It is a good thing for Arena Pharmaceuticals (ARNA) that 2013 is over. The stock did not perform well at all this year, and much to the frustration of long term investors, the patience required to own this stock has been well tested. With a new year there is certainly reason for renewed enthusiasm for this equity.
Arena will start off 2014 with brighter prospects. Its anti-obesity pill, Belviq, is now established in the marketplace and that experience could give this equity a nice running start going into the new year. As with just about anything in life, the story here simply comes down to timing.
- Arena recently renegotiated its deal with marketing partner, Eisai, that essentially gives Eisai the selling rights on a global scale. There are a few countries excluded from the deal, but with what equates to a global deal, Eisai has the motivation to up its game.
- The weight loss sector does better in the first half of a year than the second. So while sales since launch have been moderate, the simple dynamic of timing should allow good progress in the new year. Combine a consumer sentiment about weight loss early in the year with some good advertising and you could see a compelling story evolve.
- A new year often has insurance companies looking at their formularies again. The initial goal here is to get onto a formulary in any position. The longer term goal is to get onto a better tier of formularies. 2014 should be the year we see dramatic additions for obesity pills hit formularies. This leaves room for improved positioning for the tail end of the year and 2015.
- The appetite for weight loss solutions is encouraging. Arena and Vivus (VVUS) are already on the market. Orexigen (OREX) is seeking approval for Contrave, and companies like Novo Nordisk (NVO) are dabbling into the sector as well. Private companies like Zafgen jumping into the game is helpful. While it may seem odd that I see competitors as helpful to Arena, that is exactly how I feel. The more of a wave that can be created to garner attention of insurers as well as consumers, the better. The potential market is substantial, and being among the first on the market gives Arena an advantage.
- More approvals. Simply stated, Belviq is only approved in the United States at the moment. The drug is under application in Switzerland, Canada and Mexico already, and anticipated applications could be filed in Brazil, Taiwan, and South Korea. Add a new application in Europe, and the potential market looks promising.
In my opinion, 2014 will bring more clarity to the space as well as Arena Pharmaceuticals. Investors no longer need to look through a haze in seeing the future and the potential here. More clarity allows investors to remove some of the risk from the equation.
I feel that we will begin to see more compelling growth in scripts beginning in the second half of January, with good growth each successive week through the end of Q1. I believe that Eisai will be highly motivated to demonstrate traction. In May of 2013, the CEO of Eisai laid out a number of $200 million in sales by March 31, 2014. It is clear that this level of sales will not happen, but what can happen is a demonstration that big sales numbers are possible in the near future.
I estimate that sales of Belviq to consumers in 2013 totaled about $30 million. In my opinion the neutral expectation is that Q1 of 2014 (Q4 for Eisai, which is on a fiscal year) should bring in $30 million. If this can be accomplished, the growth will be demonstrative of something that can be quite compelling very quickly. If Q1 of 2014 can bring in sales of $40 million, the street would see the Belviq story even more clearly and perhaps show its appreciation.
Long-term investors may not want to hear this word, but it is exactly what is needed. As compelling and exciting as some of these catalysts are, we still need to get through the company (Arena) reporting its Q4 numbers. This report will show progress, but it will still not frame the picture of what 2014 will be all about. In Q2 of last year, the gross sales were $10 million. That essentially stocked warehouse shelves. The Arena share of that sale was about $1.4 million. In Q3 the gross sales were $10 million again. This essentially restocked the warehouse shelves. The Arena share of that sale was about $1.7 million. With revenue to Arena under $2 million, it is somewhat difficult for many to visualize a potential blockbuster. Q4 of 2013, when reported, will likely show gross sales somewhere between $20 million and $30 million. This will indeed show improvement, but as yet is not demonstrating a massive demand. The Arena share should be as high as $5 million. This is a number that investors can wrap their heads around. Follow up that with a Q1 report that shows revenue to Arena approaching $10 million, and suddenly this obesity drug is delivering revenue in a very meaningful manner that will confirm the thought process of those of us that went long some time ago based on potential.
If we assume that the first half of 2014 will deliver the vision, then the numbers will show up in the Q3 report from Arena this year. Savvy investors will monitor the progress well in advance of this. Back in October I called a bottom on Arena at about $4.50. The equity did dip as low as $4.05, but clearly made a move back up in short order. It is not a secret that Arena is a traders' stock at the moment. The activities surrounding the traders' dynamic (hope vs. performance and performance vs. expectations) will be fewer as 2014 progresses. We will likely see some roller-coaster action in Q1 of 2014 followed by a more gentle ride in Q2. By Q3 we should see a crystal clear vision of what to expect. In my opinion, what investors should consider is looking at Arena from a U.S. sales point of view and assessing the rest of the world as the proverbial whipped cream, hot fudge, and cherry on top. I believe that the sales performance in the United States alone will be enough to make Arena an investment with very real potential to make up for the 40% hair-cut we saw in 2013. Those that share that opinion will be seeking out their buying opportunities over the next several weeks.
The Short Story
I often get asked about the short side of the Arena equation. Arena has a substantial short position of about 66 million shares. That represents a sizable chunk (30%) of the shares outstanding. My opinion on the short side is relatively simple. I do not get too excited about it. A short squeeze will drive a stock price up, but we need to remember that the buying that happens when shorts cover is false demand. The same dynamic is created when a short position is entered into. It is false supply. Thus, an equity suffers, falsely, when the short position is entered into, and benefits, falsely, when it is exited. Simply stated, the short side deflates the price to a level lower than it should, and a short squeeze inflates a price that is too high. The real value is somewhere in the middle.
I most often hear from long-term investors that hold onto their shares with an iron grip. These investors have no intention of selling anytime soon, yet grasp onto the concept of a short squeeze rocketing the stock price. The big benefit of a short squeeze is for the more active trader. It is for the investor that understands that the price run on a squeeze is false, and sells the top so that they can buy back in when the market digests the false demand created by the squeeze.
The short story on Arena is one dynamic that will keep this equity in a roller-coaster of sorts in early 2014. It is my opinion that a big portion of the short side is hedging activity that is making money while waiting for the haze on sales to clear. As stated, the clarity will be somewhere in Q2 or Q3 of this year. It is not unheard of for a short position to be covered and then entered into again. That creates the roller-coaster we should all be familiar with at this point. There will always be a short side to an equity. Some investors will simply ride the roller coaster, while others will trade around it. The strategy that makes more money depends on the timing.
2014 has a very real potential to treat Arena well. That story will begin to unfold with growing sales numbers that will show through as January closes. The sector carries promise, and there are many possible catalysts in play. The roller-coaster ride is not quite over, but the ride should be more smooth after the Q1 call from Arena. I believe the street is looking for total sales to date to be at about $60 million by March 31st. Anything above that accelerates the path to clarity. Stay Tuned.
Additional disclosure: I have no position in Eisai, Orexigen, Novo or Vivus