Why The Newest Short Thesis On Arena Is Dead Wrong And Should Be Ignored

| About: Arena Pharmaceuticals, (ARNA)
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Arena Pharmaceuticals (NASDAQ:ARNA) has finally launched its long awaited novel weight loss drug, Belviq, with the help of pharmaceutical company Eisai, and the excitement about the immense potential for Arena shareholders and tension between ARNA bulls and bears has never been higher. In the past few days, Arena and Eisai have promoted Belviq on CBS, Bloomberg, and on Tuesday night made their biggest appearance yet by promoting ARNA and Belviq on CNBC's "Fast Money." The thick skepticism amongst the analysts on the show's panel was palpable. Even Melissa Lee, a well respected and allegedly indifferent third party reporter, framed every question to Arena CEO Jack Lief and Eisai America's CEO Lonnel Coats as a comparison to competitor Vivus's (NASDAQ:VVUS) weight loss drug, Qsymia, and challenged both CEO's to differentiate Belviq from the much maligned Qsymia and the less-than-stellar sales results for Qsymia thus far.

But skepticism like that found during the Fast Money interview Tuesday night, ironically, represents quite a change in sentiment from the unabashed mudslinging many ARNA longs have accused the bears of hurling at Arena and Belviq for years. While many of the short theses of the past actually had some merit, Arena has successfully refuted or alleviated the concerns on most of these claims.

Past failed short theses included:

  • Belviq would never gain FDA approval
  • The FDA would prohibit Belviq to be prescribed with Phentermine
  • Because the DEA was taking so long to classify Belviq, it likely would put harsh restrictions on the sale of Belviq
  • Institutions would never risk buying into ARNA in any large number and ARNA would remain a "retail stock" into the foreseeable future
  • The reason ARNA pulled the EU application to CHMP was because of a danger the U.S. FDA did not consider fully enough and ARNA was keeping this reason secret until forced to disclose
  • Other short theses that are looking more and more improbable include:
  • Because Qsymia flopped, the market overestimated the demand for prescription weight loss drugs
  • Doctors will not prescribe Belviq to patients taking SSRI antidepressants because of the possibility that patients would develop serotonin syndrome.
  • 30-40% insurance coverage will doom Belviq sales because most people will not fill a Belviq prescription unless fully covered by insurance

While many of those theses had some merit at the time they were being given and the fact that some of the sales theses could theoretically prove at least somewhat accurate, a new short thesis has developed that is not only contrary to common sense, but, sadly, appears to be nothing more than a tactic being used to distract unwitting longs and potential investors from the reality of ARNA's probable price trajectory in the near to midterm.

This new short thesis goes something like this:

"While initial script and sales numbers might be good or even great, ARNA shares will come crashing down once refill rates plummet due to lack of efficacy."

There are many reasons why this cleverly deceiving theory is flawed and I will attempt to explain why below.

First, those touting this theory know perfectly well that the basic premise supporting it is flawed from the start. This type of argument is what is known as a "red herring" fallacy where the speaker attempts to distract the listener from what is truly important to them. Here, the speaker is hoping to bring the focus to an event with an undefined time frame, purposely remaining vague and general in the prediction while leaving out any defined parameters for when or why this will actually affect ARNA's share price.

I believe this argument is flawed because uninformed or reactionary shareholders or potential ARNA investors will come away with the impression that they need to either sell their ARNA shares or stay away from the stock in the future. The reason the speaker does not specify a time frame for this proposed event is that, even in the worst case scenario under this theory, the stock price will surge higher based on already conceded "good to great sales" and by the time refill rates would fall enough to slow Belviq's sales growth to be noticeable to the market, ARNA will have already risen to a price commensurate with such sales figures.

Why am I so sure about this?

1) Doctors are prescribing Belviq to help seriously obese patients lose weight for health reasons and to ultimately save their lives. Doctors do not undertake programs such as "Belviq, healthy diet, and exercise" only to throw their hands up in the air a month later and declaring that the drug does not work and that the patient is doomed. If a patient is struggling to losing weight on Belviq, their doctor will try to find other reasons for the lack of weight loss first before deciding that the patient truly is a non-responder.

2) Belviq is specifically to be taken "along with diet and exercise." No doctor is going to prescribe Belviq, tell the patient to continue eating unhealthy foods without exercising, and just expect Belviq to perform magic. That is the business of the fad diet industry. Belviq is a prescription medication being prescribed and monitored by licensed physicians well versed in human biology. If a doctor is not convinced that a patient is going to give a good faith effort on a lifestyle change including a healthier diet and increased exercise, he or she will not prescribe Belviq to the patient in almost all situations.

This is meaningful for ARNA shareholders because for many obese patients, any kind of concerted effort at a diet and exercise change will bring about weight loss regardless of whether Belviq is actually helping the patient at all. An obese, 6-foot tall man weighing 350 pounds burns nearly 3,000 calories, at least 1/3 more calories than the recommended average calories for an average sized male. That same 350-pound male burns almost 500 calories doing low impact aerobics for only 30 minutes.

While the preceding information is very valuable to discerning the near term potential for Belviq sales, it becomes a slam-dunk when considering the fact that doctors almost always recommend that patients lose weight slowly, at a pace of no more than 1 to 2 pounds per week. According to the Mayo Clinic, slower weight loss encourages long-term weight management success as well as provides better health benefits to the dieter. The vast majority of doctors will not jump to the conclusion that the patient is a non responder if the patient is not losing weight. But I foresee absolutely no doctors declaring patients non responders because they are losing weight at a slower pace than fad diets advertise. Belviq's efficacy rate did not include patients that were "placebo adjusted." In the real world, placebo results are 100% as good as responder results and not one individual, not even the doctor, will be able to tell the difference.

When you combine the recommended gradual and slow rate of weight loss, patients responding because of placebo effect, the mandated changes in diet and exercise, and the incredible amount of calories morbidly obese patients have to consume and not burn, it is likely the "responder rates" will be substantially higher than determined by the FDA and there will be a massively higher refill rate than suggested by this flawed short thesis.

The proponents of this short thesis realize all of the above, and that is why they are especially careful to keep such statements overly general and vague when it comes to predicting a time frame for refill rates to allegedly plummet. Because of the mathematical phenomenon of exponential growth, any overweight people watching their friends, coworkers, or family members losing weight while taking Belviq (whether responders or not in the first 6 months or so), many of these people will also ask to be prescribed Belviq. Then friends of those friends will do the same. All the while word of mouth and "walking billboards" are advertising Belviq, Eisai will be continuing with its aggressive ad campaign, informing doctors and the public of the benefits of Belviq.

A great example to illustrate this phenomenon would be Pfizer's Viagra. Even though the amount of users of Viagra was growing exponentially within the first two years of the drug coming on the market, far less than 100% of patients refilled their prescriptions for all kinds of reasons. The "refill rate" was irrelevant to the market as the drug was experiencing massive growth in sales.

Say you have 10,000 Belviq users on the drug for 6 months. 50% or 5,000 continue on the drug going forward and 50% never use Belviq again. During that 6 months 100,000 (a very conservative number) friends, family, and coworkers are made aware of Belviq because of their relationships with the first 10,000 users. 30% or 30,000 of those people are obese. Say only 10% or 3,000 of those people fill a prescription for Belviq. 30,000 people are now aware of the drug through their relationships with the 3,000 users. This growth does not happen in a vacuum. The process is happening every single day during the first 6 months. Exponential growth will greatly outstrip the number of patients that choose not to refill their prescriptions. The street will only care about growth and until that growth begins to slow down and the amount of patients choosing not to refill Belviq prescriptions outpaces that growth, refill rates will be entirely irrelevant.

With 1.4 billion obese people in the world, it would likely take a decade or more before the "lower refill rate" short thesis could begin affecting ARNA's share price. Fortunes are often made and lost in much less time than that. Clearly, this new thesis being paraded around by ARNA shorts is a highly flawed attempt to confuse investors and should be ignored and refuted in every instance.

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.