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Last month, Arena Pharmaceuticals (ARNA) made a major breakthrough in the form of an FDA approval of its weight loss drug, Belviq. Until recently, most medical research considered weight loss drugs to be unnecessary products, which were "not worth the health risk they posed for users". The increase in obesity-related diseases, such as heart conditions, diabetes and kidney problems, has changed this opinion. Belviq has the potential to tap this potentially billion dollar market. The drug will be available in markets by early 2013, depending on the speed of the DEA ruling.

Arena's stock is currently trading at $7.21, with a market capitalization of $1.32 billion. Since the approval of Belviq, the stock has fallen from a yearly high of $11. 39 to $7.21, meaning a fall of 37%. However, the share price has increased almost 5 times in last 52 weeks. One of the primary reasons behind this decline has been the approval of Qsymia, another weight loss drug, being offered by Vivus (VVUS). Qsymia's weight loss results have been better than Belviq, but it also carries a greater health risk. People using Belviq reported a weight loss of 3%-3.7%, whereas users of Qsymia reported a weight loss of 5%. Also, a comparatively more detailed FDA guidance accompanies Qsymia. Belviq has also been added to the list of controlled substances due to its potentially addictive nature. Both Arena and Vivus can face competition from Orexigen's (OREX) Contrave in the future.

2Q2012

Analysts are expecting EPS of $-0.08, with a low of $-0.13 and a high of $0.1, for the second quarter of 2012. The estimates have moved up from a loss of $-0.12, showing a change of $0.04; however, there has been no change in estimates for the last one month. The company has a history of missing analyst expectations in the past. In each of the last six quarters, ARNA has missed analyst expectations. In 1Q2012, analysts were expecting EPS of $-0.13, but the actual results were 38% lower i.e. $-0.18. However, there was no significant change in share prices as a result of this miss. As can be seen in the chart below, the bigger misses were in the last quarter and 1Q2011. The smallest miss was in 2Q2011, when estimates were missed by 6%.

Estimates vs. Actual EPS

The company is expected to show strong growth in the next five years. Analysts are expecting a much stronger growth of 25%, as compared to the industry growth of 13%. Belviq remains the key product for Arena, and all the news related to the drug will be the key catalyst for the company. The drug is expected to generate approximately $1.5 in revenues for Arena. Similarly risks associated with the launch of Belviq remain the key areas of concern for ARNA. These risks include a delay in the market launch of the drug, and adverse findings in the future research. Currently, ARNA has a large R&D expense, whichis 450% of its sales.

Valuations

The target price for ARNA can be calculated using the NPV method. JPMorgan (JPM) estimates a target price of $9 (December 2012) using the NPV methodology. The target price for ARNA has been reduced by JPM from early July estimates of $11. The difference in this estimate is due to the approval of Qsymia. Belviq's Sales targets have been revised, as Qsymia is expected to take a portion of the total weight loss drug market. Using the industry average P/E multiple, share prices can be forecasted for 2015. We are applying a discount of 30% to the forecasted earnings in order to adjust for the uncertainty attached with the success of Belviq.

Average P/E of Industry

30x

Price after a 30% discount

2017 EPS

$1.6

Target Price 2017

$48

33

2016 EPS

$0.9

Target Price 2016

$26

18

2015 EPS

$0.4

Target Price 2015

$13

9

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

Source: Arena Set To Show Strong Growth