Seeking Alpha
Growth, value, special situations, momentum
Profile| Send Message|
( followers)  

Arena Pharmaceuticals (NASDAQ:ARNA) is a company that is full of potential. This is the company behind the recently launched anti-obesity drug Belviq in the United States. As most are aware, obesity is a huge issue not only in the U.S., but globally as well.

If obesity is a huge problem, and Arena possesses a great solution, an investment in the equity would seem to be a no-brainer. In fact, when Belviq garnered FDA approval the anticipation of a blockbuster ($1 billion of sales in 1 year) was on everyone's mind. Arena stock traded as high as $13.50 and the street was tossing about numbers such as $250 million in first year sales.

The reality has been that putting a dent into the prescription anti-obesity market does not happen overnight. Investors in both Arena and Vivus (NASDAQ:VVUS) have seen that first hand, as has Wall Street. Part of this is due to issues such as the fen-phen fiasco where the drug was pulled from the market due to serious health concerns.

Arena and Vivus have spent the better part of the year dealing with conflicting theories about what the potential of these anti-obesity drugs are, and thus the potential of the company. Arena has seen the price of its stock in a tug-of-war between exuberant and hopeful bulls and doubtful and pessimistic bears. Each side has had its moments of celebration with the trading action. Meanwhile savvy shorter-term "traders" play the battle like a fiddle and profit from the volatility.

When Arena gets profitable, or when the viability of Belviq demonstrates serious traction, the guessing games will be over and the equity can trade based on great sales numbers rather than hope or doubt. A lot of my coverage of Arena is geared toward the near-term volatility of the stock, while I hold the equity based on my belief that the potential in Arena is real. It is simply a matter of time.

Some key elements that keep me a long in the stock are as follows:

  • Arena has a marketing partner. Eisai is well rounded and experienced in pharma. While the deal may be "expensive," it can still be profitable for Arena. In fact, it can be very profitable.
  • The United States has about 100 million obese people. That is an impressive potential market to cater to. I like the fact that at just 1% penetration into that market, Belviq is a Blockbuster twice over in gross sales. 1 million patients x $200 per month in gross sales x 12 months = $2.4 billion. When that happens, Arena will have achieved every milestone target and garner over $1 billion in bonuses. This is on top of the ongoing "royalty" (a percentage of net sales) of just over 36%.
  • Doctors and insurance companies are beginning to treat obesity proactively. The AMA has now classified obesity as a disease, adding to the credibility that treatment should be covered. Insurance coverage is just getting started, and with more coverage, the financials of Arena improve dramatically.
  • People are thinking about weight loss more. Obesity has been linked to other health conditions for quite some time, but people have seemed to be content in whatever condition they might have. That is shifting. A product like Belviq can help that shift happen faster.
  • Belviq has other attributes that are positive. It has positive impacts on diabetes, and may even show a proclivity to help with smoking cessation. As testing and labeling happens, the potential market broadens.
  • Belviq, in theory, has a good safety profile. As time passes the theory of that will be proven out more and more. As a new drug there is sometimes hesitation. After a year, if there are no major events, the perception of that safety vs. risk will improve. The more time that passes, and the more people that try it without adverse reaction, the better the safety profile will be.
  • Belviq has "pipeline" in expanding into other countries. This will simply add to the potential with each passing quarter. Arena is free to negotiate deals for Europe and other regions. When Belviq proves successful in the U.S. the negotiating power of Arena increases greatly. This can lead to more impressive "royalties" (percentage of net sales).
  • Arena has additional testing and trials to conduct for Belviq, but thanks to the Eisai deal, does not have to fund much of it. This allows profits to build a new pharma pipeline, thereby creating more potential.

Specific to workings of the Eisai deal, I like the concept that when Belviq becomes viable in terms of profits, the numbers make a very dramatic shift. This will happen in one swoop, and could catch many off guard. For those already invested, this event will be the beginnings of a substantial reward. It is the workings of the deal, combined with the current state of the company that can potentially set up a perfect storm. Read on.

Arena currently "burns" between $20 and $30 million in any given quarter. That story will shift very quickly as Belviq ramps up in sales. This is accomplished through a combination of organic traction, timely expansion into other territories and countries, and the mechanics of the Eisai deal. The structure of the Eisai deal calls for milestone payments as well as adjustments upward in "royalty" payments at specific levels.

As discussed above, Arena burns about $25 million per quarter. Sales of Belviq will begin to lessen the cash burn each quarter until such a time when the company is reporting profits based on sales of its drug rather than one-time milestone payments. That can potentially happen within the next 18 months. It just so happens, that if sales and added territories take a bullish path, the first milestone payment from Eisai will be more than just an aspiration, but rather a reality shaping up to happen. Timed correctly, the perfect storm of additional approvals in other territories, impressive sales in the U.S., and insurance companies adding coverage to a level above 50% or 60%, the top line and bottom line growth could see a dramatic shift in the space of 1 quarter. That is potentially 18 months from now, and if it happens, could take this equity to the types of levels that would produce very meaningful returns even for those that invest at current prices.

Make no mistake. There will be a lot of volatility between now and then. The territories and other markets may take a differing track, competitive forces may come into play, or the prescription anti-obesity space may be slower to adopt than people think. This is not an overnight story, but what I like about it is that at just 1% penetration into the potential U.S. market, the Belviq story can be a very positive one. I have long maintained that I see this as an investment worth betting on at anything below $8.50. I still feel the same way based simply on 1% of the U.S. market. If a perfect storm comes then the potential is even more impressive.

Yes, I write mostly about the near-term volatility of the stock. My near-term analysis is not always appreciated by some. If you look at things realistically, the near term has a lot of competing forces at play. Those that are buy-and-holders seem to oft get caught up in the near-term vortex even though their strategy and outlook is long term. Don't sweat the volatility if you fall into the category that is "great success at 1% penetration." Do make it a point to understand the near term, as it is there that you will see the first concrete indications about the longer term. Essentially what I am seeing is a slow but steady pace that will break into a sprint when the timing is right.

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

Source: When Arena Gets Profitable