Arena Pharmaceuticals: Near Term Gamble May Be Worth It

Arena Pharmaceuticals (ARNA) is supposed to release phase 3 data on its new obesity drug, lorcaserin, at the end of March 2009. Data from this first of three ongoing Phase 3 trials will likely cause a big move in the stock. Buying the stock based on the expectation of good news would at first seem to be a pure gamble.

At second glance it might be better than that. The stock is currently at $4.43. It has just rallied off a bottom which has good technical support (approx. $3.90 to $4). On Feb. 12, 2009, the stock had reached a near term high of $7.42. At about that time, the market really started to tumble. It could be argued that ARNA simply tumbled with the market. Hence the recent top may be a more accurate reflection of its somewhat speculative worth. Since the market has not yet rallied significantly, it is a very positive sign that ARNA has rallied by 10+%. Yet this is still a very questionable reason to invest.

Let’s look at the competitors. There seem to be three major new obesity drug candidate companies. They seem to all be developing in roughly the same time line. Vivus (VVUS) announced good results from a phase 3 trial of its obesity drug candidate, Qnexa, on Dec. 11, 2008. Orexigen Therapeutics (OREX) announced “mixed” results from a clinical trial of its obesity candidate drug, Contrave, on Jan. 9, 2009. OREX argued that its results still do meet FDA benchmarks for approval.

The fact that both of these companies reported at least decent results would tend to argue that the likelihood for a good result from ARNA is high. In addition, ARNA announced on Feb. 18, 2009 an initiation of a Phase 2 clinical trial of an orally administered niacin receptor agonist drug candidate to treat atherosclerosis (a collaboration with Merck (MRK)). Furthermore, at least one analyst has recently increased his estimate for the value of ARNA’s obesity drug in the market. These things should give ARNA significant upside potential in the near term.

Looking again at the technical picture, the expectation for the extent of the near term price rise due to good Phase 3 results by ARNA would be the recent top put in February 12, 2009 -- $7.42. It could go higher, but $7.42 would be a technical resistance point. The expectation for a “mixed” result might be about $3, which was approximately the base of the Oct. 2008 low. It seems unlikely that a completely negative result will be reported. Some hint of that would have leaked out by now. Plus the competitor companies’ results simply do not argue for this as a significant possibility.

In sum, it looks like there is a “most likely” potential for a $3 gain, while there is a “less likely” potential for a $1.50 loss. Stops at $3.70 might be able to curb some of the loss, if there is one. Overall this investment seems like a good bet to make in the current market. Good news from ARNA could swamp out almost any further bad news from the markets. Plus if the markets started to rally significantly, ARNA could shoot through the roof on further appreciation due to the overall market rally. A near term price appreciation to the $11 to $12 range is not technically out of the range of possibility.

With all of this in mind, Arena looks like a better gamble. It’s all really about “risk/reward”. Naturally if you feel strongly that the overall market is going to fall 20% in the next 20 days, you probably do not want to take this gamble. If you feel a mixed (or even a good) performance of the overall markets for the rest of March is more likely, this investment possibility may have some appeal. Many analysts are forecasting at least a slight rally after the huge recent fall. This might occur at a sweet spot for this investment opportunity.

Disclosure: Long ARNA.

Comments

[David White:]

User376026: Apparently Zacks came out with an article on ARNA today. They are likely more expert than I, or at least more experienced with drug releases. I quote, "We think the data will be positive. As noted above, management has access to the blinded data, and clearly must be seeing a blended mean weight loss consistent with the above figures that would make the trial successful. There have been no safety signals to date, and at this point there seems little to be concerned with as far as valvulopathy. Management still has to conduct an abuse study later this year, but we believe that lorcaserin is unlikely to fail the phase III program based on side-effects or tolerability."

However, even though they think the drug will be successful, they thought it was too big a risk to bet on before the results of the phase 3 trial. They thought it might decline to $1 on a bad result. They thought $8 might be a day of the news target for ARNA. This sounds remarkably similar to my comments with one difference. I thought there was very little chance for a totally negative result. At worst it should be a mixed result (i.e. marginally successful). I estimated that the stock might go down to $3 in that case. Perhaps this is an underestimate. However, Zacks did seem to agree with me that the phase 3 trial was very likely to be a success. They cited the fact that there have been no warning indications.

I don't pretend to be the world's most expert biotech analyst. However, I was around U.C. Berkeley and UCSF when a lot of the major Biotech's got started. I have also followed Biotech stocks for years. There is no saying exactly what any stock will do on any on a given day. A lot of times the actual result may be impacted by the behavior of the overall market that day. However, the Zacks figure of $8 seems much closer to my estimate than the much larger spike you are indicating.

I clarify that my estimate was only meant to indicate the price of the stock at the time of the release of good news for this first phase 3 trial. It was not meant to indicate the price of the stock when the drug is finally approved. Presumably this price would be higher.

I feel somewhat vindicated by Zacks comments. I think your tone is excessively insulting. I do acknowledge that there may be some short covering. I was aware ARNA was shorted. Again it is hard to predict the exact effect of this in a generally declining market though. Many people may chose to remain short temporarily to allow the market (and the normal retracement after such an announcement) to bring the stock price back to them. The figures I see for short interest currently are 19.55% of float short (4.6 days to cover).

If the result is "fantastic", then I would tend to agree that the rise should be much more than the amount that I was suggesting. However, I think I indicated that also.

Mar 14 01:16 AM

[David White:]

User376026: I should have added that I do not like to be accused of pump and dump schemes. I also do not like to perhaps seriously mislead people. Therefore I might tend to be a little conservative. I think this is responsible and appropriate behavior.

Mar 14 01:23 AM

[User 376026:]

"As noted above, management has access to the blinded data, and clearly must be seeing a blended mean weight loss consistent with the above figures that would make the trial successful. "

This is nonsense. Magangement can't say anything either way in advance of the data, so this type of statement is ludicrous and misleading.

Saying " I was around U.C. Berkeley and UCSF when a lot of the major Biotech's got started." is about as stupid as my saying I was around when the Broncos won 2 superbowls so I'm a great quarterback. Ludicrous!

I'd have more respect for your opinion if you had complete a PhD.

Mar 14 06:50 PM

[David White:]

User376026: The comment about the Ph.D. is probably fair, especially since it is your opinion you are talking about. However, as for the quote business, you clearly misunderstood. What you quoted from my comment was a quote by me from the Zacks' article. It was not something I said. You might try to read a little more carefully before you again try to insult me.

What I have heard online and other places more or less agrees with what the Zacks' article said. The Zacks' article is on SeekingAlpha if you are interested.

As for how much the stock might rise on a good result. It likely depends on the "goodness" of the result and on the actual market action on the day of the announcement. If my estimate was offending you, I'm sorry. I was simply going off the technical charting info and other analysts' comments that I read online. I make no claims to being able to peg the exact extent of the rise on a good result. For the moment, other knowledgeable analysts seem to be agreeing with me about the ballpark for the amount of rise to expect on the phase 3 results news. If your result prediction becomes a reality, you can say I told you so.

Mar 15 02:59 AM

[David White:]

ARNA was downgraded today by Canaccord Adams to sell. They expect "modest weight loss" results from the phase 3 study, but they also expect lorcaserin could have central nervous system side efects. They note none have shown up yet.

You can look at this as a warning to stay away or as a buying opportunity, since the stock is down on the downgrade today. i tend to see it as a buying opportunity. Canaccord Adams has reinforced my belief that the drug will be successful. Anytime you are trying to fool the brain function with a drug which may mediate effects in the Hypothalmus, there is always a possibility of side effects. This is not news. In fact if there are not serious side effects, this may mean that the drug will work very well indeed.

My opinion is overall unchanged by Canaccord Adams downgrade. I also cite the Zacks article in which they state side efffects are unlikely.

For my part, I have always thought the side effects issue was the more likely to be the "gotcha" for lorcaserin. I do think the drug should be successful in its objective. I am hoping that side effects turn out to be a non-issue as the Zacks article suggests.

Mar 16 11:16 AM

[David White:]

It is also just possible that Canaccord Adams has written a lot of March call options for ARNA. They may want to depress the stock price until after the option expiration at the end of this week. If this is their goal, they are likely hoping that the phase 3 announcement does not come out this week. If you are buying options on ARNA, you might want to consider April options as a better alternative, given the Canaccord Adams action. Or you might still look for a quick bounce upward in the next few days. Downgrades tend to be forgotten about a day after they are issued.

Mar 16 01:46 PM

[David White:]

If I seem a little skeptical of Canaccord Adams downgrade, it is probably because nothing has dramatically changed about the stock recently. As Zacks says (and I generally have much more faith in them than Canaccord Adams), "lorcaserin is unlikely to fail the phase III program based on side-effects or tolerability." Further Zacks says, "If the placebo group delivers the expected 1.5% to 2.5% weight loss, the lorcaserin group must deliver weight loss after the first year at 6.5% or greater. We believe this is easily achievable."

I actually expect the results to be substantially better than that. I can see no reason for the stock to fall through the floor prior to the announcement. I do not buy the side effects argument, although it is a possibility. All this has been known for some time. It is always possible Canaccord Adams could have some insider information that they are not sharing with us. I just don't think this is the case. The hold rating by Zacks seems much more appropriate. For those with a bent to take a risk on a potentially great drug, ARNA is a buy. I am looking for a bounce back upward tomorrow, providing the market doesn't implode again.

Mar 16 02:01 PM

[David White:]

At least one investor today took advantage of the fall in ARNA due to the Canaccord adams downgrade. This person sold 7000 Apr $5 puts and bought 7000 Apr $2.50 puts. The person is clearly thinking that ARNA is likely to be above $5 at the April options expiration deadline. The $2.5 puts are just protection against a really bad loss if the phase 3 results disappoint.

These huge type of option positions may be the reason behind Canaccord Adams downgrade of the stock. They may wish to avoid paying out on a lot of $5 call options that expire in March. Perhaps I am too cynical. Then again, perhaps I am not.

Mar 16 03:39 PM

[David White:]

I read an article today centered on OREX. Interestingly the author seemed to think that OREX would benefit from the attention that ARNA would draw with its lorcaserin phase 3 results at the end of this month. The author thought lorcaserin would be successful, and that success would overflow onto OREX. When the competition expects to benefit from your success, I would say that is a good vote of confidence that you will be successful.

Mar 17 10:21 AM

[David White:]

ARNA was down again at the start of the day. However, it has recovered to be about even currently. This is likely a sign that the Canaccord Adams sell rating effect is over for the moment. I would expect ARNA to proceed upward after this for the next few days, presuming the overall market cooperates. There should still be a lot of speculators bidding it higher.

You can call me cynical, but there may be some pressure exerted to keep ARNA below $5 through Friday, which is the options expiration day. That way some people can avoid paying off on the naked March $5 calls they may have sold (i.e. perhaps brokerage houses).

Mar 17 03:37 PM

[David White:]

I should poitn out that the mean recommendation on ARNA is 2.3 (Yahoo Finance). That is a buy.

Mar 17 03:42 PM

[David White:]

The mean recommendation on ARNA is now 2.2 on Yahoo Finance.

Mar 20 12:32 PM

[David White:]

CNBC had an article about Glaxo Simth Kline's new weight loss drug Alli. Apparently it has very unpleasant side effects if the food you eat contains a lot of fat.

As part of this article a video showed an interview with one of the "successful" cases of the ARNA lorcaserin trial. He had dropped 50lbs within a year. He seemed very pleased with the drug. The video went on to state that probably not all patients will respond favorably to the same drug, so there is likely room for all three of the new drugs in the market (Vivus' and OREX's too). Overall, I think you have to view this video as great news for ARNA.

Mar 23 11:27 AM

[David White:]

ARNA now has about 20% short interest. The results of the first phase 3 trial are due out by the end of March. ARNA could really pop if the news is favorable, which is looking more likely all of the time. Observers are also saying that the CEO of ARNA has been looking "happy" lately. While this is not scientific proof of success, it is probably a good indicator that a successful outcome is likely to be reported soon.

Mar 23 11:34 AM

[David White:]

If by some chance you are thinking that ARNA will run short of money before it can fully develop lorcaserin, that is probably the wrong way to think of things. ARNA is definitely shorter on money than they used to be. However, the whole ball of wax is still almost completely dependent on lorcaserin. If the phase 3 trial results that are supposed to be released in the next week or so are good to great, ARNA will be able to get more short term investment money without any problem. ARNA will also be able to negotiate a much better deal with a partner, who would market the drug (and likely get up front money in the bargain). Without a positive phase 3 result, ARNA will not be in a good position to negotiate. In fact they will be hurting. However, the CEO seemed very upbeat in the conference call. Other people have made similar comments about his current demeanor. The "experts" seem to think this drug should succeed. One of the participants in the ARNA study appeared in a CNBC video recently. He seemed overjoyed with the results of his participation. He lost over 50lbs. Of course, it is only a guess that he wasn't a placebo. However, that seems a reasonable guess.

ARNA apparently is not going to release results regarding vulvopathy at this point. Still good to great weight loss results should cause the stock to shoot up considerably. Remember there are a lot of shorts, so there should be some short squeeze effect (about 20% of the float is short).

Mar 23 05:33 PM

[David White:]

Today, Monday 23, 2009, ARNA obtained an equity financing agreement with Azimuth for $50M. This is generally good news for ARNA stock holders. It will cause some dilution. However, it will help ensure that ARNA has the money to pursue their development goals. They may still be looking for a marketing partner. This agreement does not seem to preclude that. It only puts limits on how much stock ARNA can sell, so Azimuth won't lose out by over dilution. In a way, this too is good for the current share holders.

Mar 23 06:27 PM

[David White:]

A few more details about the deal with Azimuth:
1) ARNA can only sell an added 20% of its stock under this agreement, so the possible dilution is limited.
2) ARNA will sell its stock at a slight discount to the market value. However, it basically gets to dictate 10-day periods in which the stock must be bought (over an 18 month period of the agreement). It could ask Azimuth to buy its stock during relatively high periods.
3) ARNA is not required to sell all (or any of this stock). It can simply require Azimuth to buy its stock at a discount during this period. The cap amount it can require Azimuth to buy is $50M. The cap amount in shares that ARNA can sell is 14,838,891 shares of common stock (about 20% of the current amount of stock on the market).

Mar 24 10:33 AM

[David White:]

This agreement with Azimuth is good for another reason. The relative guarantee of this extra $50M should allow ARNA some breathing room as far as costs go. This in turn will put it in a much better bargaining postion when it goes shopping for a partner to help it market its obesity drug, lorcaserin. ARNA should get a better deal when it negotiates from a position of greater strength.

Mar 24 11:50 AM

[David White:]

One final point to make on the Azimuth deal is simply that it clearly indicates confidence on thepart of Azimuth that ARNA is going to be successful in developing lorcaserin. They would never have agreed to be forced to buy a stock that they thought was likely to go to $1.00 or possibly lower in the near future. This likely means that the ARNA CEO et al have assured Azimuth that lorcaserin will be a viable product (at least from all the data they have seen). Since the phase 3 data from the BLOOM trial is about to be made public, the CEO probably has all the data from that at his finger tips. In my mind, this means the phase 3 results are virtually guaranteed to be good to great. ARNA should be a great near term buy. If I were short this stock, I would cover my position before the actual news came out. It looks very much like the touted short squeeze will occur.

Mar 24 12:27 PM

[pharmaman:]

Now that you have seen the data from the Bloom Trial, what is the view of the experts about approvability by the FDA and also about the comparison with the competition -- Vivus and Orexigen?

Jun 29 02:21 PM