Arena Pharmaceuticals (ARNA) is one of the most over-hyped stocks I've seen in recent memory. Prior to FDA approval of Belviq, the company's flagship anti-obesity drug, Arena bulls were calling for pie-in-the-sky share prices of $20, $30, and even $50 a share. When the stock barely mustered a run to $13.50 and quickly fell below pre-approval levels, bulls resorted to a whole host of conspiracy theories. If you subscribe to this paradigm, there is probably little I can do to enlighten you to the reality of Arena. So please save the death threats and rude comments simply because I will not fall in line with the incessant pumping of ARNA. Instead, I am here to remind ARNA investors of a basic fact of the stock market: stocks generally trade on their fundamentals. And according to the fundamentals, ARNA does not appear to have stellar performance going into 2013.
Previously, I called for a short of ARNA anytime the stock hit $9.20, and that trade has worked out twice since the article appeared in Seeking Alpha. On a side note, I called Amarin Corporation (AMRN) a strong short candidate in the $11 dollar range, and that worked out even better. I bring up these two previous calls because they were based on a fundamental analysis of the companies at that time, and both worked out to my benefit. That said, here is what the fundamentals, coupled with a "hype" factor, suggest will happen with ARNA in the coming year.
ARNA in 2013
Arena is now set to receive a $65 million milestone payment from their Marketing Partner, Eisai Pharmaceuticals, for the DEA scheduling of Belviq. With that money to be realized as revenue in the 1st quarter, I think ARNA is actually a buy at current levels ($8.85). Furthermore, Belviq now looks to be launched sometime in the late first quarter. So here is my strategy for ARNA in the next 3 months. Buy in at current levels, and let the combo of the milestone payment, coupled to speculators jumping in prior to Belviq's launch, push the stock into the low teens. My exit price is $13.00, which is based on how the stock reacted during approval. There is no good way to know how far hype will push the stock, and I wouldn't be surprised by a move to the mid-teens. That said, the fundamentals clearly show the Belviq launch will be the time to get out (i.e., sell the news), and I plan to get out well before this event.
Why the Belviq launch is the time to exit
ARNA bulls love to suggest that the stock is going to double or even triple next year. Unfortunately, the logistics of Belviq's launch, the marketing agreement, and the present valuation of the company all suggest otherwise. Of course, ARNA bulls will tell you "none of these are facts, and are misinformation." But my challenge to anyone who thinks that way is to do the math. The math will set you free, and shows ARNA is a bubble ready to burst.
Ok, so let's do the math and consider the logistics of the launch in light of the Arena's marketing agreement with Eisai. For didactic purposes, I'll do some basic rounding, but it won't affect the big picture. I want investors to see the forest through the trees so to speak.
Arena's market cap is presently close to $2 billion, and the company hasn't sold a single pill yet. That's important to keep in mind, and a fact that ARNA bulls keep forgetting to mention. The marketing agreement states that Arena will receive approximately 31.5% of revenue from annual net product sales during the initial launch. The average historical forward P/E of biotechnology stocks is 19 - let's call it 20 to err on the safe side. To support a market cap of $2 billion under these conditions, Belviq sales must hit a minimum of $300 million in 2013. If Belviq were to go against all historical precedents of anti-obesity meds and hit this substantial mark in its first year, it would only support the current PPS based on fundamentals. See the problem now?
So for the stock to double on fundamentals, Belviq would need to sell $600 million in its first year. I hate to be the harbinger of bad news, but there is literally no way Belviq will come close to either one of these sales figures in its first year. This leads me to believe that ARNA bulls believe they can push the multiple to levels not supported by fundamentals (i.e., 40-60). While that does occasionally happen in the wild sector that is biotech, I wouldn't base my investing strategy on such hopes. Perhaps this is why ARNA bulls vociferously attack anyone who points out the problems in ARNA's valuation going forward? One can only wonder.
Moreover, Eisai and Arena have agreed to a limited initial launch targeting obesity specialists, which is another fact that bulls keep leaving out. As such, a stellar sales figure in the first quarter on the market would be $10 million. I would consider that a very successful launch, but far short of the minimum $300 million needed to support even the current PPS. The reality, however, is that the number is more likely to be $1-3 million for Belviq's first quarter sales. Remember, it's only the initial launch, doctors have been burned badly by anti-obesity meds in the past, and the launch is only targeting specialists, not general practitioners. All of these are facts, but I am sure bulls will call it misinformation nonetheless.
If you are an ARNA long, you have to ask yourself a difficult question going into 2013: What is going to happen to PPS if Belviq sales are sluggish? Let me give you a hint: shorts are going to jump all over this stock without mercy. It's very difficult to attack a stock when the PPS is supported by fundamentals, but all too easy to ravage it when the PPS reflects hype. Look at what happened to Dendreon (DNDN) when sales of Provenge were nowhere near bullish estimates.
In conclusion, the fundamentals clearly suggest that ARNA is trading based on hype at this point, and it will have a difficult time living up to this hype in 2013. I plan to ride the next speculative wave in early 2013, exit prior to launch, and watch from the sidelines. If the stock is ravaged by shorts after the launch, I would likely re-enter once the bloodbath is over, because I do believe Belviq will be a long-term winner. But 2013 will be significantly more-rocky than ARNA bulls are willing to admit.
On a final note, if you are a realistic investor and plan to hold for a minimum of 5 years, none of these arguments matter much. I didn't write this article for investors with a long-term mindset. I wrote it for the pumping crowd that is selling a "get rich quick" scenario on the back of ARNA shares. I find that paradigm terribly misleading, and even dangerous to naive investors. Remember, always do your own due diligence, and never forget to do the math.