Now That Vivus Was Downgraded, Where Should Investors Turn?

by: Matt Schilling

When it comes to pharma stocks, an analyst upgrade or downgrade can determine the behavior of a stock over the next few sessions. The recent downgrade of Vivus, Inc. (NASDAQ:VVUS) is sure to weigh heavily on the short-term performance of the company's stock. In this article, I'm not only going highlight the reasons why potential investors should look for alternatives, but also why Arena Pharmaceuticals (NASDAQ:ARNA) is positioned much better in the sector.

VVUS opened trading at $20.95/share on Friday, Aug. 17, after it was reported that the company was downgraded by Jefferies Group from a Hold rating to an Underperform rating, and had its price target changed substantially from $31.00/share to $16.00/share. The biggest question surrounding VVUS now concerns the prescription method by which doctors may distribute the drug, or alternative forms thereof. According to Thomas Wei, an analyst at Jefferies:

There is a strong motivator for physicians to prescribe the two generics since branded Qsymia is unlikely to be covered by payors and the two generics will be more affordable for patients. We are concerned that the data suggest no material difference between Qsymia and a morning phentermine/evening topiramate regimen … While there may be a perception of liability risk among physicians initially, we believe the actual risk has been overstated by VVUS and bulls.

If that is the case, and the prescribing physicians' practice can actually save money by prescribing the two generic drugs together, this could mean the sustainability of Qsymia as a competitive drug within the weight-loss marketplace is very weak.

What alternative options should potential investors consider? There is one clear option, especially when it comes to weight-loss drugs, and that option is ARNA. When it comes to ARNA, there are several factors potential investors should consider, both on the drug side and from a fundamental perspective. On July 30 ARNA transferred the Belviq application to Eisai (OTCPK:ESALY) for two very good reasons: it will establish Eisai as the marketing authorization holder and establish a joint development relationship between both Arena and Eisai, which could in turn result in better-than-expected sales of ARNA's drug Belviq. The second benefit of Belviq comes in the form of its target market, and was recently noted by fellow Seeking Alpha contributor KLLJ Investments:

Not only is Belviq the first weight loss option approved in the last 13 years, but more importantly it is the first weight-loss drug in the history of pharma that comes with this unique blend of efficacy, safety, and tolerability. It is also a weight-loss option with very few side effects, improvements to all co-morbidity factors, and major improvements to glycemic control is going to be liberally prescribed by physicians. In particular, the 79 million pre-diabetics and over 20 million type 2 diabetics in this country will be widely prescribed Belviq as a preventative treatment for diabetes.

In other words, Belviq is a more diversified drug than Qsymia in that not only does it combat weight-loss, but it also serves as a preventative measure against diabetes -- something no weight-loss drug has ever done before.

In terms of fundamentals, at the current point in time ARNA currently does something VIVUS does not -- generate revenues. According to Robert E. Hoffman, CFO of ARNA:

We recorded revenues of approximately $24.2 million for 2012, compared to revenues of approximately $7.2 million for 2011. 2012 revenues included a $20 million milestone payment from Eisai for the inclusion in the FDA approved prescribing information of the efficacy and safety data from the BLOOM-DM trial in patients with type 2 diabetes. Research and development expenses for 2012 decreased to $28.5 million from $30.6 million for 2011.

Based on Hoffman's comments, potential investors will also see that R&D expenses actually decreased when compared to the year-ago period, which is certainly a positive catalyst moving forward.

Final Analysis

I believe potential investors looking to establish a position in the pharmaceutical sector -- and more specifically a position in the weight-loss drug makers -- should avoid VVUS at all costs. As an alternative, investors should consider a position in ARNA. There are various angles to consider, especially when it comes to Belviq, such as its diversified functions vs. that of Qsymia and the rate by which it will be prescribed by physicians. ARNA is also the clear winner in terms of fundamentals as the company currently generates revenues, whereas VVUS does not.

Potential investors looking to establish a position in ARNA could do so with a small to moderate long position, and those looking to short shares of VVUS could do so with a moderate sized position as I think this stock could fall well below the $16.00/share price target Jefferies has set. My only concern when it comes to any of the weight-loss drug makers is that once these drugs hit the market, they may not initially live up to the immediate sales estimates analysts have set in the billions of dollars.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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