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Arena - Putting A Value On The Pipeline

|About: Arena Pharmaceuticals, Inc. (ARNA)
Summary

Arena has several drug candidates in the pipeline.

Drug candidates in Phase 2 carry best valuation.

Funding the pipeline development and timing are challenges.

Arena Pharmaceuticals (NASDAQ:ARNA) was the company with an anti-obesity pill named Belviq that would serve a huge need to a massive market. At one time it was imagined that sales of Belviq would be so successful that not only would the stock rise, but the profits would be able to fuel an ever-growing pipeline that would put out other wildly successful drugs. Then reality set in. As it turns out anti-obesity pills are not selling, doctors seem reluctant to write scripts, insurance companies balk at paying, and consumers simply stop taking these pills after a few months.

This leaves Arena investors looking to the pipeline as the savior of this equity. So what is the pipeline really worth?

Analyst Edward Tenthoff from Piper Jaffray has followed the company for quite some time, and is one of the more bullish analysts on Arena. He carries a $3.50 price target which was lower than his previous target of $5.00, but is well above where Arena is currently trading.

If Arena investors learned one thing over the past few years it should be that setting realistic expectations is prudent. Yes, it is tempting to assign a massive valuation to Arena after seeing Celgene (NASDAQ:CELG) buy Receptos for $7.2 billion, but there are many factors to consider.

In his most recent analysis of Arena Pharmaceuticals, Edward Tenthoff outlined the troubles relating to Belviq sales, but also touched on the pipeline and how he currently vales it.

APD334

APD334 is an orally available S1P1 receptor modulator, discovered internally by Arena. It has therapeutic potential in autoimmune diseases such as ulcerative colitis. S1P1 receptors have been demonstrated to be involved in the modulation of several biological responses, including lymphocyte trafficking from lymph nodes to the peripheral blood. By isolating subpopulations of lymphocytes in lymph nodes, fewer immune cells are available in the circulating blood to effect tissue damage. The drug is currently in phase 2 clinical trials and we learned during the last quarterly call that data from the trial has been pushed from the second half of 2016 to Q2 of 2017.

Tenthoff calls APD334 the highest profile asset in Arena's pipeline. The analyst sets a valuation of APD334 at $500 million.

This is the drug that many compare to the Receptos drug which generated the Celgene buyout. The Receptos drug is further along in studies

The big question surrounding this drug is whether it can land a lucrative deal, and more specifically what kind of timing will that deal have. In some ways Arena is approaching a cash crunch where landing up-front money could delay or even mitigate the need for raising capital through dilution or debt. Can the company get a great deal prior to the announcement of phase 2 data? Will good data at the conclusion of phase 2 make the commodity that is APD334 more valuable. These are some of the tings investors need to consider.

At the moment I think that the value Tenthoff places on 334 is fair and realistic. He seems to have resisted the temptation to over-value the drug candidate, but at the same time is applying solid logic to why a $500 million valuation is realistic and reasonable.

Ralinepag (APD811)

Ralinepag is an orally available agonist of the prostacyclin (NYSE:IP) receptor. It is an investigational drug candidate internally discovered and developed by Arena and intended for the treatment of vasospastic diseases, such as Pulmonary Arterial Hypertension. The drug is currently in phase 2 clinical trials and is a likely candidate for an early partnership to bring in cash that may help the company avoid debt or dilution.

Tenthoff values Ralinepag at $100 million. Some will argue that the drug is entering a market with big sales numbers and thus the valuation should be higher. Indeed the market has many candidates, which is why a realistic valuation of Ralinepag is actually more appropriate. In my opinion this is one drug that may be partnered at a relative "discount" because of the cash position of Arena. Investors have not been in the loop of whether the company feels that an early partnership to avoid dilution or debt is the chosen direction, so in the absence of that information it is prudent to carry a more conservative assumption.

APD371

APD371 is an orally available agonist of the CB2 receptor. It is an internally discovered investigational drug candidate that Arena is exploring for potential development in several indications. One indication is for the treatment of pain. This compound, through its selectivity, is designed to provide pain relief without psychotropic effects and without the potential for dependence or abuse. Preclinical efficacy with APD371 has been shown in several animal models of pain.

Tenthoff values this drug candidate at $50 million. In my opinion this drug has the potential to be worth much more because of its non-addictive properties. The likely reason for a lower valuation from Tenthoff could likely be that the drug is only in phase 1 trials. This is also another drug that could be partnered earlier than perhaps what is optimal in the pursuit of keeping the cash situation in better control and avoiding debt or dilution. In my opinion prudence wins the day here on valuation over optimistic speculation.

Temanogrel

Temanogrelis an orally available inverse agonist of the serotonin 2A receptor. It is an internally discovered investigational drug candidate intended for the treatment of thrombotic diseases. Arena believes that this drug candidate has the potential to inhibit serotonin-mediated platelet aggregation and vasoconstriction. Temanogrel's dual mechanism may be therapeutically useful for the treatment or prevention of thrombotic diseases. This drug is already partnered with Ildong.

Phase 1 studies are ongoing and seem to be taking quite a long time. Tenthoff has lowered his valuation on this drug from $50 million to $25 million. While such a cut in valuation may seem harsh, it is likely prudent. If this drug candidate was demonstrating that it was a home run, the movements on advancing it would be getting more attention. Sometimes you can learn a lot by how a drug is advanced and where it rests in the pecking order of discussion about the pipeline.

Nelotanserin

Nelotanserin is a potent and selective inverse agonist of the 5-HT2A receptor that has been implicated in the pathophysiology underlying psychosis. Nelotanserin was discovered and developed by Arena, and completed Phase 1 trials in healthy volunteers and Phase 2 trials in subjects with insomnia before development was discontinued for that indication.

Nelotanserin is partnered with Axovant Sciences Ltd., which has exclusive worldwide rights to develop and commercialize the drug. Axovant has announced that it intends to initiate two Phase 2 clinical trials with nelotanserin in 2016 in areas such as dementia.

The value of this drug and deal are essentially not a big part of the Arena valuation story. If this drug shows potential in new trials there could be value here, but for the time being it is sensible that Tenthoff excludes this from his assessment.

The Bottom Line

The bottom line here is that indeed there exists value in the Arena pipeline. Some of that value may begin to unlock if the cash situation at the company reaches resolution in the second half of this year. If that can happen through a partnership deal, dilution, or debt, it could lead to a very bullish situation with APD334 when results become available in mid 2017.

Tenthoff has Arena's cash at about $51 million at the close of 2016. This is well below the $100 million that we would typically like to see. In the next three to six months we will see the cash issue come to the forefront in one form or another. One path is some early partnerships which could bolster the equity. The other path is debt or dilution, which could carry a negative impact on the equity. A hybrid path of a deal which bolsters the stock price and allows dilution at a higher stock price is [possible, but in my opinion it is not preferred.

I see the key here being whether or not APD334 is as good as advertised. This is the one drug in Arena's portfolio that actually has a chance to live up to "blockbuster" type hype that once surrounded Belviq.

Arena is a speculative play at its current price. If you speculate that the path to solving the cash issue is debt or dilution you invest on the short side. If you think that partnerships can cover the gap while not selling out the entire future of two well tested compounds, then the equity is likely near its base. Stay Tuned!

Disclosure: I am/we are 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.