The Approaching Arena Battle

Dec.19.12 | About: Arena Pharmaceuticals, (ARNA)

Today Arena Pharmaceuticals (NASDAQ:ARNA) finally received the long-anticipated Schedule IV designation recommendation from the DEA. This is the first major step to be completed prior to the marketing and distribution of BELVIQ in the U.S. There will now be a 30-day comment period for the public to provide input followed by DEA formal scheduling, which generally takes 15-45 days to complete. There will then likely be a 30-day delay in "effective date" to comply with section 553 of the Administrative Practice Act. So with DEA scheduling now complete, what can investors expect over the next 90 days as BELVIQ finally approaches launch?

Since a week after BELVIQ's approval, ARNA has been in a tight trading range bouncing between $10 and $7 as a transition took place between speculative retail investors looking to make a quick buck and institutions who have an investment horizon of many quarters or years. In an article on Seeking Alpha I published on August 2, when the stock was trading at $7.50, I wrote:

I attribute the recent sell-off of Arena to a very simple process; the transfer of shares from retail investors to institutions. If you look at any biotech over $1B in market capitalization with a drug approved within the last 24 months, the institutional ownership will be somewhere between 60-100%. As of the last full reporting period for Arena, its institutional ownership position was only 25%. In order to get to an institutional ownership more in-line with other biotechs with approved drugs, 100,000,000 shares needs to move from retail owners to institutions. Institutions will use "dark pool" orders and those orders will be filled with high-frequency trading bots. This has resulted in manipulation in the stock price that has no doubt caused many retail investors to capitulate and sell their shares to institutions. I believe by November 2012, you will see the institutional ownership increase from 25% up to above 40% and by February 2013, when year-end statistics are available, an increase up to 75%.

At the end of the institutional reporting period ending September 30, the institutional ownership did in fact close above 40% to an impressive 45% and I believe that buying trend has continued for Q4. Once institutional ownership is above 75%, which should happen by the end of the year or at the latest, the end of Q1 2013, I believe ARNA is poised to go much higher as BELVIQ launches in the marketplace. There is a pending set-up for an epic battle with Arena the third week in January for options expiration. This month was used by many traders and hedge funds prior to BELVIQ's PDUFA date to offset positions and capture volatility premium.

The out of the money strikes between $10 - $15 represent a whopping 128K Call contracts or 12.8M shares on the open market. The largest open interest is at the $10 strike representing almost half of that volume with 60K contacts outstanding for 6M shares. Contrast this to only 200 Put contracts for this same strike range in January. Across the April '13, Jul '13, Jan '14 and Jan '15 time periods, there are fewer than 1K Call contracts between $10-$15. Clearly, there is going to be a MAJOR battle at the $10 strike price in the weeks leading up January's options expiration on January 19. To further complicate matters for January option writers, over the last two months the chart has formed a bullish inverse cup and handle formation that often leads to a long-term breakout of an issue.

Over the next four weeks, there are some catalysts that may make it very hard to keep ARNA under that $10 level. The first of these is the pending update from Europe's CHMP via the 180-day assessment report, which could come as soon as Christmas eve and at the latest, the first week in January. This report will provide important insight as to the approvability of BELVIQ for the EU. If there are no outstanding questions and there is no need for an oral hearing in front of the committee, then approval for the EU is practically guaranteed and will be confirmed at the 210 day review period in late January - early February. To add more flames to the fire of January options expiration week, the CHMP January meeting takes place in the beginning of that week. It is quite possible that the CHMP discusses BELVIQ approval at that meeting (if there are no outstanding questions in the 180-day report) and the minutes confirming approval could be released on the Friday before options expiration.

The next major potential catalyst between now and January 2013 options expiration are additional partnerships for Europe and the Rest of the World. I feel a European partnership is in the cards at any point post receipt of the 180-day assessment from the CHMP if that assessment indicates approval is imminent. If there are still lingering concerns, then a partnership for the EU likely wouldn't take place until after the 210-day assessment.

Confirming the Global Market Potential for BELVIQ

As I covered in my last article, my long-term investment thesis is built on a belief that there is great demand for a safe, tolerable and effective drug that can improve cardio-metabolic health for many millions of patients. A first in class drug for this largest unmet global medical need has the potential to be the best-selling drug ever - despite the skepticism by the market, and rightfully so. It must first be accepted by prescribers as a first line therapy for this space, something that will only be confirmed over time.

I believe my investment thesis has been given some recent support by statements made by Ildong Pharmaceuticals at a ceremony to celebrate the recent partnership with Arena to market BELVIQ in South Korea, the 15th-largest drug market in the world. Ildong is a highly respected pharmaceutical company for this region, built on 70 years of tradition. I believe its guidance for BELVIQ for the South Korean market can provide a baseline of the potential for the drug in the U.S. and Europe. At this ceremony, Ildong's Chairman and CEO said that his sales goal for BELVIQ in South Korea is 30B won, a figure I have confirmed with Arena.

We will focus on Belviq with all the core resources we have to succeed in marketing Belviq and cooperate with Arena to reach the annual sales goal of 30 billion won.

So how can you translate this statement to the revenue potential for BELVIQ in the U.S. and EU? 30 billion South Korean won equates to approximately $28M USD (some analysts have forecasted U.S. BELVIQ in 2013 of $30M.) I have written previously that the sweet-spot for BELVIQ are pre-diabetics and Type II diabetics given its improvement to not only weight loss but glycemic control. So looking at the South Korean market for diabetes drugs and comparing that to the U.S. market for diabetes drugs could give a good rough estimate as to the translated potential in the U.S. It is important to remember that the overall market for BELVIQ is at least 4X the drug market for Type II diabetics.

According to a recent article in The Pharma Letter, the annual market for diabetes drugs in South Korea (which has a similar diabetes & obesity rate as seen in the U.S.) is approximately $330M USD and forecased to grow to $550M by 2016. In the U.S., the branded diabetes drug market is over $14B according to IMS Health.

Given Ildong's estimate for BELVIQ is about 10% of the total diabetes drug market in South Korea for 2014 (reasonable given the market for the drug is actually 4X larger than the diabetes space), the translated potential for BELVIQ in the U.S. would be at least 10% of the $14B diabetic market here or approximately $1.4B a year. If you add in Europe and the rest of the world, the initial market guidance would be around $3B a year. That is of course prior to label expansion for combining with phentermine, metformin or future indications. As I discussed in my last article, that is about the revenue Arena needs to have with BELVIQ to justify a $20B marketcap.

This is of course all speculation based on Ildong's guidance. We will have to wait for Eisai's and Arena's guidance by May to really know what their expectations are for BELVIQ in the short term. Only actual sales will tell the reality here but I feel even more confident in BELVIQ being a blockbuster given Ildong's guidance. With DEA scheduling now complete and the catalysts ahead, the upcoming months are going to be very exciting for Arena longs as BELVIQ approaches possible approval in the EU followed by a March launch in the U.S.

Disclosure: I am long ARNA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.