Obesity is one of the leading causes of death in the world and as of late, has become an incredibly hot area for companies trying to find a way to penetrate the market. There are three main companies in this space including Arena Pharmaceuticals (ARNA), Orexigen Therapeutics (OREX), and Vivus Inc. (VVUS). While all 3 companies have their own unique advantages and disadvantages, I believe that now is the time to establish a position in Arena Pharmaceuticals. Below are 6 reasons why the stock is well positioned for the future.
Company Profile: Arena Pharmaceuticals is a clinical-stage biopharmaceutical company focused on discovering, developing and commercializing oral drugs that target G protein-coupled receptors (GPCRs), in four therapeutic areas: cardiovascular, central nervous system, inflammatory and metabolic diseases.
Flagship Product: Arena's flagship product is called Belviq, used to treat obesity. Belviq received FDA Approval on June 27, 2012. The U.S. Food and Drug Administration approved Belviq as an addition to a reduced-calorie diet and exercise for chronic weight management.
Reason #1 - Fundamentals
Arena reported its latest earnings on March 4, 2013. The earnings report was well received by investors and analysts. Total revenue for 2012 came in at $27.6 million, an increase of more than 100% from the 2011 total, which was $12.7 million. Most of this was due to an almost tripling of revenue received from collaborative agreements. Even more impressive, Arena was able to do this while at the same time reducing their operating expenses. Total expenses for 2012 came in at $84.7 million, compared to the 2011 total which was $95.5 million.
Additionally, the net loss was also much lower than in 2011. The net loss was $85.5 million in 2012, compared to a net loss of $109.2 million in 2011. Although still running in the red, the company is showing significant progress for a company just beginning its commercialization of Belviq.
In addition to the income numbers, the company also sits with a very comfortable cash position. This is extremely important to all biotechnology companies. At the end of 2012, the company had $156.1 million in cash, compared to just $57.6 million at the end of 2011.
The company also achieved a milestone for which its partner, Eisai, paid Arena $20 million.
This earnings report clearly paints a picture of a company that is improving. Hopefully, the company will make even bigger strides in the near future.
Reason #2 - Technicals
Arena has had an interesting year. In the early part of 2012, Arena was trading between $2 and $3 per share. As the chart below shows, however, Arena had an incredible move in the summer once Belviq received FDA Approval.
The stock reached its peak last year at a price of $13.50 per share. The stock has fallen off since then, but appears to have found a pretty steady trading range as of late between $7 and $10 per share. Also the stock increased by about 4% after the latest earnings release. Although there doesn't appear to be a lot of trading momentum, it does appear to be a safe entry point with the stock currently hovering at just over $8 per share.
Reason #3 - Upcoming Catalysts
Investors are anticipating the official launch of Arena's drug, Belviq, used in the treatment of obesity. The official launch is expected to occur shortly and the company will benefit from a $65 million milestone payment from Eisai. At that point, Eisai and Arena will begin a marketing campaign to get the word out about this drug that millions of people will be extremely interested in. This launch should help to get traders and investors excited about Arena again and perhaps propel the stock to a new high. The company will still have to prove itself with actual sales, but as with all biotechnology companies, the first move will be based on potential.
A second catalyst is whether Belviq will receive approval to be marketed and sold in Europe. The European Medicines Agency's (EMA) Committee for Medicinal Products for Human Use (OTCQB:CHMP) will decide whether to grant approval soon. There is great uncertainty regarding this decision, but it seems like a negative decision is already priced in to the stock. Should a surprise approval be given, investors should expect rapid appreciation in the share price.
Reason #4 - Stable Volatility Levels
Volatility is a good indicator of what kind of price swings in the underlying might occur at some point in the future. The higher the volatility, the more of a price swing that might occur. This helps investors gauge whether they want to get in now or wait until later when perhaps the volatility has settled down.
The volatility chart below shows that Arena is currently trading at historically low levels of volatility, when it tends to mean it is a safer investment than it has been in the past.
As the chart clearly shows, after a period where the volatility was consistently above 100, it has settled down into a comfortable range of about 50 to 60. This bodes well, as there shouldn't be any "going concern" catalysts. By this I mean there are no upcoming catalysts that have the potential to send the stock into a death spiral, which many biotechnology investors are scared off. Instead, with volatility at historically low levels, it may be a good entry point for investors, especially when combining these low volatility levels with a stable trading range.
Reason #5 - Market Potential
With Arena still running in the red, investors may be asking what do they have to look forward to. Well, the answer is a lot. Besides the improving fundamentals, the future market potential in the obesity space is immense.
The World Health Organization predicts that by 2015, 2.3 billion adults will be overweight and more than 700 million will be obese. The United States is currently the biggest market for weight loss drugs, with around 68% of the population that is either overweight or obese.
In 2010, GlobalData estimated that the anti-obesity drug market could reach $2 billion by 2017. As we saw in the fundamentals section, Arena only had revenue of $27.6 million in 2012. Clearly, the potential to capture more of this market is there. But with two competitors, Orexigen and Vivus, what will separate Arena?
Reason #6 - Competitive Advantage Over Vivus and Orexigen
The obesity drug space is an incredibly competitive market with three companies looking to dominate. However, both of the competitors will face difficulties in trying to beat out Arena for the lead.
The primary competitor is Vivus, having already obtained FDA approval for its drug Qsymia, in July 2012. It has also already began its official launch, but has been unable to obtain the sales it would have hoped for. A primary reason for this has been that Vivus has been limited to mail order drug operations. Vivus is trying to get the FDA to allow it to sell the drug in pharmacies such as CVS. Arena will not face this problem with its launch. Since it already has a strong partner in Eisai, Arena can rely on the company to pick up the costs of building a strong marketing campaign.
Another problem with Vivus is that it was already denied approval into the European market. This occurred in October of 2012, and the stock took a big hit for it as the chart below shows.
A final problem for Vivus is simply the fact its valuation is getting out of hand. Sales continue to struggle, yet the company is trading at a price to sales ratio of 547. Compare this to Arena, which only trades at 62 times sales, and things just don't make sense. Arena is better positioned to sell and still has the potential for Europe, none of which Vivus has, yet Arena trades much cheaper than Vivus does. I expect this valuation to come back into line this year.
Another competitor, Orexigen, faces different challenges than Vivus. Orexigen will face the FDA later in 2013 and try to get approval for its drug called Contrave. The exact date of this decision is likely to occur in the fourth quarter of 2013. So clearly, the first challenge the company faces is trying to get it approved. J.P. Morgan does think it will receive approval but even so, it will be well behind both Vivus and more importantly, Arena. It will have a lot of catching up to do, and I'm not sure it can make it in time.
Orexigen, like Vivus, trades at a rather expensive valuation as well. It currently has a price to sales ratio of 149, which makes it more than twice as expensive as Arena, and Orexigen hasn't even received FDA approval yet. When piecing all of this information together, the picture starts to become a little clearer, and Arena is the shining star.
Obviously, Arena does not come without its own set of risks. It does face incredibly intense competition in its industry. Vivus and Orexigen won't give up lightly, and will do everything they can to maintain a foothold in the space. They may take some of the market share away from Arena that Arena could have had all to itself if it had been the first to market. A second risk is Europe. Investors are crossing their fingers for a European approval, but whether it comes or not is a different story. A third risk is the regulatory risk that the obesity space faces. There haven't been many health concerns yet, but as the product gains approval, the chances for adverse events occurring are much higher. If there are any major incidents that get in the public eye, Arena, as well as others, may have to answer some hard questions.
The pieces are there for Arena to grow in 2013 and become the dominant company in the anti-obesity drug market. The market potential is increasing and growing at a 7% annual rate. Arena also has several upcoming catalysts, which could add a lot of value to the share price. Even if the catalysts don't turn out as good as investors hope, I still expect the company to grow and prosper in the near future and long term.