Typically I do not place much worry in the short interest of an equity if the days to cover that short interest is below 10. My reasoning is simple. The absolute number of shares short is not the driver of a short squeeze. It is the days to cover that short position that is the driver. If the short position of a company can be absorbed in just a few trading days the impact of a squeeze is mitigated.
Right now, with Arena Pharmaceuticals (NASDAQ:ARNA), things are a bit different. The current days to cover on Arena is 13.7. That is enough to get me to pay attention. However, there is another dynamic to consider. By most reasonable accounts we are just days away from the highly anticipated North American launch of the anti-obesity drug Belviq. Being short or even entering a long position at this point in time is a speculative move. One side or the other could find themselves caught up on the wrong side of a trade.
The current amount of shares held short on Arena is 55,323,077, and as stated, the days to cover is approaching 14. If the Arena launch is a success, the stock price associated with Arena could get quite interesting. This is the classic case of whether or not a company can meet expectations.
In my opinion the expectations of the street on Belviq have been tempered down quite a bit. Investors and the street have learned a lot from Arena competitor Vivus (NASDAQ:VVUS). Vivus had a very modest launch, and though prescriptions are showing traction, the numbers are not yet at overwhelming or "blockbuster" status. Blockbuster has been a term associated with both Arena and Vivus over the past several months. Most people associate blockbuster status with a drug that generates $1 billion in sales in a year. That is a tall order. It is perhaps a good thing that analysts and savvy investors have backed down from using the term anymore. This was likely associated with the Vivus results.
Through 5 months Vivus has had 57,000 scripts written and revenues have been just over $2 million. Arena marketing and distribution partner Eisai has priced a month prescription of Belviq at $200 wholesale. If we consider that the product will retail for $250 it would take 333,000 patients on the drug for an entire year to garner $1 billion in sales. At this point I do not think the street is expecting anything close to this.
In my opinion the shorts have been betting on the concept that expectations are too lofty and that Arena will disappoint. In my opinion, particularly since Vivus had its Q4 call earlier in the week, the expectation level is actually much more realistic. I think that the shorts may be the ones on the wrong side of the trade. However, I do not feel that Arena is going to blow away any expectations either. In essence I think that the current price of the equity represents realism more than anything else. Arena held the $8.00 level that I had pegged as a low early in the month and has seemed to bounce off of it quite well. Now, with a launch happening as early as next week, I feel that there is potential for at least a mini short squeeze.
If Arena can deliver first month scripts in the neighborhood of 10,000 to 15,000 I think that the downside risk is minimized. If it can deliver first month scripts in the neighborhood of 20,000 to 25,000 I think that the shorts may well want to consider covering that position and thus create buying pressure. They key thing for investors to understand is that a pop on a short squeeze is often a short lived pop. It is a false representation of demand, and once that demand evaporates an equity will settle down. This is why understanding the days to cover dynamic of the short interest is so valuable. An active trader can play the action in a mini squeeze like a fiddle.
I am intrigued by the days to cover as the launch approaches. We need to bear in mind that the short data is already about 2 weeks old and a lot could have happened in the last week or so. The volume is the key metric to watch. If volume is over 7.5 million shares there is action happening that will impact the price of the equity. The last item to note is that there will be a lot of excitement about the launch, but it will take a week or so for the first channel checks and data to begin to filter out. If you are invested in Arena you will want to watch the news wires. Especially over the next week and a half.
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.
Additional disclosure: I have no position in Vivus.