A recent Seeking Alpha article by Steven Breazzano titled "Obesity Sector Update And Compelling Short Opportunity" laid out the fundamental bear case for Arena Pharmaceutical's (ARNA) flagship anti-obesity drug, Belviq. Breazzano provided a compelling case for why ARNA is presently overvalued at its current market cap of $1.9 billion, and suggests that initial sales of Belviq will be lackluster. As such, he argued that the stock should be a good short candidate. This is not a welcome argument to ARNA bulls, who have high hopes of reaching $20-$30 price targets in the coming year. However, I argue here that ARNA bulls should at least listen to the bear case, especially when it's grounded in factual information.
A previous article of mine on ARNA testifies to the fact that I am essentially bullish on ARNA. After reading the comments in the aforementioned article, however, it's hard not to notice that the broader investment community is overly optimistic about Belviq's prospects in the short term. Over my 10-year career trading biotechs, I have found that retail investors are all too often unrealistic about new therapies and the subsequent appreciation of a company's common stock. The retail crowd surrounding ARNA appears to be repeating this dangerous pattern yet again.
Retail investors in the biotech space, in my experience, tend to quickly buy into the hype of novel drugs without thinking critically about the difficult process of gaining market share after FDA approval. Nevertheless, one needn't look very far in the biotech sector to find a graveyard of catastrophic failures for overly optimistic retail investors -- e.g., Avanir Pharmaceuticals (AVNR), Dendreon (DNDN), Horizon Pharma (HZNP), and Peregrine Pharmaceuticals (PPHM), among countless others. Not to say that ARNA is absolutely destined to be a shipwreck, but bullish investors should carefully consider the substantial risks facing ARNA. Breazzano, for example, cogently argues in his article that Belviq's initial sales revenues may fall far below expectations, in a manner similar to Vivus's (VVUS) Qsymia. Unfortunately, he does so, in my opinion, without clear factual info, which I hope to remedy in this article.
Personally, I have always found the optimism surrounding Belviq's launch rather disconcerting, and share the author's short-term sentiment. Several Arena executives, for instance, have already stated at numerous investor conferences that the launch of Belviq will be limited to obesity and endocrine specialists, and this effort is part of a larger educational effort to gain acceptance of Belviq by the broader medical community over the long term (more on this below). Moreover, Belviq will only be made available initially to patients willing to adhere to a strict dietary and exercise regimen. So the company itself is clearly trying to temper retail investors' lofty expectations for Belviq in the coming year, and avoid a crash in the stock when the initial numbers are released. Based on these self-imposed marketing restrictions, it's now difficult to imagine how Belviq's first year on the market even reach a $10 million sales figure, much less the expected $300 million to $400 million mark expected by retail.
Arena Pharmaceuticals' primary goal, after all, is not to focus on short-term sales of a drug it spent a decade shepherding through FDA approval, but rather to achieve steady, sustainable growth over the long term (five-plus years). Investors dreaming of a quick and substantial return on investment should also take note that the only major catalyst on the horizon is the approval of Belviq in Europe, and that is far from a given. It's fairly obvious from the substantial current market cap of $1.9 billion for ARNA that the market has already baked in DEA scheduling and the subsequent launch of Belviq. If ARNA does gain EU approval, this event should help to buoy the stock against what will surely be disappointing sales numbers from the launch of Belviq in North and South America -- again, disappointing to retail investors with unrealistic expectations, but not to Eisai or Arena (see below). An EU approval would thus only help the stock to trade sideways until Eisai can convince doctors to prescribe Belviq on a regular basis.
Why I Believe Belviq Sales Will Be Sluggish in 2013
As a professional investor in biotech stocks, I often use my extensive network in the medical community to gain insight into how doctors view new therapies. Prior to FDA approval of Belviq, I put in a number of calls to my medical colleagues specializing in obesity and endocrinology. After some friendly chats, it became quite apparent that the doctors dealing with this epidemic on a daily basis are less than enthusiastic about pharmaceutical options. Nearly every doctor I spoke to admitted that they would probably not prescribe any of the pending drugs, unless specifically requested by the patient. Even then, they would be hesitant to do so. During and after Arena's AdComm for Belviq, a number of authors and message board posters claimed to have spoken to doctors who "couldn't wait to prescribe Belviq to their patients." By contrast, I got nearly the exact opposite response from my colleagues. This well-known medical blog, for example, mirrors the feedback I received from medical professionals. As you can see, the basic sentiment is that doctors are generally going to take a wait-and-see approach regarding this new wave of anti-obesity therapies, which does not bode well for a strong launch of Belviq in 2013. Based on the comments coming from Arena at investor conferences, it's clear that the company is fully aware of the uphill battle in getting doctors to prescribe Belviq.
The overarching problem facing all anti-obesity drugs is simple: Doctors believe that obesity is best treated by altering dietary and exercise habits, not drugs. Drugs are an option of last resort. If you don't believe that this is the prevailing view within the medical community, I suggest you re-read the AdComm's comments about lorcaserin. The majority of the panel was less than enthusiastic about the Belviq's prospects in the real world, but passed it mainly because the drug was shown to be safe.
That is the significant challenge any anti-obesity drug faces, and that's why Eisai has planned to engage specialists during the initial launch. Simply put, Eisai is planning to educate doctors on the medical benefits of Belviq in hopes of changing the medical culture surrounding the obesity epidemic. Eisai's plan is the strategically correct move, but it's one that will take time. Expecting the medical culture to change overnight and welcome Belviq with open arms is a fool's game. Yet, it would appear that's exactly what many retail investors in ARNA are doing.
In conclusion, the initial launch of Belviq is slated to be anemic, and Arena has telegraphed this anyone willing to listen. A slow launch does not mean Belviq will be a bust, but it does mean that ARNA stock will have a hard time holding current levels due to the unrealistic expectations held by many retail investors. Overall, investors should temper their expectations of 100%-200% gains in the coming year, and instead take a longer-term approach to investing in this drug/company. Arena Pharm is working diligently to make Belviq a blockbuster over the long haul, but investors shouldn't simply ignore the significant headwinds facing anti-obesity drugs in general. These problems have clearly not escaped institutional investors, as evidenced by their paltry 31% stake in ARNA to date. So just like doctors, professional money managers are taking a wait-and-see attitude toward Belviq.
Disclosure: I am long ARNA.