Arrowhead Research Corp: What Am I Missing?

Arrowhead Research Corp (NASDAQ:ARWR) shares have now more than tripled this year and jumped almost another 10% yesterday on heavy volume. What's mysterious to me is that this monstrous move appears to be based almost exclusively on initial early stage trial results for the company's Hepatitis B drug candidate ARC-520. Specifically, investors have piled into Arrowhead this year because of a Phase I study for ARC-520 that consists of 36 total subjects enrolled at a single center in Melbourne, Australia. And the final data readout hasn't even occurred yet.

If you know anything about Hepatitis B, or Hep B, then you are probably scratching your head like me. Most Hep B infections do this weird thing where they, well, resolve spontaneously. Consequently, the cost to patients is a big fat goose egg.

Although glowingly positive articles like this one report that 350 million people globally are infected with Hep B, it also fails to note that less than 1% of individuals actually require medical intervention. So the real market size for a Hep B drug is much, much smaller than 350 million people. And don't forget, there are 7 Hep B drugs already on the market, with most of them generating the bulk of their sales via other indications such as Hep C. So unless ARC-520 is a curative treatment, it will find it tough to gain significant market share for an indication that isn't known for generating blockbuster treatments.

A bigger problem is that the bulk of serious Hep B infections are found in Asia, and the patient population there is too poor to afford fancy medicines like ARC-520. And yes, I've seen the reports that say China has a growing $800 million Hep B market. But I live in Asia and travel to China frequently. So let me pop this bubble right now: The people that need the drug the most simply can't afford it.

According to Industry insiders in Asia, only about 20% of patients that need Hep B treatments in China actually get them. Why? Because most of these unfortunate souls can't afford to eat. So how are they going to pay for a Hep B drug? Again, I am scratching my head at the multi-billion dollar sales projections that have been tossed around for ARC-520, and have propelled the stock to its current levels.

If this critique sounds harsh, perhaps you might want to check out why Medivir and their South Korean partner Daewoong Pharmaceutical Co decided to mothball their Hep B drug. According to Medivir, "the commercial environment for HBV drugs, with the current standard of care approaching generic status, requires a robust cure profile". In short, there are too many drugs on the market and the only way to gain significant market share is to essentially be an outright cure for chronic Hep B infections.

While the story Arrowhead tells for ARC-520 as a potential "functional cure" for Hep B is interesting, the compound hasn't even completed a Phase 1 trial yet. So it's got a long way to go before such enthusiasm is warranted. And interesting immunological responses in a handful of patients is a far cry from a functional cure.

What's not surprising is that Arrowhead used the overly zealous investor enthusiasm to do what all biopharmas do in similar positions: raise cash! Last October, Arrowhead raised $60 M via a private placement. Arrowhead has now raised close to $100 M in dilutive funding this year.

With a market cap now exceeding $230 M, I find this developmental stage biotech to be remarkably overpriced. And the underlying cause of its year-long ascent is the most baffling aspect of this story.

When you take a close look at the stock's catalyst, it fails to hold up in terms of the proposed value proposition. I know the Baker Brothers have been buying this stock lately, and I suspect this has something to do with the rise. But what retail investors should key in on is the phrase "functional cure". There is a reason why Arrowhead keeps hammering on that phrase. As I've shown here, a new Hep B drug will have to essentially blow away the competition to be a major revenue generator, and that's a tall order for a drug still in Phase 1 development.

I believe a day of reckoning is imminent for this stock, and I'm apparently not the only one who thinks this way. Shorts have been piling into Arrowhead of late, and now hold over 5% of the float. What's most important to note about the short numbers is that they have doubled over the last two months. I expect this trend to continue, especially as the stock defies logic.

That said, I am closely watching to see if the stock breaks a $300 M market cap before taking a short position. I believe this will be close to Arrowhead's inflection point, and will be an excellent short candidate at this point. So yes, I am conceding that hype can drive this stock even higher in the short-term. Biotechs are strange animals that way.

In the long run, Arrowhead looks more profitable to me as a short candidate. The drug's chances of truly being a "functional cure" are remote at this stage in the game, and the company's cash burn rate is about to ramp up with its increasing clinical activities. And if you aren't familiar with the Hep B drug game, you might want to read into why so many promising candidates have been shelved over the years. In short, they are shelved because the current host of therapies are usually effective at medically managing the disease. As such, new therapies will have to be "apparent virological cures" to overcome their competitors. I'm betting ARC-520 can't meet this lofty goal, and will eventually be shelved like so many promising therapies before it.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in ARWR over the next 72 hours. 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.