Is Eisai Making A Down Payment On Arena?

| About: Arena Pharmaceuticals, (ARNA)
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Arena Pharmaceuticals (NASDAQ:ARNA) reversed its recent slide last Friday after the company announced that it had reached an amended marketing agreement with Eisai (OTCPK:ESALF) for Belviq. Under the terms of the agreement, Eisai gains exclusive commercialization rights for Belviq in all countries except South Korea, Taiwan, Australia, and New Zealand. Furthermore, Arena will receive $60 million upfront, up to $176.5 million in milestone payments, and up to $1.56B in back end payments. That's a stellar deal given that Belviq sales for weight management haven't exactly taken off yet.

My view is that Eisai has an eye to the future with this deal. As CEO Jack Lief stated in their recent earnings call, Arena was negotiating with multiple potential partners for the so-called Rest of World (ROW) commercial rights for Belviq, and they ended up sticking with Eisai. Based on what Lief has stated publicly, Eisai was ready for this deal all along.

The question is, what does Eisai gain from such a deal? Lief's comments during the quarterly call stressed that Eisai is still facing an uphill battle on educating caregivers about Belviq's benefits, sales are way off the blockbuster mark, and Belviq's blockbuster potential may not be realized until the label is expanded. Frankly, this rich deal makes little sense until you think about it from a buy-out perspective.

With that in mind, I'd like to explore this thesis in this article.

Motive for a Buyout

Eisai's marketing agreement with Arena is worth billions in milestone and royalty payments. Moreover, Eisai has already handed over hundreds of millions in upfront and milestone payments to Arena for Belviq to date. Interestingly, these monies have mostly gone into funding Arena's remaining clinical candidates. In a way, Eisai is thus both licensing a potential blockbuster (Belviq) and funding the clinical development of a population of GPCR drug candidates.

Think about it this way: Eisai would probably have to pay somewhere around $1 billion to develop each one of these candidates on their own, based on recent estimates. By giving Arena a couple hundred million via milestone payments, they now have most of the global commercial rights to Belviq and have indirectly funded Arena's strong GPCR pipeline.

The best part is that if Belviq fails commercially or the remaining pipeline turns out to be a dud, Eisai has saved itself billions in research and development costs going this route. This marketing agreement also gives Eisai the luxury of waiting to see how the label expansion efforts for Belviq unfold, how global sales of Belviq perform, and how Arena's other clinical candidates develop prior to paying a premium for the company. Why? Because this amended marketing agreement is essentially a poison pill against would-be buyout competitors. A potential rival would have to buy Eisai out as well, and that might be tough to do based on the current agreement. Eisai wins no matter what.

Bottom line: Eisai gets the best of both worlds by floating Arena a few hundred million upfront. Arena can develop another clinical candidate that could turn out to be a blockbuster, and Eisai won't have to make a move until most of the risk is off the table.

That said, I wouldn't expect a buyout for at least another three years because time is Eisai's greatest luxury in this relationship. The longer they wait the better they can define the risks of a potential buyout. And oddly enough, Arena now has a little over two years' worth of cash on hand before they would have to resort to dilutive funding (based on the current burn rate and Belviq sales).

In another weird twist to this tale, a buyout by Eisai would essentially be a company buying back its own cash and revenue stream (i.e., milestone and royalty payments). So another way to view Eisai's recent milestone payments to Arena is actually as a down payment. A buyout would also let Eisai off the hook for billions in potential royalty payments, and perhaps this will end up being one of the biggest factors driving a buyout. Why pay royalty payments when you can buy the whole company after all?

Keeping with this theme, when you compare the amount Eisai has already paid Arena in milestone payments compared to the cost of developing their own GPCR candidates, this deal begins to make a lot more sense. Simply put, this deal has already saved Eisai potentially billions, if they pull the trigger on a buyout later.

Conditions for a Buyout

That said, I don't believe a buyout is imminent. By contrast, I think at least a few of the following milestones need to occur first.

· One of Arena's additional clinical candidates reports positive Phase II trial results

· Belviq label expansion efforts prove fruitful for one or more indications

· Belviq is finally approved in the EU

· Belviq sales in the U.S. for weight management hit or exceed $100 million

My guesstimate is that it will take at least 3 years for most of these possibilities to come to fruition.

Does Eisai have the cash to pay for a buyout?

Earlier this year, Eisai reported having over $10 billion USD in assets and close to $2 billion in cash. According to their annual report, their cash position is expected to grow by more than 10% annually. So the short answer is yes and no. Within 3 years' time, Eisai could do a mixture of a stock offering and cash, and the number I would expect based on my research is around $3 billion, or roughly $14 a share bid based on Arena's current share count.

I can already hear the calls for my head emanating from Areniacs, who are sure to think is estimate is way too low. But think of it this way: Salix Pharmaceuticals (NASDAQ:SLXP) is only paying $2.6 billion for Santarus's (NASDAQ:SNTS) entire pipeline, and Santarus's product portfolio generated $99 million in revenue in the 3rd Quarter alone. For you mathletes out there, that's about $400 million per year. By contrast, Belviq is currently on track to make 10% of Santarus's commercial pipeline this year. So don't expect Eisai, or anyone else for that matter, to run out and over pay for Arena. A $14 bid offer is still a 300% gain from current levels, and this can probably be realized within 4-5 years. That works out to a 60-75% annualized gain, making Arena an intriguing speculative buy at current levels.


In sum, I still believe Areniacs aren't seeing the forest through the trees and are suffering from Belviqitis. Eisai is no dummy, and they didn't hand over hundreds of millions to Arena for a drug that may never see $300 million in peak sales. And sorry to say, I don't believe Belviq will hit $300 million based on its current label. Orexigen's (NASDAQ:OREX) Contrave will probably come onto the market next year thus increasing competition, and Vivus' (NASDAQ:VVUS) Qsymia is being marketed more aggressively now. In other words, Belviq's weight management indication is not a good reason to invest in Arena. By contrast, Arena's pipeline and an expanded label for Belviq make this stock much more interesting from a valuation perspective. I suspect Eisai views Arena in a similar manner.

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.