacy, I find it difficult to believe that ARNA will have fewer patients opting not to fill their prescriptions and that doctors will readily write significantly more prescriptions for a less efficacious drug.

Financials and Valuation - With the recent sell-off, VVUS' market cap stands at approximately $1 BB. Vivus also holds an FDA-approved asset for the treatment of erectile dysfunction, STENDRA (avanafil) which must be factored into any valuation. During this time, Arena has not taken the valuation hit reflecting the realities of launching a drug into the obesity market. Arena's market cap stands at $1.8 BB, only slightly lower than the July highs, and it is difficult to make the case Arena is worth 80% more than VVUS.

Diving into the details of the Arena's partnership with Eisai, Arena is poised to receive milestone payments and the drug will be purchased for a percentage of net sales, theoretically similar to a royalty rate. Arena will sell Belviq to Eisai for a purchase price starting at 31.5% of Eisai's annual aggregate net sales. The purchase price will increase on a tiered basis to as high as 36.5% on aggregate annual net sales exceeding $750 MM. Arena is also eligible to receive up to $1.2 BB in one time purchase price adjustment and other payments based on Eisai's net sales of Belviq. The first purchase price adjustment of $25 MM plus a milestone payment of $30 MM are due if annual sales reach $250 MM. For the post-marketing studies, ARNA is responsible for 10% of the cardiovascular outcomes trial, and 50% of the pediatric trial expenses. Eisai covers the remaining costs.

On the other hand, Vivus must pay for everything itself, and the launch of a drug into the primary care market is very expensive. VVUS' SG&A for the 3rd quarter rose to $31.2 MM, and total operating expenses were $40.5 MM. Cash and cash equivalents totaled approximately $274 MM, giving VVUS time to ramp up sales. As a wholly owned asset, VVUS shoulders all the risk and reward. Given the high cost associated with supporting a launch into the primary care market, it does not appear that VVUS will be profitable until 2014 at the earliest with expenses running at $40 MM a quarter. However, it does appear the market is pricing in new, lower expectations, and a $1 BB market cap more accurately reflects peak sales of approximately $250-$300 MM a few years from now (4 times annual revenue) for a wholly owned asset.

Even if annual Belviq sales reach $300 MM, ARNA will only be capturing ~$110 MM of revenue + milestones, while still paying for manufacturing and corporate overhead. It would appear that the market is pricing in annual sales upwards of at least $800-900 MM to justify the $1.8 BB market cap. Given the Vivus initial launch results, it is unlikely that sales numbers like these are achievable in the first few years for ARNA, if at all.

Conclusions and Future Directions - While new treatment options in the fight against obesity is a positive for patients and physicians, investors must objectively assess the value of the assets in light of the stock price. While it is still early in the launch of the first obesity candidate (Qsymia from Vivus), initial obstacles in reimbursement and patient uptake are troubling and indicative of the challenges in penetrating the obesity market. In Arena's case, the current share price of approximately $8 (market capitalization of $1.8 BB) and 80% premium to VVUS significantly overestimates the potential of Belviq. Given the current clinical, commercialization, and valuation realities, ARNA's fair value is significantly lower than its current valuation. I believe this fundamental market mispricing will be corrected in the next 3-9 months with the launch of Belviq in Q1 2013.

Source: Obesity Sector Update And Compelling Short Opportunity