Arena Buyout Rumors Are Overblown

| About: Arena Pharmaceuticals, (ARNA)
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What happens when a small pharmaceutical company hitches its wagon to a drug that finally gains FDA approval? The stock runs, and images of dollars raining down upon the smart early investors cloud reality. Sudden assumptions of a stock that was trading at $5 will now be worth $50 enter water-cooler conversations all over. When the reality does hit, and the stock settles down after a more modest run that people had hoped for, they want to find some way to keep those visions alive.

First thing's first. Yes, Arena (NASDAQ:ARNA) has approval for Belviq, and the drug has wonderful potential. Potential is indeed worth something, but it does not create a 1000% appreciation overnight. Does the potential for a buyout exist? Certainly. Anything can be bought or sold. The question at hand is whether a buyout of Arena is currently on the table.

In my opinion, buyout rumors are simply wishful thinking on the part of investors. Once invested in a company, we tend to have an emotional attachment to it that wants to breed immediate successes. Part of that is to justify, in our own minds, an investment decision we made.

Why do I think buyout rumors are overblown? Because there is simply too much at stake, and while Belviq has promise, it is difficult at best to tag a true value to the profit potential that the drug offers - at least at this early stage. Even in looking at the company statements, you can see that there are simply many unknowns:

Arena also announced an update to its full year 2012 financial guidance. Arena increased its 2012 revenue guidance from $66-$72 million to $91-$97 million, which includes the $20.0 million milestone payment received from Eisai for the inclusion in the FDA-approved prescribing information of the BLOOM-DM data and, although the timing remains uncertain, $65.0 million for milestone payments that Arena will receive from Eisai following DEA scheduling designation and delivery of BELVIQ launch supply. If DEA scheduling and delivery of launch supply do not occur in 2012, revenue guidance would be $65.0 million lower. Guidance for research and development expenses of $57-$67 million, for general and administrative expenses of $20-$24 million and for capital expenditures of $2 million remains unchanged. Arena now expects to end 2012 with approximately $215 million in cash, cash equivalents and short-term investments. If DEA scheduling and delivery of launch supply do not occur in 2012, cash at the end of 2012 would be $65.0 million lower. 2012 revenue and end of year cash guidance do not include revenue or cash from product sales for BELVIQ or from Arena's entry into any new collaboration. [emphasis added]

The company is guiding to revenue of $91 to $97 million, but will need to adjust that by $65 million if 201 (ARNA2) passes DEA scheduling approvals. The Street, and any potential buyer, was expecting revenues of $40 million. The research and development costs and administrative costs are expected to be $77 to $91 million. None of these forecasts include revenue or cash from Belviq. The potential sounds great, but how do you, or a buyer, value that?

Let's take a moment to look at this realistically. Arena's potential is with Belviq. The real size and scope of that potential is an assumption by Arena, investors, and potential suitors that would want to buy out the company. Essentially, the only way a deal happens is if the buyer and seller are aligned in the value potential and one side makes is making a mistake in its assumptions.

In my opinion, the time to buy out Arena was prior to Belviq FDA approval, or after initial sales of Belviq are realized and there is a lot more data to work with to determine a proper valuation. I simply do not see another company making a move at this stage. It would require a massive premium based on potential and not real numbers. In 2013 everyone will have a better understanding of whether or not the potential matches up with the gains.

I think many agree that Belviq will be a home run, but will people all agree that it is a game-winning grand slam in the bottom of the 9th inning to win a 7th game World Series championship against your biggest rival?1

Simply stated, a buyout now would have to come at a huge premium. As great as that would be for investors, it is not the way things are working in an economy like we have now. Buyouts are happening based on proven data and results, not potential. There will be a day when a buyout may be in the cards, but I simply do not see it as being right now. That does not mean that investors should feel down in the dumps. After all, if you bought this equity for a couple of bucks, you are still quite happy with where thing currently stand, and there is still a huge potential to look forward to.

Disclosure: I am long ARNA.