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Edited by Kate Boehme

Arena Pharmaceuticals (NASDAQ:ARNA) shares have taken a hit recently as investors show concern over the rising competition posed by Vivus (NASDAQ:VVUS). In response, Arena has announced an expanded marketing and supply agreement with Eisai. In my previous article, I presented a very simple and straight-forward revenue model for Vivus Inc. Here, a similar effort will be made to analyze the market share and revenue potential of Arena within the domestic market.

The assumptions posed by this model are very straightforward and easy to understand. I have made an effort to refrain from complex methodologies and assumptions. As there is no information available on Arena's pricing strategy, the assumptions concerning revenue are based on the market share and ignore the cost component.

The U.S. obesity market is currently valued at $1.2 billion. In 2011, drug companies achieved revenues of $222 million, and the market is expected to grow at 20 percent annually. Arena has given the domestic marketing rights to Eisai Inc. Arena will therefore get 31.5 percent of the net sales from Eisai as well as an additional 36.5 percent of any sales above $750 million. This deal makes Eisai the primary operator in the domestic obesity market. Therefore, in order to accurately assess Arena's revenues, we need to calculate the market share and sales estimates for Eisai and then filter out the numbers.

This particular model represents a scenario analysis; three scenarios are considered, each with their own probability. The first scenario is the best-case scenario. In the best case, Eisai Inc performs ahead of the competition and, at its peak, captures a market share of 80 percent. As the name suggests, moderate-case scenario gives Eisai Inc a moderate market share, wherein its market share is nearly equal to that of its key competitor. Lastly, the third scenario puts Eisai and Belviq in the worst position in terms of market share and revenues.

Dropout rate for both of my models is quite high at 50 percent. The reason behind keeping the dropout rate high and constant for both companies is that they both face certain challenges. Vivus carries a perhaps less-than-ideal label, which could potentially pose certain side effects for pregnant women. On the other hand, Arena has issues with the efficacy of their drug. It can thus be assumed that this high dropout rates assigned to both companies creates a level playing field.

Arena Revenue Model

      
  

2012

2013

2014

2015

2016

Best Case

Probability: 0.40

      

Obesity Market

$ in billions

1.20

1.44

1.73

2.07

2.49

Market Share for Eisai

in percents

0.40

0.50

0.65

0.75

0.80

Market Share Revenues for Eisai

 

0.48

0.72

1.12

1.56

1.99

Drop Out Rate

 

0.50

0.50

0.50

0.50

0.50

Market Share Revenues For Eisai Adjusted For Dropouts

 

0.24

0.36

0.56

0.78

1.00

Market Share revenues for Arena @ 31.5%

 

0.08

0.11

0.18

0.24

0.31

Adjustment for Revenues above $750 million

     

0.36

Total Revenue Best Case

$ in billions

0.08

0.11

0.18

0.24

0.68

Moderate Case

      

Probability: 0.30

      

Obesity Market

$ in billions

1.20

1.44

1.73

2.07

2.49

Market Share for Eisai

in percents

0.20

0.25

0.35

0.40

0.45

Market Share Revenues for Eisai

 

0.24

0.36

0.60

0.83

1.12

Drop Out Rate

 

0.50

0.50

0.50

0.50

0.50

Market Share Revenues For Eisai Adjusted For Dropouts

 

0.12

0.18

0.30

0.41

0.56

Market Share revenues for Arena @ 31.5%

 

0.04

0.06

0.10

0.13

0.18

Adjustment for Revenues above $750 million

     

0.20

Total Revenue Moderate Case

$ in billions

0.04

0.06

0.10

0.13

0.38

Worst Case

Probability: 0.30

      

Obesity Market

$ in billions

1.20

1.44

1.73

2.07

2.49

Market Share for Eisai

in percents

0.10

0.15

0.18

0.21

0.25

Market Share Revenues for Eisai

 

0.12

0.22

0.31

0.44

0.62

Drop Out Rate

 

0.50

0.50

0.50

0.50

0.50

Market Share Revenues For Eisai Adjusted For Dropouts

 

0.06

0.11

0.16

0.22

0.31

Market Share revenues for Arena @ 31.5%

 

0.02

0.03

0.05

0.07

0.10

Adjustment for Revenues above $750 million

     

0.11

Total Revenue Worst Case

$ in billions

0.02

0.03

0.05

0.07

0.21

Total Expected Revenue

$ in billions

0.05

0.07

0.11

0.16

0.45

It must be mentioned that this model only represents the revenue figures for the domestic market. Arena still has the marketing rights for Europe and other territories, and their revenues will surely increase once the company secures approval for these territories. Eisai may also try to market the drug to patients with diabetes as Belviq showed Hba1c reduction of 0.9 percent, promising results during upcoming clinical trials. However, these points are moot with relation to this particular model as, for simplicity's sake, it takes into account only the domestic obesity market.

It is clear from the model that Arena will be able to garner revenues of around $450 million at its peak. Manufacturing costs will comprise 20 percent of net sales. However, results would be better if Arena had exclusive rights for the domestic market. While profits may have been higher if this had been the case, understandably Arena chose a less risky route for the marketing of their first approved drug by partnering with an experienced player. In this manner, Arena was able to shift most of the risks to Eisai Inc.

Arena vs. Vivus

When comparing these two companies directly, it is clear that both parties carry their own unique advantages. While Vivus has a more effective product, Arena has a product with a safer profile. One thing particularly in favor of Vivus is that it has an established pipeline and is not reliant on a single drug for revenue.

In the future, it can be expected that both companies will emerge ahead, as the obesity market is desperate for an effective drug. Though both of these stocks may show some volatility in the short-term, the long run prospects are optimistic. However, it is important to also consider that there always remains the possibility of a takeover; both companies have drugs that could prove to be a vital component of any big player's portfolio.

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

Source: My Conservative Revenue Model For Arena