Building wealth through investing in stocks is a difficult undertaking for most casual retail investors. When times are good you can throw a dart at a list of stocks and probably do OK. Short-selling, naked short-selling, high-frequency-trading and the advent of hedge funds have made it very difficult for the retail investor to make money and as a result, it has forced many out of the market. The recent leak of internal emails from Goldman Sachs underscores how the retail investor is at a disadvantage in today's market. Once again, this has become a stock-picker's market. For me, the best way to make money is to pick stocks that are out-of-favor, undervalued and the underdog to beat the odds. Since 2009, one of those underdog stories has been Arena Pharmaceuticals (NASDAQ:ARNA). In this article I'll discuss why Arena may no longer be a speculative stock and instead a biotech growth opportunity worthy of consideration.
This has been a long road for Arena investors who have believed that their lead drug Lorcaserin could be the first safe and tolerable weight loss drug ever approved. In 2010, Arena investors were blindsided by unanticipated FDA concerns over the lack of a safety margin for cancer, which ultimately led an Advisory Committee to recommend additional studies. Arena resubmitted their New Drug Application (NDA) in late 2011 and at a recent Advisory Committee meeting, members voted 18-4 for approval. Investors now wait for the final decision date of June 27th to see if the FDA will follow the panel recommendation and approve the first new weight loss drug in 13 years. If approved, Arena may have competition if the FDA follows a few weeks later by approving Vivus' (NASDAQ:VVUS) Qnexa after they received a 20-2 vote for approval, with a subsequent 3-month delay for a decision. Investors who have followed this obesity-race can attest that Wall Street has primarily been behind Qnexa and its better weight loss efficacy to be the better selling drug. Why would anybody prescribe Lorcaserin when you could prescribe Qnexa and have much better weight loss?
Keep in mind, none of these drugs have been approved yet, but with their overwhelmingly positive panels behind them, the odds favor approval for both. So if we assume approval (dangerous I know,) who will win in the market and become the first line treatment for the biggest unmet need in pharmacology? It is the drug that physicians reach for first that will be the biggest blockbuster.
"Primum non encore" - first do no harm. It is the responsibility and in fact the oath for physicians to be conservative in their approach to wellness for their patients. When treating obesity, physicians first discuss diet and exercise as the preferred path to lose weight. Unfortunately, diet and exercise is easier said than done - especially when the "low fat" diet hasn't worked and modern nutritionists now understand that it is foods high in carbohydrates and glucose that result in weight gain. This is the root-cause of why we have almost 80M pre-diabetics and an estimated 25M Type II diabetics in this country struggling to keep the weight off and why doctors and patients are desperate for new tools to try. That is a prime target market of 100M Americans who may be interested in trying a new drug that is safe, tolerable and provides a good opportunity to lose 5-10% of their weight. With this in mind, let's look at both Qnexa and Lorcaserin to see which drug profile will likely be the first choice for most physicians.
Vivus' Qnexa is up for approval on July 17th after a 3-month extension from the FDA following a positive 20-2 vote for approval. I believe this delay is a direct result of a very difficult label and REMS program for the FDA to agree upon. As anyone who has followed this space knows, Qnexa is a combination of two generics - phentermine and topiramate. Phentermine is a 50-year old generic for weight loss and is the most-widely prescribed drug for this indication still today. Vivus' combines phentermine with topiramate, a generic primarily used to treat seizures and migraines. Qnexa does result in better mean weight loss than Lorcaserin with an average mean weight loss after one year of 8.4% (pooled Phase III results.) It also improves most co-morbidity factors including reducing HbA1c by .4, reduces cholesterol and blood pressure. However, this isn't an efficacy only decision and that average weight loss will be weighed against the risks documented in the trials and the label if it is approved. These risks included increased heart rate, approximately a 500% increased risk of cleft palates in newborns, tingling in the hands and feet, constipation and dizziness. Analysts expect a restrictive REMS program to accompany approval which will likely include limiting exposure to women of child-bearing age, a cardiovascular outcomes trial and distribution only through approved mail order pharmacies. Given the expected label and documented risks, I believe Qnexa will not be a first line treatment but rather a second or third line treatment. Physicians can already prescribe these two drugs in combination, but very few have because of the risks.
Arena's Lorcaserin results in less weight-loss than Qnexa with 5.3% average mean weight loss after one-year, but with a better safety and tolerability profile. However, in the real-world, we need to look at responders to determine real-world efficacy for any anti-obesity medication. Responders for Lorcaserin present themselves within the first 12 weeks, usually losing 3-4% of their weight. As a result, if it is approved I expect the approved label will recommend discontinuing use if you don't hit those thresholds. For the responders who stay on the drug for one year, the average weight loss is an impressive 11%, or 25lbs on average, and the top quartile lose 35 lbs. Unlike Qnexa, Lorcaserin is a novel agent that has the potential to be combined with other drugs, such as phentermine (think LorPhen) or even Qnexa. Most importantly, Lorcaserin accomplishes this while improving every single co-morbidity factor including heart rate, blood pressure, cholesterol, fasting glucose and reduces HbA1c by .9 (twice as much as Qnexa.) It is clear from the FDA's briefing documents that there is no increased risk of cardiovascular valvulopathy, cancer or any severe adverse event. The only adverse event significantly more than placebo is a mild and transient headache. There is no doubt when guided by the mantra "primum non encore," that the responsible choice is to start with Lorcaserin first. It doesn't work for everyone but it will for at least a third of patents, which is tens of millions of people just in the United States.
While at the Arena Advisory Committee a few weeks ago, I spoke with representatives from the National Institute of Drug Abuse (NIDA,) who were there to follow the meeting because they were excited about "lorcaserin's potential to treat drug addition," which nicotine falls under. I have written about the potential for Lorcaserin to be used as an effective tool for smoking cessation in the past so it was interesting to see NIDA at the panel. According to the CDC, there are over 45M smokers in the United States and following the overall US incident-rate of 66% as being overweight, that would indicate over 31M of those who smoke, also need to lose weight. Smoking cessation provides an excellent off-label opportunity for Lorcaserin along with future label-expansion.
Arena could receive approval for Lorcaserin by June 27th if there is no delay from the FDA. Despite the Advisory Committee recommendations, I do not expect echocardiograms will be required for new patients but I do believe there will be post-marketing requirements to track MACE events to power new assays in order to tighten up the risks for valvulopahy. There should not be a REMS program to accompany approval. Lorcaserin will likely be classified as a Class IV drug and as a result, be monitored by the DEA which will delay launch until late 2012. Arena's marketing partner, Eisai, recently commented in their last earnings call that they are ready to launch Lorcaserin before the end of the year and they are in final label negotiations with the FDA. Eisai will first target specialists including endocrinologists and then expand to primary care physicians through a contract sales force. I believe we will see over 1M patients on Lorcaserin before the end of 2013 assuming no restrictive REMS program.
Arena's Swiss manufacturing facility should be ready to start producing pills in July and can make up to 1B pills a year before capacity expansion -enough to satisfy around 1.4M patients. Pricing hasn't been officially released from Eisai, but it is believed to run between $2.50-$3 per pill or $1,825 - $2,190 per patient year. Until we have the final label in hand and a quarter of sales to review, you cannot estimate cost of goods sold and expected net income so it is difficult to truly estimate the value for Arena. However, finding 1.4M patients to take Lorcaserin is not going to be an issue in my opinion; it will be keeping up with demand that will be a problem. As a first-in-class obesity drug, Lorcaserin has the potential to have a hockey stick growth curve and become one of the best selling drugs in the last several decades.
With FDA approval in hand, Arena is going to become a prime acquisition target. There is a stand still contract in place with Eisai to prevent them from acquiring Arena but don't discount the two working on a deal that is acceptable to the Arena board. Furthermore, I wouldn't be surprised if a blockbuster-hungry Big Pharma makes a move to acquire Arena and the rest of the world rights to Lorcaserin that goes with it. Sometime in Q3 or Q4, Arena could sign a partnership for Europe where it is looking for marketing authorization before the end of the year. I believe Arena's acquisition value with FDA approval in-hand is $5B and with both US and EU approvals it could be at least $8B. With 100M pre and existing Type II diabetics, 31M overweight smokers and an inevitable LorPhen craze, even a 1% market penetration makes Lorcaserin a blockbuster and taps out existing production capacity. A 5% market penetration makes Lorcaserin compete for the best-selling drug of all-time, which has been my prediction for the last 3 years. That is the potential for a first line treatment for obesity. I believe Arena at $6 with a positive panel behind them, provides just as good of a risk to reward profile as it did when I recommended it at $1.25 last year before they resubmitted their new drug application.
Arena should still be considered a slightly speculative stock until they have final FDA approval in hand but with the positive panel and a shift in FDA sentiment towards this class of drugs, it appears likely they will. Once it is approved, then Arena no longer speculative but rather a long-term growth story.