What Analysts Won't Tell You About Arena

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KLLJ Investments submits:

Analysts have a job to do, but it isn't to look out for the retail investor. It is to align expectations with an Investment Bank or Institutions strategy for making money. You will never see an estimate come out of one of the major firms that is on the surface, an audacious prediction. That isn't to say they don't forecast aggressive revenue targets internally, but they are for their own consumption and not of a retail investor. Instead, they put out conservative targets and conservative revenue estimates. They come up with negative biases or 'fear, uncertainty and doubt' to cap expectations and the share price. They are in this game to make themselves and their wealthy clients' money, not Joe Investor.

That is why you will never see one analyst come out and say what the real value of a Safe and Effective weight loss drug's potential is. Instead, they will say that weight loss drugs in the past haven't done well so Arena's ( ARNA ) Lorqess will only do a few hundred million dollars instead of pointing out the reasons for current and past weight loss drug failures, which Lorqess has overcome. They'll come out with FUD (fear, uncertainty and doubt) on how efficacy wasn't great and use placebo adjusted weight loss figures instead of actual weight loss percentages. They'll say that 8% weight loss isn't that meaningful. All of this to keep the share price in check. How wrong they are, and they may even know it. Why do you think Arena's institutional interest is so high? Even when ARNA was trading at $3 it was high. Do you know how hard it is for institutions to justify investing millions in a $3 stock? Arena underscores the reason why investors have to perform their own extensive due diligence. You can' t relay on headlines or analyst opinions if you want to make money.

How many analysts from major firms called Human Genome Sciences ( HGSI ) or Dendreon ( DNDN )? Not one of them publicly. That doesn't mean they didn't call it internally for themselves but publicly, no way these companies would get through the FDA. Well Dendreon did and Human Genome Sciences is well on their way. These stocks were worth $2, just 18mo ago, and now both companies have $5.5B+ market caps. Each of their lead drugs are estimated to do around $1.5B a year, yet they already have $5.5B+ market caps. Did all of the Investment Banks get that wrong? I doubt it but only long retail shareholders who did their due diligence and didn't trust what the analysts were saying held and saw their investment sky rocket in value. So why won't just one analyst come out and say that a safe and effective drug for the biggest pandemic in the world could be the most valuable drug ever? Because they would rather keep it for themselves and hold off their lofty revenue targets and valuations until well after the fact. Just look at Celgene ( CELG ), a company which did $2.5B in 2009 yet has a market cap of almost $25B dollars. Do you think anyone projected that 7 years ago it would be worth $25B before they had an approved product and the stock was at $5?

Again, they may have internally but nobody ever came out and said that 7 years ago, a $5 stock would be worth a split-adjusted $200. Nobody puts their job on the line for that, but I guarantee some of the institutions have made a killing on it during the last 7 years. Yes, I'm sure that behind the closed doors of Wall Street some Investment Banks have run their own models showing how Arena could be the next Celgene in terms of valuations, but they'll be keeping that to themselves. So let me explain why I think that the market for a safe and effective weight loss therapy, that can be taken long term as a maintenance drug, could potentially be one of the most valuable drugs ever despite most analysts saying the potential is only a few hundred million - $1B.

There are more than 230M Adults in the United States. About 68% of those are overweight or obese, which equals over 156M. Who can't stand to lose 10-20lbs or more? Most of us for sure or there wouldn't be an epidemic in this country and the rest of the developed world for that matter. Losing 17lbs could be the difference between becoming a Type II Diabetic or not. It could be the difference between a person having high blood pressure or significantly reducing their risk of a heart attack. There are over 20M diagnosed Type II diabetics in the US, 80% of which are Type II because they are overweight. There are another 57M overweight Americans whose fasting glucose is so high, they are on the verge of becoming diabetic. According to the ADA, we spend over $218B a year treating diabetes alone. That is more than the Gross Domestic Product of Hong Kong, the Czech Republic, Israel or Malaysia. Just a 7% reduction in weight (less than the 8.2% average Lorqess provides) can cause a 58% reduction in the chance of getting full blown diabetes if you are a pre-diabetic. The leading cause of kidney disease is obesity, Type II diabetes and HBP. Over 600K Americans are on dialysis and that number is growing rapidly. The cost just for dialysis is $50B+ and growing with Medicare picking up the tab.

I am only talking the United States here. Europe also has a major Obesity problem and there are now more overweight people in Asia than the good ole USA. Perhaps America's fast food industry is the secret weapon to put a dent in Chinese productivity? Women in Asia have even resorted to swallowing parasites to keep the weight off. Talk about extreme measures.

Big Pharma's drug graveyard is littered with failed attempts for a safe and effective weight loss treatment. After all, that is the biggest market in the world for a drug, despite no analysts coming out and saying that. The 50 year old drug Phentermine is still the market leader for fighting Obesity but it is limited to 12-weeks in duration and is a Class IV controlled substance. VVUS' attempt to bring Qnexa to market is probably dead given the 6-10 negative vote by their Advisory Committee in July. I questioned why Qnexa was subjected to such an early panel meeting and I stand by my opinion that the FDA doesn't want wide-spread use of a Phen/Top combo drug. Of course that didn't stop CNBC running fluff commentary on VVUS in their 'One Nation Overweight' documentary prior to their panel date with Leland Wilson agreeing that Qnexa could be the most valuable drug ever. A Topiramate-Phentermine combination drug the most valuable drug ever? No, I think you need a novel new safe and effective compound for that designation. I believe the FDA will feel the same about OREX's Contrave but the jury is still out. Even if Contrave or Qnexa is eventually approved, it will never become a first line therapy because of the AE profile (22% drop out rate for Contrave due to AE) and a likely black box warning inherited for suicide ideation. Doctors will reach for the safe choice first, Lorqess, before ever writing a prescription for a Topiramate or Wellbutrin combination drug.

There must be a tremendous amount of pressure on the FDA to approve new therapies for weight loss but they still have a job to do. That job first and foremost is making sure yet another dangerous weight loss drug doesn't hit the market, like Redux or now Meridia. The medical community is clamoring for a SAFE and Effective drug to prescribe to a majority of their patients. None of the currently available weight loss drugs have become blockbusters, not because of high drop-out rates due to AE's, but because prescribers are hesitant to provide them! Very few primary care physicians are high-prescribers of weight loss drugs. Endocrinologists, who see more overweight patient than any other specialty, only account for 4% of the overall prescriptions for weight loss drugs! Why? I'll tell you. It is because medical professionals are highly dissatisfied with the currently available therapies. What's your poison, a Class IV stimulant that can only be taken for 3 months then patients put the weight back on, drugs that cause increased blood pressure and heart rate, drugs that cause intestinal problems like anal leakage? No thanks.

The only drug that will be a multi-billion dollar blockbuster in this segment is a SAFE and effective drug that can be taken long term as a maintenance drug to help keep the weight off. That is the exact profile of Arena's Lorqess and why it has the potential to become a mega-blockbuster. Look at the biggest selling drugs of 2009, the four leading categories by revenue are for the treatment of arthritis, statins for high cholesterol, schizophrenia and atherosclerosis. According to the American Heart Association, 106M Americans have high cholesterol, the CDC says 19M suffer from arthritis and 2.2M have schizophrenia making Obesity bigger than all three combined. By far the biggest market for pharma would be a first line treatment for obesity. There has never been one, at least until now. Obesity is killing our country and causes tens of thousands of early deaths every year. A drug like Lorqess with just moderate weight loss can and should become a valuable weapon in the fight to help with this epidemic.

So how big is the market? 156M Overweight Americans to start. We also have a huge obesity problem with adolescents but for these purposes, I'll stick to the adults. Once the adults get healthy, maybe they can help their children without the need for pharmacology but eventually, Lorqess may need to be prescribed for pediatric obesity as well. I believe only 9 states cover insurance reimbursement for weight loss drugs, but some say that number is as many as 13 states, I haven't found good figures on the subject. Hopefully coverage will change with Lorqess' availability given the improvements in cardiovascular risk factors, cholesterol, HbA1c, fasting glucose and Quality of Life. Keep in mind Arena's BLOOM-DM study for diabetes is complete and the results of which will be filed as a sNDA in 2011. Expect top line results before the end of this year. This could garner Lorqess a label designation as a drug to prevent and treat Type II DM. If that happens, insurance covers. Roughly 15% of America is uninsured which means 85% have some sort of health coverage. 156M overweight Americans x 85% = 132M+ Americans with health coverage. Over half that number, 70M are Type II or Pre-Type II diabetic. Sobering numbers.

Now, it is a complete guess on how many will pay for Lorqess out of pocket so I'll keep the penetration numbers low to start. Assuming that Lorqess gets a label for Type II DM in 2011, then the coverage and market drastically expands in 2012 and beyond. The key is getting PCP and Endo's to write the scripts for Lorqess. In a study done by Arena, they discovered that 25% of all Lorqess scripts will be to replace another weight loss drug and 75% would come from patients who wouldn't have qualified to take one previously. That to me shows that there is a huge untapped market that Lorqess will quickly take over and the key to becoming a mega-blockbuster.

Let's look at some scenarios using the 132m overweight Americans with health insurance figure. As most should know, Arena is partnered with Japanese Big Pharma Eisai for the US-only marketing rights for Lorcaserin. Eisai will pay Arena as follows:

  • $50M Initial Upfront
  • $90M Upon FDA Approval (PDUFA October 22nd) bringing upfront for US marketing rights to $140M
  • $70M After additional regulatory goals are met (I suspect from the completed BLOOM-DM Study), which in effect gives them over $210M in upfront
  • $1.16B in one-time purchase price adjustments after certain sales goals.
  • 31.5-36.5% of annual Lorcaserin Sales as manufacturing payment.

Here are 4 scenarios for Lorqess sales from a Doomsday scenario to a Super-Optimistic scenario to determine the current intrinsic value of the drug.

I have not accounted for any Tax loss credits which account for $900M to be offset over the next number of years and have not included any milestone payments from Eisai, only Lorqess revenues. I used a fully diluted share count of 150M (current outstanding are 121M.) Each pill I estimate to cost $1.50-$2 each. Using the median of $1.75 x 2 pills per day x 365 days = $1,277 per patient year, which I'll round down to $1,200. Keep in mind, Lorqess is a maintenance drug to be taken long term, like a Statin would be, so prescriptions are cumulative. Small molecules are cheap to produce so the margins I list are conservative.

click to enlarge




To determine the Expected Value of Lorqess, we can assign a probability to each of the scenarios. I personally think Scenario 3 is the most likely and perhaps even conservative if Lorqess is accepted as a first line treatment for Obesity. Scenario 4 demonstrates the potential of a standalone indication for diabetes and acceptance by endocrinologists. If BLOOM-DM results are good and the sNDA is approved, then this scenario increases in probability. However, I want to have a conservative target in this example so we'll assign a 15% chance of utter failure in Scenario 1, a 40% chance of moderate acceptance, a 40% chance of great acceptance and a 5% chance of the diabetes scenario playing out.

= ($5.27 x .15) + ($25.47 x .40) + ($52.92 x .40) + ($103.08 x .05)

So the current intrinsic value of Lorqess in my opinion is $37.30. This of course does not include any milestone payments from Eisai which could total well over $1B during this time period or any additional revenues from other compounds, just Lorqess. It is possible for ARNA to get there after approval and prior to launch. After the most recent stock purchase by Deerfield, there are approximately 121M shares outstanding. This would put ARNA's market cap at only $4.5B for a potential first line therapy in the biggest market in the world, $1B+ less than HGSI or DNDN whose target market is but a fraction of Arena's and HGSI's Benlysta isn't even approved yet! If Arena receives great market acceptance and just 10% market share among the overweight or obese with healthcare coverage, that could equate to Net Income of $1.7B by 2015, which would be earnings of $10+ / share. In reality, much of the revenue will go to fund new research and trials, perhaps even launching their next approved drug on their own so earnings will certainly be much less than that figure but you can see that they would surpass Celgene's income and hopefully their $25B market cap.

The shorts have just a few trading days left to cover their mistake. Briefing docs come out on Sept 14th and will provide insight into what the FDA is thinking. Anything that can be construed as negative will have the hedge-funds use their friends at various 'news' outlets such as Motley Fool or The Street to put out negative FUD pieces to scare retail shareholders out of their holdings. With an overwhelmingly positive vote from the panel, shorts will pay the price on September 17th when they are scrambling to cover with shares in strong institutional, insider and long retail hands. With very little float to buy from, we could see $20 before the short covering is over and before Arena's October 22nd PDUFA date. But don't look for any major analysts to come out with these lofty predictions, you'll have to wait a year or two for that to happen.

Disclosure: Long ARNA.

See also Why I'm Not Buying Petrobras Just Yet on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Technology

Referenced Stocks: ARNA , CELG , DNDN , HGSI , OREX , VVUS

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