Was Arena Taken Down Too Far?

| About: Arena Pharmaceuticals, (ARNA)
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Arena's (NASDAQ:ARNA) Q1 conference call was anything but a success. With the anti-obesity drug Belviq still waiting on the sidelines until final DEA scheduling, the expectations regarding the quarter were not very promising. In fact, savvy investors were expecting a ho-hum call that offered little in terms of the fundamental story. The biggest hope was that the company would offer clarity on the DEA process and any progress in Europe. Investors have been expecting positive news from both of these government entities for months now.

Instead, what we got was a bomb dropped on us. In lieu of some clarity on when we might anticipate positive news out of Europe, we got the exact opposite. Arena pulled its application for marketing authorization in Europe. No one was really expecting that news Thursday, and the after hours action took Arena down an incredible 17% to $6.91. This is a level that most were not expecting this equity to ever see again.

As an investor, I have seen plenty of times when the reaction to bad news gets overblown in the pricing of the equity. Essentially, people get scared and bow out in numbers that are not indicative of the norm. This could well be the case with Arena. That does not mean that investors should run to their computers first thing in the morning and hit the buy button. Instead, what a savvy trader will do is let this play out and then jump in as close to the bottom as possible.

How do you identify the bottom? If we had that answer, we would all be far wealthier than we are. One thing that I watch on events like this is volume. In fact, I use volume as one of my trading gauges in almost every investment I make. Specific to this situation with Arena I would watch for the volume to dry up on a downward move and then look for the equity to trade sideways or even tick up. This can happen intra-day. At that point, I would call it a buy signal. Investors that want to be more aggressive will make their play here. Those that are more conservative will wait longer to see a confirmation. Either way, there is potential for profits. The early mover is simply taking on a bit more risk for a bit more of a reward.

I see a big potential here with Arena because in my opinion a development on the positive side from the DEA could be delivered at any time. Once the DEA finalizes the scheduling of the anti-obesity drug Belviq, the company can launch sales in the United States. This opportunity can not and should not be underestimated. It is not often that the over-reaction to bad news is followed up in a short time period with a positive development. Savvy investors will be able to play this like a fiddle.

One additional and unfortunate aspect of Arena pulling its application in Europe is that there was little flavor given on why this happened: what questions the regulators in Europe had, what testing (if any) needs to be done, and what the time-line might be for applying again. This could set up longer-term speculation with the company once again. For buy-and-holders this will present frustration. For active traders it presents opportunity to play ranges.

I am still a firm believer that the most important aspect of Arena at this point is the sales results once Belviq is launched. It is the sales that will determine the current valuations as well as the potential of the company over the next year or so. Belviq can have a future ability for some new combination drugs, but that process is in its infancy. The more successful Belviq can be as a standalone, the more potential investors can assign to future combinations.

In summary, I believe the immediate reaction to the Europe news will be overplayed and followed by a possible spike on DEA scheduling news and a U.S. launch. That is my assessment of the short term. The mid term will be driven by sales figures once Belviq launches in the U.S. The success level of the mid term will be the key for determining the longer term potential. Stay tuned.

Disclosure: I am long ARNA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.