The Obesity Race: Update, Part 2

Jun.26.12 | About: Arena Pharmaceuticals, (ARNA)

Although rules of thumb about taking profits can be useful at times, ultimately the only logical thing to do with investment money is to keep it where you think it will most appreciate. Thus, whatever a stock has done in the past is irrelevant. Even if it has gone up from $2.00 to $10.00 per share in a few months, like Arena (NASDAQ:ARNA) did, the only issue that matters for an investor is what it will do from here. This article will discuss medium- and long-term values.

I) Medium-term value

It's obvious that being the first FDA-approved weight loss drug in 13 years will mean a very large number of obese and overweight people will want to try it. However, Mathew Herper reports that the historical pattern for obesity meds has been a decrease in sales after the first year's peak. His proposal is that after people try them they stop taking them, the prescriptions steadily drop, making these companies not very valuable.

This line of thinking reflects a brilliant analysis first generously shared with us retail investors in Seeking Alpha (yes, this mag hits some high points at times) in 2010 by Dr. John Tucker. Mr. Tucker's kind of thinking is one reason why Wall Street has predicted that Vivus Pharmaceutical's (NASDAQ:VVUS) med Qnexa will do much better than Arena Pharmaceutical's med Lorcaserin, and why VVUS has twice the market cap that ARNA does. There are basically two lines of evidence.

Poor continuation in the real world: First, in currently marketed anti-obesity meds, less than 10% of patients keep taking the drug for a year or more. This high discontinuation rate is the main reason obesity meds have done poorly overall, and have dropped in sales after their initial peak. After people try them they are disappointed and stop taking them. MDs start to prescribe them less and less because of this.

Thus, Tucker predicted an upper limit of 1.3 billion in world-wide sales for new anti-obesity meds, based on a high patient acquisition rate and a patient dropout rate typical of marketed anti-obesity drugs.

Dropout rates from clinical trials that also suggest poor customer demand: Second, if Lorcaserin were a great improvement over the previous meds, it would be shown by a lower drop-out rate in the clinical trials. These were people interested in losing weight. If they saw the drug as working and helping to achieve their goals, they would want to keep taking it.

The total drop-out rates for previous meds, Alli, Xenical, Meridia and Accomplia were in the 40-50 percent range. Lorcaserin is right there along with them at 43%. That does not make it seem like it is much of an improvement.

Dr. Tucker's analysis differentiates dropping out because of side effects versus dropping out due to all "other causes." Drop-outs due to other causes is the biggest factor, more numerous than drop-outs due to side-effects. His interpretation is that these drop-outs are due to disappointment with the efficacy of the product, because there was a correlation between efficacy of the drug and rates of drop-out due to other causes. Thus, Qnexa, with many more side effects than Lorcaserin, has higher side-effect drop outs. But Lorcaserin, with weaker efficacy, has more overall dropouts due to "other causes." Qnexa, with the best efficacy, has the lowest dropouts overall.

He then uses a regression analysis to predict that an obesity med would have to achieve 10% weight loss with few side effects to reach the kind of low drop-out rates needed for blockbuster status. Qnexa seems closer to that goal because efficacy trumps side effects.

Even though Dr. Tucker's is reasoning is quite logical, I think the model starts with some flawed assumptions. Tucker is essentially pessimistic about current obesity meds based on how disappointing the previous ones were. He says, "As incremental improvements over existing drugs, they are likely to achieve sales by taking market share from existing products and modestly increasing overall market penetration." He may be right, but what if the new ones are more than incremental improvements in the public's perception?

Improvement in continuation rates because of high-responders: One thing that Dr. Tucker did not take into account is that approximately 35% of Lorcaserin patients respond with excellent weight loss. These high-responders show losses over the 10% that Dr. Tucker's analysis predicts should lead them to stay on the drug. The standard of practice, with both Lorcaserin and Qnexa on the market, would be to start with Lorcaserin and see if the patient is a high-responder. If, instead of 10%, the continuation rate at one year was 30%, does that mean that Tucker's upper limit pushes to 4 billion per drug? Not Lipitor-like blockbuster sales, but much closer.

Improvement in continuation rates because of greater efficacy: Dr. Tucker used the placebo-adjusted rates from the clinical trials to predict to real-world efficacy. As has already been documented in Seeking Alpha and more or less accepted by Tucker in comments to his article, one cannot use placebo-adjusted phase III (laboratory) results to predict and compare real-world efficacy when the placebos are powerfully effective in some studies and not others, or where the placebo results may be correlated with the drug's results.

It's amazing how many headaches those placebo results have caused Lorcaserin. The only real question the advisory committee and the FDA have with the safety of Lorcaserin may be because of it as well. Expecting to find the general population's rate of heart valve problems in their placebo groups, Arena, with the FDA's approval, predicted that 8000 subjects would be enough to rule out valvulopathy risk from the drug to a high degree. Turns out, the placebo group had less heart valve problems than the general population. Could that be because they lost significant weight and that improves heart health? So, although there are no indications whatsoever that Lorcaserin causes heart valve problems, they will need another few thousand data points post-approval just to rule it out sufficiently.

Using placebo-adjusted results, Dr. Tucker pegged Lorcaserin as dropping 4% of body weight. However, the best estimate of real-world efficacy for Lorcaserin is 7-8%, giving it greater efficacy than any of the previous obesity meds. This is crucial because it puts Lorcaserin closer to the Tucker 10% prediction of blockbuster status. Thus, it deserves examination.

The question essentially is, "How much would I expect to lose, on average, if I start taking this drug, and finish a year on it?" In other words, "What would the average weight loss be if everyone starting Lorcaserin in the studies finished the year-long trials?" Those that went all the way through the Lorcaserin trials, the completers, lost 8.2% of body weight. But there was a high dropout rate of 43%.

It is reasonable to assume that a number of those that dropped out did so because they were not losing weight. Therefore, the completers were over-represented with those who were successful, and 8.2% is higher than the number would be if everyone finished.

We could use the 6% intent-to-treat result, which includes all drop-outs. However, common sense would tell you that not absolutely everyone who dropped out did it because of inadequate weight loss. Sometimes people move, or get sick for reasons other than the weight-loss drug, or just find that life throws them another, higher priority than the study they are in. Using the 6% number assumes that no one that dropped out for life reasons would have lost weight if they finished the trial. That is not reasonable either. Therefore, the truest estimate has to be somewhere between 6 and 8.2%.

For reasons outlined previously, the phase II study actually provides the best indication of real world results, and it suggests that somewhere in the upper range of 7% (like 7.5-8%) is the real number. Lorcaserin provides about 75% of the efficacy that Qnexa does.

Thus, Dr. Tucker is saying blockbuster status is achieved by 10% weight loss with few side effects, and Lorcaserin has 7-8% weight loss with few side effects. Like Qnexa, with the required weight loss but too many side effects, both come close in different ways to the requirements for blockbuster status but don't quite achieve it, suggesting very good sales and better continuation rates than previous obesity meds.

Improvement in continuation rates because of improvements in health outside of weight loss: Information that Dr. Tucker did not have available is how surprisingly good Lorcaserin's results were for glycemic control. These results were not shown by former obesity medications or by Qnexa. That would suggest that a number of customers may stay on the drug partly as prevention or control for type-II diabetes, even if that is an off-label use at this time.

Possible combos: Finally, specialty weight-loss doctors may decide to practice off-label to combine other meds, such as generic phentermine or bupropion, with Lorcaserin. This will come into play in the 65% who don't respond well to Lorcaserin alone. These off-label combinations might contribute a few more percentage points to the continuation rate and continuing sales.

II) Future possibilities, long-term value

I think Arena's management is very, very smart, and looking into the future. I think they will allow Lorcaserin's excellent-but-maybe-not-quite-blockbuster sales to stand alone for no more than a year or so. I don't know if there would have been a drop-off of sales after that, but it won't matter. We won't see it. They have many ways to radically increase ARNA's value, and I think they will have one on board by then.

Perhaps it will be a new FDA-indication for Lorcaserin, such as for preventing or treating type-II diabetes. They already have strong evidence from Bloom-DM that Lorcaserin does well for that, and the clinical trials don't have to take that long. This would handle the continuation rate problem and practically assure blockbuster status.

Perhaps it will be approval for sales in China, India, or other rest-of-world gems. China alone could more than double ARNA's value.

Perhaps it will be an FDA-indication for Lorcaserin combined with something else. Because Lorcaserin is safe and specific to the 2HC receptor, it is easily combinable with other drugs. What that combo will be I am not sure. It may be the next drug in their pipeline, which seems to target diabetes, or perhaps phentermine or buproprion.

Finally, if they are seeing terrific potential they may decide their best next thing is simply the next drug in their pipeline.

There are so many possibilities that are within reach of the company that it seems unlikely at least some of them won't materialize.

Qnexa should also do very well. VVUS supporters are banking on two things, results from the Tucker-kind-of-analysis showing that efficacy counts for customer demand more than side-effects (and Qnexa's side-effects are not horrible, anyway), and the mind-set of the average MD.

The 35% responding well to Lorcaserin know it within the first 30 days. So, although some MDs will have their own preferences or accede to patient requests, most will probably try the safest option first to see if the patient responds well. But what happens after that to the other 65% is the issue. Although there will be some weight-loss specialty clinics that will try combining Lorcaserin with phentermine, the average general practice MD might not want to mess with off-label uses when there is an FDA-approved drug that meets the need for greater efficacy, Qnexa. Assuming these drugs achieve broad acceptance, most prescriptions may be given by general practice MDs, and VVUS is thinking to capture most of the 65% that don't respond well to Lorcaserin.

Because of efficacy over 10%, it is also considered less certain that Qnexa sales will start to drop after the first year. One of VVUS's meds is already FDA-approved for erectile dysfunction, and it has drugs in the pipeline as well.

Orexigen (NASDAQ:OREX) still needs to do a long-term study for Contrave, at least so far, and that will delay them by a couple of years. Personally, although they have a good med, it is hard for me to predict what will be happening in two years, so it's hard for me to recommend it as an investment right now.

III) When to sell

In my previous article, I indicated that a floor value for ARNA right now is at least $15.25 per share, and it could possibly be much more. If I make all the estimates myself from scratch I get a higher number. I recommend those owning ARNA shares plan on holding them until after the first year of sales, then re-evaluate. At that point, the radical gains of a successful start-up biotech might be over, but the company will shift into more of an established pharma, and I suspect it will continue to be a good, if less speculative, investment. Along the way, watch for increases in value from current due to Europe, other parts of the world, other indications for Lorcaserin and other meds.

Disclosure: I am long ARNA.