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by James Allen

In a turnaround from a rejection in 2010, Arena Pharmaceuticals (ARNA) received FDA approval on its latest version of the obesity pill, Lorcaserin. This is the first time a drug for obese and overweight people has been approved by the FDA in over 13 years. News of the approval sent Arena's stock to a new 52-week high, increasing its price on the market by around 30 percent. A number of shareholders made out on this major uptick, as FDA approval is promising news for Arena Pharmaceuticals looking forward. There is still plenty of time for speculation until the commercial launch of the new drug Lorcaserin, marketed as Belviq, towards the end of 2012. Therefore, shareholders and interested investors should be wary looking forward and follow breaking developments for the remainder of the year. Below, I will explain how headwinds with the launch or efficacy in the consumer market could send Arena's stock price and balance sheet into a downward tailspin or create dips for ideal entry points into this investment.

Arena's stock price has increased substantially since 2011. Year-to-date, Arena's sales growth has decreased by over 44 percent since 2011. However, since the last quarter, Arena's sales growth has increased by almost 5.5 percent, while its beta is close to zero. Its current price to book ratio and price to sales ratio are very high at over 45 and over 200, respectively. Arena's returns on equity, operating margin and net margin are currently measured at a significant loss and have been worsening substantially over each of the past three quarters. Its current ratio has increased substantially in 2012 and is currently above 7.5. Arena's debt to equity ratio has also decreased since being over 8 at the end of 2011; it is currently below 2 as of the end of the first quarter of 2012.

Arena's growth rate for this year has been four times the industry average. Its growth rate is projected to be nearly three times the industry average next year. Its price to book ratio for the most recent quarter is much higher than the industry average, more than 10 times as such. Its net profit margin and return on equity for the trailing 12 months are more than 8 times and 4 times below the industry averages, respectively. Arena is currently priced at a premium with extremely poor margins. Its beta suggest minimal growth in the past but the uptick in sales growth and projected growth rate this year and next year suggest there is change on the horizon. The real question at hand is figuring out if recent developments are strong enough to turn around seemingly abysmal margins at high premium values.

The potential opportunity for an effective obesity drug is monumental. According to the CDC, around one third of the American populace is obese; this is about 80 million people and growing rapidly. Estimates suggest by 2030 over 40 percent of the American populace will be obese. This is instantly a $1 billion revenue generating drug at less than one percent market penetration. Sales could generate $2 billion by 2020 under moderate pricing. Reducing body weight by 5 to 10 percent can help minimize the risk of cardiovascular aliments, diabetes and other serious health problems as well. Arena has succeeded where other large pharmaceuticals had failed thus far. Abbott (ABT) attempted an obesity pill called Mendia in 2010 that was denied due to safety issues. Abbot expected to generate around $30 million in the first year that Mendia would have been launched. Reuters believes Arena could double those projected numbers in the first year of Belviq's launch, and many analysts believe that the revenue ceiling is 10 fold that number for annual sales if all goes well in the next few years. Sanofi (SNY) also attempted an obesity pill called Acompia in 2008 but pulled its request for FDA approval due to concerns about the drug causing depression. This market is increasingly competitive, and there are a number of headwinds ahead of Arena that must be overcome before Belviq can be considered a success.

The FDA recommended the DEA review and classify Belviq as a scheduled drug. The DEA has around 6 months to review and make a decision on its final designation. Aside from this, Arena still has to deal with competitors in the industry. FDA approval helped raise the stock price of direct competitors like Vivus (VVUS) and Orexigen (OREX) by around seven percent and 20 percent, respectively. Vivus has an obesity drug called Qnexa that is expecting FDA approval around mid-July. According to reports, this drug has more safety concerns but is also at least twice as effective as Arena's Belviq. In clinical trials, Belviq helped reduce body weight by 3 to 3.7 percent while Qnexa reduced body weight by 6.7 to 8.9 percent. Orexigen has a weight-loss drug called Contrave that could be hitting the market in 2014. As more of these drugs gain approval by the FDA, the market will become more competitive as larger pharmaceuticals try to enter and gain market share in this lucrative market.

Aside from increasing competition and gaining further regulatory approval, Belviq still has to be successful amongst consumers and physicians. As of now, the FDA will require Belviq to have labels that prohibit supplementing or combining Belviq with other weight loss drugs. The label will also tell consumers to stop using the drug if five percent weight loss has not been achieved after 12 weeks. Getting the label changed in order to pair Belviq with generic drugs like phentermine will be extremely beneficial for Arena making an impact with its commercial launch. The drug could cost up to $4 or $5 per day, so adequate insurance coverage will most likely be required for most consumers as well. Acceptance among the medical community and maintaining efficacy amongst the increasing number of competitors in the industry is going to be integral to the long term success of this new obesity drug. In light of the amount of time and headwinds ahead, there are many opportunities for shareholders and interested investors to absorb a loss on Arena's stock between now and a successful commercial launch of Belviq.

Source: Arena: What Analysts Are Missing