Arena Pharmaceuticals: Risk Vs. Reward

| About: Arena Pharmaceuticals, (ARNA)

Obesity is one of the largest and most publicized epidemics in the U.S. So it stands to reason that a drug company ready to launch a treatment for this condition stands on the cusp of phenomenal growth.

Arena Pharmaceuticals (NASDAQ:ARNA) received Food and Drug Administration approval of Belviq in June 2012, the first obesity drug to earn federal OK since Fen-Phen was discontinued in the late 1990s due to its extreme side effects.

The big question now is: When exactly will Belviq be launched to the public? The company is still awaiting final clearance from the U.S. Drug Enforcement Administration before it can make it available to the public. The company has not provided any guidance on a specific date for when that might happen, only to mention in its last earnings report that it anticipated revenue from Belviq sales in 2013.

Arena isn't the only company ready to cash in on the obese population. Vivus (NASDAQ:VVUS) has also received FDA approval for an obesity drug named Qsymia, which it has already launched but has yet to receive much positive feedback. In fact, the company recently announced it will lower the price of the drug. Another competitor, Orexiegen (NASDAQ:OREX), is working to obtain approval for its Contrave treatment.

About Arena

Arena was founded in 1997. It is a biopharmaceutical company that focuses on clinical stage trials of medications for weight loss, heart disease, inflammation, etc. Given the time it takes to develop, test, earn approval and market new drugs, Arena is still a baby in the industry. In fact, Belviq is currently its only approved drug. That, in and of itself, makes it a risky investment with the potential for reward if the drug becomes the next blockbuster.

Arena has four other drugs in its research and development pipeline: one for arterial thrombosis, one for pulmonary hypertension, a Niacin receptor for arteriosclerosis and a treatment for Type II diabetes. On two of these drugs, Arena is collaborating with industry giant Merck and Ortho-McNeil-Janssen.

Arena has partnered with Eisai Co. Ltd. to market Belviq in the U.S. Following FDA approval of Belviq, a milestone in the agreement between the firms, Arena received a $20 million payment from Eisai. This payment accounted for nearly three-quarters of Arena's 2012 annual revenue. It also collects revenue was from manufacturing services and collaborative agreements.

2012 Earnings Report

Arena Pharmaceuticals reported fourth-quarter 2012 revenues of $1.9 million, a decrease of 9.5% from $2.1 million in 2011. Full-year revenues increased 117%, from $12.7 million in 2011 to $27.6 million in 2012. The company booked a net loss of $88.3 million, $0.45 a share, for the year, lower than the $111.5 million loss it took in 2011.

Research and development expenses increased 6% in the fourth quarter of 2012, but were down 8% annually. At year end, Arena had cash and cash equivalents of $156.1 million.

For 2013, Arena expects revenues of $65 million in milestone payments from Eisai, $6 million from amortization of upfront payments from existing collaborations, about $3 million from manufacturing services, and $1.5 million from additional regulatory milestone payments from Eisai. The company expects research and development expenses of $70 million to $78 million and general and administrative expenses of $28 million to $34 million.

The company has maintained strong liquidity, with a quick ratio of 5.40 and a current ratio of 5.70. Its long-term debt-to-equity ratio is 0.74.

Shares of Arena traded under $2 as recently as a year ago, but jumped to $13.50 following approval of Belviq. Since then the stock has hovered around the $8-$9 mark.

Large Market Potential

Because of the sheer size of the obesity epidemic, estimated at 78 million Americans, a penetration of just 0.2% would result in 156,000 patients for Belviq. Even after splitting revenues with Eisai, Arena could pull in between $59.6 million and $138.2 million in the first year. That doesn't take into account the likelihood that obesity will continue to grow, with estimates that as many as half of Americans will be classified as obese by 2030.

Arena has a distinct advantage when compared with its competitors: safety. Belviq is considered the safest of the obesity drugs. Vivus only received approval with Risk Evaluation and Mitigation Strategies. It cannot be prescribed to women ages 16 to 45. Belviq does not have such a restriction.

Analysts also believe that Arena will have greater chance of success because of the marketing agreement with Eisai. Arena said that 200 representatives were strategically added in places where physician and patient targeting was high. Eisai also has specialists dedicated to developing reimbursement schedules with health insurance companies.

Two years ago, Eisai made sure to inform the public that the New England Journal of Medicine had published favorable results of clinical trials for Belviq. The data presented in the article showed that the drug caused statistically significantly greater weight loss and improved maintenance of weight loss compared to placebo. The drug also improved values for biomarkers that may be predictive of future cardiovascular events, including lipid levels, insulin resistance, levels of inflammatory markers and blood pressure.

During Year 1 of the trial, the proportion of patients achieving at least 5 percent body weight loss in the drug group (47.5 percent) was more than twice that achieved by the placebo group (20.3 percent). Nearly three times as many patients achieved at least 10 percent weight loss in the drug group (22.6 percent) than in the placebo group (7.7 percent). Patients who took the drug and completed the trial lost 8.2 percent of the body weight, or approximately 8.2 kilograms, as compared to 3.2 percent, or approximately 3.2 kilograms, in the placebo group. In Year 2, patients who continued to take the drug were significantly better able to maintain their Year 1 weight loss compared to those who were switched to placebo.

Still, the company is in a risky position. For one, approval from the European Union, the other major market for an obesity drug other than the U.S., appears unlikely for all companies involved. Second, the company could be indirectly impacted by the lackluster launch of Qsymia.

But if Belviq's sales are three times what those of Vivus is doing, it will be a financial victory for the company as well as investors. That would be enough to deliver about $140 million in revenue for Arena.

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Business relationship disclosure: This article was written by an analyst at Catalyst Investments.