It has not been a good day for Arena Pharmaceuticals (ARNA) longs. The equity dipped over 10% on a downgrade from Credit Suisse (CS) analysts Lee Kalowski. The analysts lowered sales projections for the anti-obesity drug Belviq and in doing so, rated the company as "underperform" with a price target of $4.00 per share. The previous price target was $5.00.
For a couple of weeks now I have been stating that I expected analysts to revise Belviq sales targets downward, and now it appears that process has started. This week it was Credit Suisse. I expect more analysts to assess sales and make adjustments of their own. Unfortunately, for longs, I do not see any analyst revising sales targets upwards. Some readers have been seeing the low prices of late and expressed a desire that I call Arena a "buy". My assessment then, and now, is to wait for the dust to settle.
I think it is far more likely than not that we will see more downgrades in the days ahead. Sales of Belviq have been more modest than initial expectations, and that trend has not yet been broken. Even with direct to consumer advertising starting, the outlook is not as rosy as many investors thought it would be.
Credit Suisse made its adjustment after meeting with management on Friday. While we have no way to know what was discussed in the meeting, what we do know is that Credit Suisse thought it prudent to adjust sales models between now and 2018 as a result.
Credit Suisse has essentially outlined numbers that make the term blockbuster something that will not happen until years from now. For Q4 of this year the firm is estimating sales of $12 million. There is some good improvement in 2014 to $157 million, and 2015 is now expected to deliver $325 million. Credit Suisse assume that a more exponential growth is demonstrated and that Eisai will need to increase the sales force.
Another aspect of the note relates to the possibility of a need for financing. The analyst bases this on the assessment that "royalty payments" (Arena's share of Net sales) will be slower than anticipated and push out milestone payments. Credit Suisse sees Arena as profitable in 2017 vs. its earlier model which had that event happening in 2016.
If you consider that, back in May of this year, Eisai spoke about $200 million by March 31st of 2014, in June spoke of $150 million by December 31st of 2013, and more recently seems to indicate $150 million by June 30th of 2014, the trend seems to be modifications downward, giving merit to the thought process that the ramp up in sales will be more of a slow build than a fast track to blockbuster.
In my opinion, whether you agree with Credit Suisse or not, we can not ignore the numbers we have seen to date. I have modeled sales figures weekly, and for weeks now have noted that even the pace to the $70 million in sales that would have met the expectations of more bullish analysts was in jeopardy. Whether we like it or not, it is difficult at best to ignore a trend. The trend is that sales will be more modest than outlined.
In my mind investors should give serious consideration to the prospect of additional downward adjustments coming in the days ahead. The anti-obesity door is not closed. It is just not open yet either. Consider that Credit Suisse is projecting over $300 million in sales in 2015. That is a big number, and certainly does not point to failure. What investors need to be considering is the possibility that sales will be $157 million for all of 2014, and that milestone payments could be at 2105 and beyond. This is where the time/value of money becomes a factor in investment decisions.
Yes, there is a possibility that television ads are compelling, or that a spokesperson can become a catalyst. Yes, more doctors are being spoken to weekly. Yes, insurance companies are being engaged by Eisai. These all add to the potential side of the Arena story. In addition, the Arena pipeline, and the use of Belviq for other indications may be in the cards. For the moment however, the Arena wagon is hitched to Belviq as an anti-obesity drug.
A passionate long may well remain a passionate long, but having shares and holding them does little to invoke an upward trajectory that builds excitement in the stock price. What we need to see is very compelling traction in sales. This can happen with a great ad campaign, with a distinct shift in insurance coverage, or with the a viral acceptance of Belviq by consumers. In the mean time we have to assess what we know as the driver of the price action. Current sales, with current insurance coverage, with the current pace of reaching out to doctors and consumers.
What Is The Strategy
My opinion is simple. The safer play is to be in a holding pattern and wait for the dust to settle, the analysts to offer up their opinions, and the company to report numbers for Q3 (and hopefully guidance of some sort). A more aggressive play is to let the analysts dust settle, see the equity bottom, see a recovery start, and then speculate that a new upward trend can form.
With all of that being said, and investor needs to ask a few questions.
If 2014 sales are $150 million, what does that mean for Arena? We need to remember that Arena gets a percentage of net sales. If we use $100 per bottle as a net number, we are looking at $75 million for next year. Arena's share would be about $24 million. What type of market cap should a company that generates $24 million be worth (bear in mind Arena does get other revenue as well)? As an investor can you wait on stock price appreciation for Arena? If blockbuster status ($1 billion of sales in 1 year) is 5 years away is that okay?
Essentially, if we consider Credit Suisse as the biggest bear case, what is the most reasonable and biggest bull case? Is it double the sales projected by Credit Suisse? Triple? There are a lot of moving parts here, but in very real terms, we are looking at the most compelling bullish days for Arena and Belviq coming at least a year from now, and possibly 2 years out. Stay Tuned!