Don't Get Suckered In By Friday's Strong Rally In Arena Pharmaceuticals

Apr.30.12 | About: Arena Pharmaceuticals, (ARNA)

Arena Pharmaceuticals (NASDAQ:ARNA) shares surged strongly on Friday, up 34% intra-day to $2.89 from Thursday closing price of $2.15, settling at the end of the day at $2.62 for a gain of 22%. The company is a biotech developer of oral drugs for cardiovascular, central nervous system, inflammatory, and metabolic diseases. In investing circles, ARNA is most well known for its lead drug under development, lorcaserin for obesity, in what has a become a three-way horse race with peers Vivus Inc. (NASDAQ:VVUS) and Orexigen Therapeutics (NASDAQ:OREX) that also have obesity drugs under late-stage development.

There was no fundamental news story that can we can attribute this surge to, which is troubling given that the stock has had similar surges in the recent past, and it gave back most of the gains in those cases. It is most likely then that Friday's move was most likely purely 'technical', and possibly short-term. We tried to figure out the trigger that would have caused the massive surge in ARNA shares on Friday, and the only link that we could come up with was the then upcoming FDA approval on Friday, after the close of market, of rival VVUS's Avanafil for the treatment of erectile dysfunction.

Of course, there is no relationship between the fate of lorcaserin and Avanafil, but it is conceivable that traders were positioning themselves ahead of that news hoping that a strong up-move in VVUS on Monday following the approval of Avanafil would lead to a sympathy move in ARNA. Another possible reason could be short covering. ARNA has over 42 million shares short, out of 173 million shares outstanding, and a short squeeze triggered by a technical breakout from the short-term base at the bottom could have led to a short squeeze. The volume, however, was heavy, coming in at over 33 million shares, about three times the average daily volume.

ARNA also continues to be at the center of a drama between TheStreet's Adam Feuerstein and ARNA bulls and long-term shareholders. Mr. Feuerstein has expressed his tough stance and belief that lorcaserin is no better than a placebo, and that the company has failed to disprove a link between lorcaserin-fueled rat tumors and the potential for breast cancer in humans.

Furthermore, there continue to be concerns about the risk of heart valve damage. The FDA has already rejected lorcaserin once, and in light of these concerns, it is difficult to be bullish on this story. Furthermore, in its race with peers VVUS and OREX, VVUS may already have jumped ahead of the pack with its favorable 20-2 FDA Advisory panel vote in February.

Either way, given the lack of fundamental news, and lingering concerns about the efficacy and safety of lorcaserin, we think it would be prudent to avoid getting suckered in by the surge. While short-term traders may benefit from hopping on the train, as the momentum of the surge is strong and could easily last into the early part of next week, only the most nimble stand a chance of benefiting from it. The stock has given back its gain from past surges, and in the absence of fundamental news, it is difficult to be optimistic that this time would be different.

Comparing ARNA to its peers VVUS and OREX, we see that institutional investors are more bullish on VVUS and OREX. For example, in the last quarter for which institutional data is available, namely the December 2011 quarter, funds added 5.6 million shares of VVUS while at the same time shedding 3.6 million shares during the quarter. In the case of OREX, funds added 13.5 million shares while shedding just 1.7 million shares.

In comparison, then, funds massively bolted out of ARNA, shedding 7.0 million shares during the quarter while adding only 4.1 million shares. Furthermore, looking back even further, institutional investors have continued exiting out of ARNA for the last three quarters in a row.

Credit: Fundamental data in this article were based on SEC filings, Zacks Investment Research, Thomson Reuters and The information and data is believed to be accurate, but no guarantees or representations are made.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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