It has been some time since I have written about Arena Pharmaceuticals (NASDAQ:ARNA) and after receiving several inquiries, I thought I would provide an update on the company and my long investment thesis on why I believe it will be the next major biotech. The biotech landscape is similar to what the Wild West must have looked like in the 1800's with everyone in search of the next gold rush town. Investments in the biotech space can result in massive returns but more often than not, disappointment and unrealized dreams. Finding that diamond in the rough which can become the next Gilead (NASDAQ:GILD), Biogen (NASDAQ:BIIB) or Celgene (NASDAQ:CELG) is every investors dream. I have believed for many years that Arena Pharmaceuticals has all of the components to become the next major biotech winner following in those footsteps.
The Belviq Launch and Future Expectations
I have written extensively about Belviq (lorcaserin) for several years and fundamentally, not much has changed. It still remains the only novel, new chemical entity approved for chronic weight management in 14 years. It is the only approved weight loss drug with the trifecta ingredients of safety, tolerability and efficacy. It can be considered a "Diabesity" drug not only because of its ability to result in weight loss but also because it can reduce HbA1c by an average of 1.2 if you are a drug "responder." However, even though this drug has tremendous upside, it hasn't flown off the shelves over the last 6 months since it was launched.
As Jack Lief, Arena's CEO, stated at this week's J.P Morgan Healthcare Conference there are 3 keys for Belviq becoming the blockbuster they expect it to be: 1. Education, 2. Coverage & 3. Consumer Awareness. Eisai (OTC:ESALF), which owns the Belviq marketing rights for most or the world, is focused on all 3 of these pillars and is spending 10's of millions of dollars to execute. The sales force has recently doubled to 400 in order to expand detailing to 65,000 physicians and tremendous investments have been made with eDetailing assets, sponsoring continuing medical education sessions and trade shows. Excellent progress has been made with expanding payor coverage which is now up to almost 50% of commercial lives, ahead of expectations. Finally, direct to consumer ads started in the fall in dozens of magazines and it is rumored, television commercials are being shot this month in Los Angeles to be aired in February or March.
Looking into 2014 and beyond -- education, coverage and consumer awareness will continue to improve. I believe there will be a direct correlation between the time on the market and the willingness for a physician to prescribe. The longer Belviq is on the market, the more comfortable physicians will become prescribing it and that along with increased coverage and consumer awareness should lead to a dramatic uptake in scripts later this year.
Another important consideration is the outcome of the Treat and Reduce Obesity Act (H.R. 2415,) which has now been added as an amendment to the SGR Repeal and Medicare Beneficiary Access Improvement Act, the "DocFix" Act, which has excellent bi-partisan support. On Page 88 of the document, there is a "Prevention of Diabesity Amendment." Yes, that is correct -- diabesity which is the same phrase I used to describe what Belviq can be a 1st line treatment for in a previous Seeking Alpha article here. The amendment states "The Medicare Diabetes Prevention Act of 2013 and H.R. 2415, the Treat & Reduce Obesity Act, both expanded to include Medicaid and thereby concurrently addressing the prevention and treatment of obesity and diabetes in both the Medicare and Medicaid programs. This amendment would also remove prescription drugs for the treatment of obesity from the List of Drugs Subject to Restriction for Coverage on Medicare and Medicaid under section 1927(d)(2)(A) of the SSA. These drugs are defined as prescriptions for the treatment of obesity or for weight loss management for an individual who is overweight and has one or more co-morbidities." Passage of this Act would usher in 100% payor coverage for Belviq in the coming years and drastically improve the chances of it hitting blockbuster status far earlier than many believe.
I do not pay very close attention to the weekly scripts for Belviq as the month over month trend is a more important indicator of growing medical acceptance. The practice of treating obesity as a disease, as the American Medical Association now has recommended, is in its infancy. This shift to treat obesity as a chronic condition like diabetes is just now beginning and how it ends is far from being known. Eisai's investment going on now in physician education, expanding payor coverage and consumer awareness I believe will pay big dividends in the quarters and years ahead. However, despite the lack of attention, Arena Pharmaceuticals is worth far more than Belviq alone.
As biotech investors have recently seen with the explosion of Intercept Pharmaceuticals (ICPT), which soared from $70 to almost $500 in a matter of days with early positive results of a Phase II trial which could expand their market to nonalcoholic steatohepatitis (NASH) patients, there can be mind-boggling valuations given to promising novel drugs with great Phase II data. Intercept could potentially file for interim approval in early 2015, a full year away, but they only have $65M in net stockholder equity. Of course that apparently doesn't matter since Wall Street has given it a $5B valuation even after a quick sell-off from the highs. Although everyone equates Arena to Belviq today, their pipeline of drugs making their way to Phase II is outstanding and no value is attributed to it currently. Belviq by its own right, has the potential to be a franchise drug with multiple uses. The value of an approved novel drug with multiple potential indications is worth far more than Arena's current $1.5B valuation in my opinion. Ironically, the best treatment for most NASH patients is weight loss, which Belviq could certainly help with.
Perhaps the trial investors are most anxious for completion is the pilot study combining Belviq with phentermine. This 12 week trial is now underway and I expect we will see results sometime this summer. Although this is primarily a safety study they are also tracking efficacy. Given the effectiveness of phentermine with the non-selective 5-Ht2 agonist fenflurimine, I would not be surprised to see over 10% average weight loss in just 12 weeks. This is equivalent to the 1 year results of high-dose of Vivus' (NASDAQ:VVUS) Qsymia, which very few patients have taken in the past 16 months, likely because that is the dose where tolerability is a major issue.
Another major study to potentially expand Belviq's indication into smoking cessation will be kicking off the 1st half of 2014. As I covered in previous articles, the pre-clinical data for the potential of Belviq as a smoking cessation drug is excellent. The global opportunity for a safe, tolerable and effective smoking cessation drug, which also causes weight loss, is in the multiple of billions of dollars. In addition to smoking, you could see Belviq used for opiate and methamphetamine addiction. In a recent article in the San Diego Tribute, Arena's Craig Audet is quoted as stating: "The other thing it does is it takes away cravings. We think in smoking it works the same way. It's the reward of nicotine. We actually believe there might be something there for drug addiction as well. It's that whole reward system in the brain. You get pleasure from doing certain things - from eating, you get it from smoking, you get it from taking drugs. This takes that away."
For me, the game-changer trial for the very long term investor is the cardiovascular outcomes trial starting this quarter entitled: Camellia. This trial will be up to 5 years in duration and will be tracking both major cardiovascular events (MACE) and the prevention of Type II diabetes. I hypothesize that Belviq will be shown to both reduce the risk of a major cardiovascular events and prevent Type II diabetes. If Camellia does demonstrate this, you could see acceptance of Belviq as great as you saw with Lipitor. This is a bold statement I realize and we are 5 years away, but I have been an investor in this equity off and on for 6 years with the belief that this drug has the potential to improve cardiometabolic health and I look forward to a large trial consisting of 12,000 patients to unequivocally show this to be the case. Belviq can become a blockbuster well prior to the results of Camellia but positive trial results could bring about mass market acceptance to take it to another level entirely. The risk of course is Camellia shows an increased risk in events and then it will be pulled from the market or receive a black box. However, given the size of the Phase III studies and defined relative risk, the chances of this happening are low.
In addition to expanding Belviq indications, there are 4 promising novel compounds that Arena is progressing through clinical trials. As Belviq gains ground in the coming years, profits should fund the progression of these drugs without the need for further dilution or debt obligations. Each of these drugs are targeting major unmet medical needs with blockbuster potentials in their own right.
ADP811 is a novel drug targeting Pulmonary Arterial Hypertension (NYSE:PAH). It is an oral formulation of a non-prostanoid prostacyclin agonist which could greatly improve the quality of life for patients suffering from PAH, a progressive and life-threatening disorder. Phase II for ADP811 will be initiated the first half of 2014.
Temanogrel is a novel drug with a dual mechanism of action for the treatment of thromboembolic disease. Arena struck a creative partnership with Il Dong in South Korea, who also owns the rights to Belviq in that market, to fund a Phase Ic trial of this drug which is now underway. A Phase IIa trial would subsequently commence in the 2nd half of 2014.
ADP334 is a novel GPRC-focused drug targeting the S1P1 receptor to treat autoimmune disorders. This is a market with broad potential to treat diseases such as multiple sclerosis, psoriasis, rheumatoid arthritis and lupus. ADP334 will start Phase I trials in 2014.
ADP371 is an exciting novel drug for chronic pain management. It is a non-opioid, non-NAISD drug which would address a huge unmet medical need. It is an agonist of the cannabinoid (CB) 2 receptor and was shown to be highly potent in pre-clinical models. In fact, in a 5 day dosing regimen, it was shown to be more effective than morphine on days 2-5. It is free of GI side effects common among pain medications and non-addictive.
In whole, you have Belviq which has additional label expansion trials underway including new indications and 4 novel drugs now in clinical trials. Outside of Belviq, I believe zero value is currently attributed to these compounds but that could change quickly depending on results of the these Phase II clinical trials.
Long Term Value
It is impossible to come up with a fairness valuation for Arena given the immaturity of this market. As Belviq sales increase, the market will start to look forward and at some point, realize that Arena is structured to produce major earnings upon Belviq acceptance. Arena and Eisai have both publicly stated that they believe Belviq will generate over $1B in annual sales in just the US. This won't happen overnight but when it does, it could lead to earnings over $2 a share. We could see Arena break-even or reach profitability on a quarterly basis by the end of 2014, earnings of $.50 or more in 2015, $1 in 2016, $2 in 2017, etc. A high-growth biotech with earnings growing at 100% year over year will receive a huge multiple and bring the market capitalization well in excess of $10B in my opinion. An example of a modest market acceptance and reaching Arena's target of at least $1B per year would lead the following results:
It is always important to remember the risks with any investment for a balanced viewpoint. The biggest risk for Arena was the risk of ever receiving approval for Belviq. With that off the table, the risks transition to one of execution. Can Eisai execute on their 3 focus areas of education, coverage and consumer awareness? Or will they spend $100M on these activities only to never see Belviq sales break $100M a year? Will a new severe adverse event pop up that didn't show itself in trials? You never know as a biotech investor. However, the risk reward at this marketcap for me, continues to be compelling. If the marketcap was already over $6B, I may feel less so until Belviq sales proves itself in the market and these additional novel drugs get through Phase II trials.
This week Arena has had a short-term breakout above the 200 day moving average with very strong volume indicating a possible shift in the direction of the stock. The shorter term moving averages will move up and cross the longer term 200-day average bringing in more technical traders at the same time we should see scripts increase. This is great to see but it pales in comparison to where I think this equity goes long-term. The prospects of Arena Pharmaceuticals to grow into the next major biotech are excellent. Today the market only values Arena on Belviq sales to date and not the future potential of this franchise, the overall market for medical weight management pharmacotherapy, the promising pipeline and the now proven platform for developing GPRC-focused drugs. As a long term investor, I focus less on the week to week progress of Belviq and more of the trend overall with an eye always towards the future. Having an investment horizon of 3-5 years with constant re-evaluation of the opportunity is important for long-term success and to not experience stress and frustration with the day to day stock movement. I continue to believe those with a multi-year investment horizon for Arena Pharmaceuticals will be richly rewarded.