Now that Arena Pharmaceuticals (ARNA), Vivus (VVUS) and Orexigen Therapeutics (OREX) have all announced full year 2009 financial results, it's time to revisit my pet strategy of investing in the obesity treatment space by investing in a basket of these three stocks.
This basket essentially represents an option on the obesity drug market that I believe will mature in 2011, and that I hold in my own portfolio.
A Tisket, A Tasket, Three Stocks In One Basket
To sum up, these are three small-cap drug developers, each of which has a late-stage pharmaceutical candidate for weight loss that has completed Phase III trials. In clinical trials, all three drug candidates met FDA approval guidelines for efficacy (that is, patients did lose weight on these drugs) and showed minimal side effects. It is possible for all the drugs, or any two, or none, to be approved.
These drugs, if all approved, should all be coming on the market around the same time in early 2011. The FDA has set decision dates (technically called "PDUFA dates," pronounced "Puh-DOO-fuh") of October 22, 2010 for lorcaserin and October 28, 2010 for Qnexa. OREX announced last week that it expects to submit its NDA for Contrave by the end of April, which would put its PDUFA date ten months later, or somewhere around February, 2011.
However, there are two notable wild cards in this schedule. The first is that the FDA may refer any of these drugs, or perhaps the entire bunch, to an advisory panel, whose recommendations are non-binding but usually respected. If this happens, it would likely happen in September 2010, at least for lorcaserin and/or Qnexa. It is very possible that a positive advisory panel recommendation would be sufficient to conclude a partnership.
The second is that the FDA has just been running very late in recent years, for reasons that are beyond the scope of this discussion, and there is not much anyone outside of Washington DC can do about this. By one count, the FDA missed 40% of its PDUFA dates in 2008. So maybe don't reserve a really fancy restaurant table for the night of October 22 just yet.
They Have The Cash To Make It To Partnership
All three companies say they are in negotiations with partners for marketing and commercialization of these drugs, although I would not be shocked if at least one of them ended up getting purchased outright. Most likely, a partner will wait for FDA approval, or at least advisory panel approval, to mitigate risk. Again, this is expected at the end of October for ARNA and VVUS, and in February or March 2011 for OREX.
Big Pharma has struggled (at best) in the obesity space, and is cash rich, and should be looking for an entry -- one or more of these companies could provide that. ARNA purchased a manufacturing facility in Switzerland and also has one on-site in San Diego (thanks commenter Mike Devry for highlighting this) and on Friday afternoon OREX announced a manufacturing agreement with Canadian drugmaker Patheon. Both ARNA and OREX have begun to claim that if need be, they could engage contract sales organizations to launch lorcaserin and Contrave on their own, but I regard this as mostly a negotiating stance.
OREX has cash and investments of $92 million, and burn of $14.8 million in the most recent quarter, which annualizes to about $60 million (this assumes any further spending on Empatic development is funded separately). VVUS has cash and equivalents of $207 million and has guided to burn of $95 million for the year. ARNA is cutting it tighter, with cash of $115 million at year-end plus another $24 million drawn down March 9, 2010 under an equity financing, versus burn of $28 million in the most recent quarter or $112 million annualized.
Buy All Three - Mitigate Company-Specific Risk
In small pharma investment, promising companies and technologies often just don't make it for one or another out-of-left-field reason. While I believe that all three of ARNA, OREX, and VVUS have a lot going for them, why put all your eggs in one basket? Owning three instead of one gives an investor some protection against the FDA taking exception to some quirk in the clinical trial data that we haven't seen, or a last-minute manufacturing bugaboo, or a scandal tainting the name of Topamax or Wellbutrin (components in Qnexa and Contrave) in some other indication that has nothing to do with these companies but falls out on them anyway, etc. etc.
While there are important distinctions among the companies and their candidates (Qnexa showed the highest mean weight loss in clinical trials, lorcaserin is a novel compound rather than a combination drug, and more), I have covered these in earlier posts and will return to them in later posts.
Signs of Undervaluation
We've made a few assumptions, all arguable but all we think reasonable, most importantly:
- a 50% chance that each of these drugs (lorcaserin, Qnexa for obesity, Qnexa for diabetes or other second indication in 2012, Contrave, and Empatic in 2012) will reach market;
- a $10 billion US market for obesity and an $18 billion market for diabetes;
- 10% market share for each drug ramped up over 4 years;
- 18% discount rate;
- 34% tax rate;
- 30% royalty rate.
- Prices as of 3/12/2010 close
This yields the following summary:
|Expected return ||42%|
The supporting documentation is back at my blog, Obesity Investor.
One other thing stands out: over the last two years, as time to approval and market has shortened, and uncertainty has dropped, the option value has risen -- as one would expect -- but the market value of the stocks has not necessarily. This would appear to be an anomaly attributable to the thinly-traded small-cap market -- an anomaly that could mean profit for those who believe this space is worth an investment.
|Share price||3/17/08|| |
Of course, it's a bit of an oversimplification to look at any of these companies as simply an option on a future obesity drug. OREX also has a very efficacious second obesity drug, Empatic, about one year back in its pipeline, plus a collection of interesting early-stage candidates. ARNA's several Phase I candidates include a partnership with Ortho-McNeil-Janssen Pharmaceuticals, Inc. for diabetes, and VVUS's avanafil, an erectile dysfunction candidate in Phase III studies, shows promise as effective in only 15 minutes with so few side effects that it may be safe for patients using nitrates for chest pain. So our quick valuation approach may well leave money on the table.
Author's Disclosure: long OREX, ARNA, VVUS
Disclosure: Long VVUS, OREX, ARNA