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Yes it was a victory for Arena Pharmaceutical (NASDAQ:ARNA) when it managed to get its obesity drug, Belviq, approved by the FDA on June 27; the first drug of its kind to be approved in thirteen years. The drug was developed along with Esai, a Japanese pharmaceutical giant. Vivus (NASDAQ:VVUS), another pharmaceutical, was granted approval on July 17, for its weight reducing drug called Qsymia. Investors are excited while Wall Street is busy calculating their optimistic projections of the potential sales that the drugs are expected to generate. There is a lot of investor talk on the large market these drugs will target; statistics show that nearly one third of Americans are obese, 500 million are obese worldwide, and 1.5 billion are overweight. But obesity drugs of the past haven't been able to generate the sales that these staggering numbers on the rising weight problem might indicate.

Obesity drugs come with many side effects; some cause pharmaceutical companies to withdraw their applications, while some are detected after the approval, when many have already taken the pill. To even come close to being a blockbuster drug, these obesity drugs will have to improve on their efficacy: side effects ratio. Xenical is another drug from Roche, which was introduced in 1999, and reached its zenith in 2001 with sales of $600 million. And that was it; sales began to drop after that. The same medicine was introduced by GlaxoSmithKline (NYSE:GSK) as an over-the-counter drug and saw peak sales of $260 million, before dropping by more than 50% the following year. Empirical evidence does not suggest anything that will take these obesity drugs to the coveted $1+ billion mark.

In 2010, Vivus' drug was disapproved by the FDA over concerns of birth defects for pregnant women taking the drug. Meridia, from Abbott Laboratories (NYSE:ABT), was withdrawn from the market following clinical trials, which revealed elevated heart complications attached to the administration of the drug. The FDA has lately decided to give the new drugs a go, regardless of their lingering safety issues.

Arena Pharmaceutical

Arena's wonder child is Belviq (lorcaserin hydrochloride). The drug targets serotonin 2C receptor in a person's brain, and in the process, triggers feelings of fullness to reduce the intake of food. Interestingly, it targets the same area, which the now abandoned drug combo fen-phen targeted (but Belviq takes a different pathway than fen-phen). In clinical trials, which involved 8,000 people with weight problems (both over weight and obese), Belviq was found to reduce 3% to 3.7% of the body weight (along with exercises). The FDA does warn people who do not lose about 5% of the weight in 12 weeks to discontinue the drug. Furthermore, Arena will have to conduct six studies, one of which will focus on whether Belviq increases the risk of heart attacks and strokes.

The launch of the drug is expected in early 2013, but that is contingent on the DEA's final scheduling of the drug, which might take up till six months. This is because the FDA has deemed that there exists a potential for the drug's misuse. Furthermore, winning over the FDA is only part of the success. The European Medicine Agency (EMA) needs to be convinced of its safety as well. Investors must nonetheless look at what the EMA has to say about the drug; a negative outcome will deprive the drug of a large market in Europe.

Estimated sales figures for FY2016 is $532.667 million. Based on the industry average P/S multiple of 4x, and by discounting the sales figure by 20% given the riskiness, we estimate a price target of $8. Analysts estimate a price target of $10. The stock is currently trading at $8.36, yielding a one-year return of 500%. Given the information, we believe the stock is fairly valued in the market, and rate the stock as a hold. Two analysts have rated the stock a buy, whereas seven have rated it a hold and two have issued a sell rating.

Vivus Inc.

Vivus got an approval stamp from the FDA on July 17 and is believed to be more effective, but also more risky. Vivus is essentially a mixture of the stimulant phentermine and topiramate (the same active ingredient used in Johnson & Johnson's (NYSE:JNJ) Topamax, which had the side effects of birth defects and suicidal ideation, amongst others). The problem with Vivus is its ingredient phentermine, which carries high risks. Phentermine triggers catecholamines, which cause tachycardia (increased heart rate) and hiked blood pressure.

Secondly, the sale of the drug is limited to 10-mail order pharmacies, which will clearly dampen the sales potential. Based on the estimated sales for FY2016, which stand at $1+ billion (we discount the figure 30% surrounding the riskiness) and the industry average P/S multiple of 4x, we estimate a price target of $31. Since Vivus' drug will hit the market earlier, it will have an advantage, but due to the concerns cited above, we believe that sales will be limited.

Orexigen Therapeutics

Anything clear about Orexigen Therapeutics (NASDAQ:OREX) is difficult to estimate, and the possible approval of the drug is far away (2014). However, OREX's primary asset is Contrave, which is a fixed dose combination of bupropin and naltrexone. A potential catalyst for the stock is Light Study, the results of which are to be reported by mid-2013. Analysts estimate a price target of $12. The stock has yielded a one-year return of almost 167%. We recommend avoiding the stock at the moment, and wait for the Light Study outcome, which will shed light on the drug's future.

Conclusion

On a valuation basis, Vivus provides an upside potential, and therefore we rate the stock as a buy. Arena seems to be correctly valued at the moment, and recommend a hold rating on the stock. Both these stocks are risky, and their performances are subject to several limiting factors. Arena will have access to an experienced sales team from Esai, and might as well be a buyout target for a big pharma.

Source: Vivus Is Cheaper Than Arena