Is It Too Late To Buy Arena Pharmaceuticals?

For years, we have been hearing that obesity is a nationwide epidemic that needs to be addressed. And between the diet regiments and pharmaceutical products, the view increasingly seems to be that the FDA, physicians, and patients see obesity as a medical condition versus a lifestyle issue. This of course, is great for pharmaceutical companies like Arena Pharmaceuticals (NASDAQ: ARNA), whose stock it up over seventy percent on Friday after the Endocrinologic and Metabolic Drugs Advisory Committee voted 18 to 4 yesterday to approve lorcaserin, a selectiveserotonin 2C receptor agonist.  ARNA focuses on using G-protein-coupled receptors (GPCRs) to examine treatments in areas including cardiovascular, central nervous system, and inflammatory diseases, and lorcaserin is its main product. The stock is held by Daniel Gold, DE Shaw, Israel Englander, and Glenn Russell Dubin.

Arena Pharmaceuticals, Inc. (NASDAQ:ARNA)

The panel felt that it could not completely rule out cardiovascular (CV) and heart valve related (valvulopathy) risks, expressing the opinion that ARNA could do as much as it was allowed to prior to approval for valvulopathy. Apparently, the fact that there was minimal to no rise in blood pressure or heart rate was enough to make the panel pronounce that the issue warranted additional studying after CV approval. But despite ARNA’s belief that its drug has no safety signals, we think the PDUFA date will be pushed back after June 27 to develop a valvulopathy monitoring program. This will probably come after the cardiovascular outcomes trial and a panel-suggested cancer monitoring registry. Management commented that it had only conducted preliminary discussions with FDA regarding post-approval requirements.

ARNA also revised its marketing agreement with Eisai (PINK: ESALY) to include most of North and South America. Post-approval, ARNA’s Swiss subsidiary will manufacture lorcaserin and sell to Eisai for an estimated 31% of the selling price. The partnership began in 2010 to sell lorcaserin in the US, whereby ARNA got $50 million upfront plus up to $160 million in regulatory plus $1.2 billion in sales milestones. If ESALY launches lorcaserin in the US, ARNA should receive around $60 million in milestones. With the favorable panel opinion, we think ARNA will look to strike a European marketing partnership since it lacks a footprint in the region—the companies expanded their marketing deal to cover most of North and South America, but lorcaserin remains unpartnered in Europe. Recall that ESLAY will cover 90% of post-approval clinical trial costs.

The logical target market for lorcaserin is obese (body mass index >30kg/m2) adults. According to some estimates, if you forecast of 1.2% penetration into this market, this would total $1.9 billion in US sales in 2018. Arena’s share of U.S. lorcaserin revenues will probably be around $80 million in 2013, $165 million in 2014 and $650 million by 2018. Estimates for lorcaserin are below estimates of $900mn and $1.8bn respectively for Orexigen’s (NASDAQ: OREX) Contrave and Vivus’ (NASDAQ: VVUS) Qnexa, driven largely by relatively efficacy differences. Note that Qnexa’s PDUFA date was extended to July 17 so it could include data from the REMS program. We don’t expect any material impact of ARNA results on Qnexa or Contrave. Qnexa will likely still be the first to commercialize given better efficacy data, and Contrave still is a few years from commercialization. Given lower efficacy for lorcaserin, it will probably be second to Qnexa, but we think the market size is large enough (estimated peak sales of $1 billion) can support several drugs.

Overall, it appears that lorcaserin has the best safety profile of all the candidates seeking obesity approval though it may need to go through additional trials before approval. We aren’t sure how significant a delay these trials could present, ranging from a few months to several months to a year. That said, lorcaserin has some serious revenue potential in the obesity market. Even if delayed, we anticipate that ARNA will be able to get $60 million in milestone payments from ESLAY and frankly, the obesity market is in need of a drug with the safety profile that lorcaserin has. The drug’s tolerability profile also makes it a good candidate for combination therapy thereby to boost efficacy levels. Most analysts are expecting approval in the second half of the year, and we think that’s reasonable. Incorporating all of the information into our valuation, we think ARNA still holds some upside potential despite a big jump on the announcement—we estimate fair value as between $8 to $9 per share based on a NPV model.

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