The biotechnology sector is no stranger to battleground stocks. Companies such as Dendreon (NASDAQ:DNDN) serve as solid examples of this fact. But perhaps no biotechnology stock is as controversial as Arena Pharmaceuticals (NASDAQ:ARNA). To the company’s critics, Arena serves as proof of the danger of misplaced optimism among retail investors, and an FDA whose drug approval standards are falling. And to the company’s supporters, Arena represents the worst of Wall Street; a stock held down by a cabal of sell-side analysts and hedge funds that seek to profit off of ordinary investors. For years, there has been little in the way of concrete evidence to support or refute either claim. With Belviq only now approved, and not yet on sale, it is difficult for either side to truly claim victory. However, with Arena’s Q3 earnings having been released about 2 weeks ago (on November 6), and Belviq nearing launch, the path forward is becoming a bit clearer. With that in mind, this article will focus on providing an overview of Arena’s Q3 2012 earnings, as well as the road ahead for Belviq, the company’s obesity treatment. Unless otherwise noted, financial data and management commentary cited in this article will be sourced from one of three places: Arena’s Q3 2012 conference call, its recent investor presentation at Lazard’s biotechnology conference (held on November 13), or its latest 10-Q filing with the SEC.
Q3 Results: Are All Obesity-Fighting Companies the Same?
From a purely financial perspective, Arena’s Q3 results offer little in terms of bullish or bearish developments for Arena’s investors. Because Belviq has not yet launched, the company’s financial results for this quarter mean little in the larger scheme of things. Arena posted revenues of $1.485 million (consisting of $882,000 in collaborative revenue and $603,000 in manufacturing revenue) for the third quarter of 2012, and a net loss of $15.521 million. And while the financial aspects of Arena’s Q3 conference call offer little in the way of material information, the operational aspects that the company’s management team spoke of offer insights into where Arena is going.
1. Relationship with Eisai: Unlike Vivus (NASDAQ:VVUS), Arena decided early on that its obesity pill would be sold and marketed through a partner, rather than through its own sales team and distribution channels. While it can be argued that the payoffs from marketing and selling a drug internally can be higher, the risks are higher as well, and ceding control of these aspects to Eisai was deemed better than trying to sell and market Belviq alone. As Belviq prepares to launch, Eisai has hired a sales force of 200 to target 30,000 physicians across the United States, with a particular emphasis on the “territories with the highest need for obesity treatment and the largest concentration of treating specialists.” Furthermore, Eisai is working with payers, at both the government and commercial level, to establish a “robust” payer market for Belviq. Eisai is emphasizing the ancillary costs of obesity, framing its argument by citing that savings that arise from tackling obesity outweigh the costs of covering Belviq. Arena declined to provide detailed commentary on this front, but did indicate that it is “pleased” with how these negotiations are going. I expect more color on the issue of coverage when the company reports its Q4 and full year 2012 results sometime in January.
2. United States launch: While the FDA approved Belviq in June, it has not yet launched due to a need to receive scheduling from the Drug Enforcement Agency (DEA). The pharmacological profile of Belviq is such that it is deemed by the DEA to be a controlled substance, and needs to be evaluated to determine any restrictions. The DEA’s scale ranges from 1-5, with a rating of 1 being the most restrictive, and including LSD and heroin. At Lazard’s recent conference, Craig Audet, Arena’s head of Global Regulatory Affairs, stated that Arena believes that Belviq is likely to receive a Schedule 4 rating. Schedule 4 requires enhanced record keeping during the manufacturing and distribution process, as well as on the part of prescribing physicians, so that the DEA can track exactly what kind of journey the drugs in question have taken. Schedule 4 does not restrict marketing, as it requires only a small symbol to be placed on the logo of the drug to indicate that it is a Schedule 4 drug. Craig Audet has stated that from an investment and business perspective, Arena views this as a non-issue, with the only uncertainty stemming from the timing of the DEA’s review process. Arena is set to receive $65 million in milestone payments from Eisai once Belviq receives its scheduling, and if the payment is pushed out to 2013, 2012 guidance of $91-$97 million is lowered by $65 million, and 2013 results are raised by $65 million. Vivus has already launched Qsymia, its own obesity drug, but it has gotten off to what most believe is a slow start. Naturally, many in the investment and sell-side communities are extrapolating Qsymia’s market performance to how Belviq will perform once it is launched here in the United States. Craig Audet believes that comparing the two is like comparing apples and oranges. At Lazard’s biotechnology conference, he stated,
I think it’s difficult to compare one drug launch to another drug launch. I think some of the challenges that VIVUS has had is that they had to sort of build the marketing organization very quickly. They had to get a contract field force up and running and trained and out there establishing relationships with physicians. They also have the issue of their REMS program. So they’ve got the pregnancy testing, and they’ve got the mail-order pharmacies…it might be a little bit too soon to start rating them on their launch…In terms of the difference here, I think we have a relationship with Eisai…So they can hit the ground running right there. And then there is no REMS program. So there is less of that hassle factor associated with that.
I do not believe extrapolating Vivus’ launch of Qsymia to Belviq’s is the right way to approach things. Belviq (as well as Qsymia) will succeed or fail based on its efficacy as well as how it is marketed and distributed. Vivus and Arena are two different companies, with two different drugs, and two different distribution strategies. It is likely too early to tell exactly how well Qsymia will perform in the long run.
3. International Belviq expansion: Now that Belviq has been approved for sale in the United States, Arena is focusing on expanding the drug to new geographies, with the European Union being the company’s primary focus. Once again, comparisons with Vivus enter the picture. Vivus has received what many see as a frosty reception from the CHMP (the European Union’s equivalent of the FDA), and once again, investors and analysts are extrapolating that difficulty to Arena’s pending Belviq application. Arena has received its 120-day questions from the CHMP, which is a document that outlines the CHMP’s concerns. Arena has said that the CHMP’s concerns are quite similar to the FDA’s (cancer risk, efficacy, cardiovascular risk, etc…). If Arena is able to “explain away” these issues to the FDA, it is likely that it can successfully explain those issues to the CHMP as well. On its Q3 call, Arena’s CEO Jack Lief said that the company expects a regulatory decision in the European Union in the first half of 2013. Arena also expects a regulatory decision regarding Belviq from Switzerland within that time. Arena announced its collaboration with Ildong Pharmaceuticals to commercialize Belviq in South Korea alongside its Q3 earnings release on November 6. Arena will receive royalty rates ranging from 35-45%, with the higher end being achieved once Belviq sales exceed $15 million. Arena will also receive an upfront payment of $5 million, and another $3 million milestone payment if and when Belviq is approved by the KFDA (Korea’s equivalent of the FDA). The agreement with Eisai covers the Americas, while the agreement with Ildong Pharmaceuticals covers South Korea. The rest of the world (especially the European Union) is not yet covered by marketing agreements, and Arena has said that it is evaluating its options for the rest of its potential markets.
4. Belviq Financials: While the excitement surrounding Belviq as a drug is certainly understandable, it is also important to remember to keep an eye on the drug’s financial profile. After all, as a public company, Arena has a fiduciary duty to create value for its shareholders. Belviq is manufactured in Switzerland through a wholly owned Arena subsidiary. Switzerland lured Arena to the country by offering the company a 10-year tax holiday. At Lazard’s biotechnology conference, CFO Robert Hoffman was asked a question regarding Arena’s tax rates going forward, as well as where cash would ultimately sit: inside or outside the United States? Hoffman responded by saying,
We have some NOL’s [net operating losses] that we need to burn through as well over the years, assuming that we reach profitability. In terms of the overall tax rate, we did acquire [the] facility in Switzerland back in 2008 and in conjunction with that acquisition we negotiated a tax holiday, an effective tax holiday whereby we are exempt from taxes…for 10 years from [initial] sales. So, in terms of what we believe the overall effective tax rate could be, if you look at what Genentech used to pay back in the day, of about 40%, [and] you look what Pfizer pays and it’s about 15%, we are hopeful that we can get a lot closer to Pfizer than we can to Genentech. And so this could be a significant transaction, this tax deployment that we put in place…there are plenty of NOLs and [a] lot of the cash currently resides in the U.S. anyway.
The fact that Belviq will be manufactured in Switzerland is a positive for Arena on several fronts. Not only does it offer the company lower tax rates, but it also puts Arena closer to the European market, so if it eventually decides to sell Belviq in Europe without a marketing partner, distribution will be much easier.
Updates From the Pipeline
During the years that Belviq was under development, Arena suspended work on most of its pipeline as it concentrated on addressing the concerns from the FDA that were holding back approval. But now that Belviq has been approved and is about to launch, Arena has turned its focus back to its pipeline, which I believe is being largely ignored by investors. Arena recently initiated patient dosing in the Phase I trial of APD-811, its drug for pulmonary arterial hypertension. On the company’s Q3 call, CEO Jack Lief stated that he expects data from this trial to be released within the first quarter of 2013. In addition, Arena is expected to begin Phase I trials of APD-334, the company’s treatment for cordial immune diseases within the first half of 2013. APD-371, Arena’s pain treatment, is in the final stages of preclinical development, but CEO Jack Lief declined to provide a timetable for entry into Phase I trials. Arena’s pipeline needs to be thought of as an upside call option, in my view. Its pipeline is in the early stages of development, but does provide room for upside potential, as few, if any analysts are taking the value of these assets into account, and most investors are still focused on Belviq.
Arena remains focused on Belviq as well and is looking at expanding the therapeutic applications for Belviq. Arena is investigating Belviq’s potential in helping patients quit smoking, as well as a combination trial with phentermine and metphormin. With regards to the phentermine trials, Craig Audet, Arena’s head of global regulatory affairs, stated that the company would tread carefully, given the obvious history of phentermine. At Lazard’s biotechnology conference, Audet said,
We want to make sure that because this is such a difficult space to get regulatory approval in, that we work like the company did for the complete response letter [to] make sure that we had a plan in place with the FDA upfront that everyone agreed to and then executed on that plan and then provided the results to the FDA…We want to follow that path for any sort of a combination or any additional work we do for the obesity indication. So, with phentermine we have a general plan in place, we want to go to the FDA with that strategy, get their input, solidify that plan, finalize it and then we’ll be willing to sort of talk a little bit about and what we don’t want to do is tell you something that we then have to retract a few months later. In terms of timing with the FDA, we see this as a priority…we can’t give you specific timing but suffice to say we are pursuing it.
In my view, Arena’s pipeline is underappreciated, and in the years to come it will likely offer some positive developments for investors, and some negative ones as well. But, on balance, Arena’s diversified pipeline is a good thing for investors. The company is not only trying to expand the market for Belviq, it is also looking at new drugs as well. Few, if any companies can survive for long on the back of a single drug. Alexion Pharmaceuticals (NASDAQ:ALXN) may be an exception, but that is because Soliris (Alexion’s only approved drug) targets extraordinarily rare diseases for which there are simply no alternative treatments available. And Alexion is working diligently on expanding its pipeline to diversify away from Soliris, something that Arena is working to do with regards to Belviq as well.
Conclusions
As any readers of Seeking Alpha are likely aware, Arena Pharmaceuticals is one of the most controversial stocks in the market. Every article published on the company leads to intense and emotional debate about the company and Belviq. In my view, such emotion has no place in investing. Emotion is one of the most dangerous threats to profit, and needs to be eliminated when making investment decisions. With that in mind, do I believe in the long-term potential of Arena? I do. Do I think its stock is worth more than $8.50 (its current trading price)? I do. But do I think it is worth more than $20? Not at the moment. Expectations for Arena need to be more realistic. The company’s stock has already handed investors returns of over 350% so far in 2012, and while I think that there is more upside in the long-term, patience is essential. Jefferies, in its research note following Arena’s Q3 earnings, cut its price target from $20 to $14, citing Vivus’ poor Qsymia launch. Even if Jefferies is comparing apples and oranges, its new price target of $14 still represents upside of 64.7% from current levels, and that is upside I will gladly take.
