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By Jeffrey Shek

With all the over-the-counter drugs (OTC) for fat loss, it comes as a surprise (for those not in the industry) that it's been 13 long years since the last weight loss drug was approved by FDA (orlistat in 1999, marketed as Alli/Xenical by GlaxoSmithKline Plc (GSK)). America has a weight issue, and the statistics are scary. We have one of the highest obesity ratings in the world, and it isn't getting any better.

Most fat-loss pills don't work. The ones that work often have side-effects. Some of them might work for you, but fail to work for your friends. Doctors are generally unwilling to recommend an OTC pill for weight-loss, instead advocating a nutritional diet and exercise (which is probably the better option of the two). This leaves most of us jaded of the weight-loss industry as a set of fad diets and fake placebo pills.

Enter the recent FDA approval of lorcaserin, a weight loss pill manufactured by Arena Pharmaceuticals (ARNA). Belviq (lorcaserin) was FDA approved on June 27th and hit a 52W high shortly after. The New Drug Application (a process for all new drugs submitted to the FDA) was started in 2009, hit some hurdles in 2010 (where the FDA rejected the application on concerns of safety), and was resubmitted in 2012 with additional restrictions such as use only for certain BMIs (30+) or discretionary health issues. ARNA's stock began a notable uptick back in March, which became more pronounced in May (rising from a mid 2 dollar range to a price level of 6 dollars).

Vivus Inc. (VVUS), a competitor of Arena with a market cap of 2.84bn, is currently seeking FDA approval for Qnexa, a weight-loss pill combined with phentermine and topiramate. It's important to note that both phentermine and topiramate have been approved independently, yet VIVUS is combining the usage of the two in an extended-release capsule for a specific weight-loss treatment. In the past couple of days at Vivus, we've seen a lot of insider activity.

Many of Vivus' insiders have recently exercised their call options and have proceeded to sell the exercised shares. However, don't take this as negative news, as FDA approvals are never a "sure-thing". Instead, insiders are probably looking to lock-in the rise in Vivus' stock price (it's surged 287% since January). Mark your calendars as the FDA's decision to approve or reject Qnexa comes out on July 17th.

One of our observations has been that hedge funds were more open to purchasing VVUS over ARNA during the first quarter in 2012 (see the list of hedge funds here).

Here are some of likely reasons:

1) The FDA decision on Qnexa was supposed to be April 17th; they later pushed the decision to July 17th. Funds such as QVT Financial had probably loaded up on some of these positions expecting the decision in April. In contrast, FDA's decision on Arena's Belviq was expected to be on June 27th.

2) Qnexa was a combination and smaller dosages of two already independently approved drugs (phentermine and topiramate), in contrast to Arena's Belviq (lorcaserin) which was completely new. New drugs can be harder to approve as the potential side effects are less known.

3) FDA's Advisory Committee had given support to Qnexa on February 22nd (Note: This is not a binding decision, only an advisory recommendation to the FDA). FDA's advisory committee on Arena's Belviq did not vote to recommend until May 10th.

Arena's Belviq did get the FDA approval first, has the head-start on market share, and has a strong distributor and marketing relationship with Eisai. Yet, this isn't as significant (as it may appear) if Vivus receives FDA approval.

The weight loss market is largely an untapped growing market. Doctors are not used to prescribing weight-loss pills, nor are patients aware of Belviq and Qnexa. Even if Belviq does have a head-start, assuming Qnexa receives FDA approval, these two blockbuster drugs could very well drive the bottom line for years as doctors and patients become familiar with Belviq and Qnexa. It's a huge untapped industry that can support multiple players. While Vivus is still risky, there's a lot of investor sentiment that Qnexa will obtain FDA approval (some of this is already priced in its current stock price). If Vivus doesn't get the FDA approval, expect Vivus to tank and Arena to surge.

Orexigen Therapeutics Inc. (OREX) is another pharmaceutical to keep interested in the next couple of months. While approval for Orexigen's Contrave, another weight loss drug, has about another year before a final FDA decision to approve or reject based upon the Light Study (Contrave was rejected back in 2011, this study aims to refute some of FDA's concerns), expect to see investor sentiment trying to make some plays leading up to the decision. A review of our hedge fund holdings show that there were only a few funds purchasing Orexigen during Q1 2012. This will probably change over the next couple of months. Observations of Arena and Vivus's respective stocks showed a surge in investor interest and stock price a few months before the FDA Decision was announced.

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

Source: Why Hedge Funds Prefer Vivus Over Arena