Credit Suisse Sets A New Low Standard For Poor Analysis In Their Coverage Of Arena Pharmaceuticals

By Reza Ganjavi - September 9, 2012 | Tickers: ARNA, CS, OREX, OSTK, VVUS | 0 Comments

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 [Disclaimer: All the points which are not explicitly attributed to CS are only general statements and should not be considered as being about CS. Issues with CS's report on Arena are listed in the APPENDIX]

Arena Pharmaceuticals (NASDAQ: ARNA)  is a San Diego, California company which has recently had its drug, Belviq, a potential mega blockbuster approved by the FDA -- the first weight management drug approved in 13 years, targeting a huge global market with a safe, efficacious drug. In clinical trials involving over 8000 people Belviq showed a strong efficacy of around 8% weight loss for responders (with many achieving much more) and an excellent safety profile.

In two investor conferences this week Arena reminded the investor community what a great company it is. They have an approved product with a good chance of being a blockbuster marketed by Eisai who have experience marketing blockbuster drugs. The balance sheet looks excellent. They have a solid intellectual property portfolio. They have a strong pipeline involving several extremely interesting programs including a CB2 selective agonist for treatment of pain without addiction and psychotropic side-effects. And they're on the verge of inking more lucrative partnerships. I do not rule out an aquisition despite partnerships. Jack Leif might just surprise the shorts when they least expect it.

Wall Street misunderstood the science behind Belviq and miscalculated its chances of approval and as a result institutional ownership is very low and there are over 40 Million shares shorted. Given Arena's bright future, institutional ownership should at least double in the next few months to keep up with its peers. Even without any news, that stream of demand plus demand from short covering should propel the stock to new highs. These two articles (article1, article2) provide a good discussion on valuation of Arena by authors who understand the science much better than some analysts at big investment banks. Wall Street is still waking up to Arena's facts (vs. the fiction it was promoting for a long time) and apparently it doesn't like having missed the boat.

Credit Suisse (NYSE: CS) is Switzerland's second largest bank. My impressions of the bank have been positive – it seems to be well managed and socially responsible. However, I was completely shocked to read CS's research report on Arena. It seems to me to be so poorly researched and provide such bad investment advice based on that poor research (see APPENDIX) that I could not believe a firm as reputable as CS had written it. I would have expected something like this from some small firm commissioned by one of Arena's big short sellers to write a hatchet job to help them cover. I am not accusing CS of having done that but the report did carry enough clout to cause a big drop in the stock, and unjustifiably so because some of their arguments simply holds no water.

CS has attracted a lot of negativity online due to their report on Arena and unfortunately it is well justified. Many investors are upset because some of the report’s arguments are unfounded and the analysis is terrible (see APPENDIX). It’s a sad reminder of a long period of attacks, misrepresentations and lies about Arena by hedge funds and their analysts and journalists who were betting Belviq would not get approved. But it was approved, and overwhelmingly so. Wall Street was proven wrong.

Arena's management and shareholders are used to proving Wall Street wrong time and again. The same people who were bashing Arena when it was under 2 dollars were still bashing Arena after it sextupled in price. Shorts have pumped Arena's float with artificial supply worth 23.7%. In my opinion, that artificial supply will have to turn into real demand which would provide a boost to the share price. Shorts can’t hold down Arena forever by shorting more.

The latest attack on Arena was from a reputable bank which has actually been buying Arena's shares! Credit Suisse has been one of many institutions who’ve been adding shares of Arena since the approval. See my MF article on increasing institutional appetite for Arena. As of 6/30/2012 CS increased its holding of ARNA by 161% shares. In the same hit piece titled “Anti-Obesity Drug Market” CS touts Vivus (NASDAQ: VVUS), and Orexigen Therapeutics (NASDAQ: OREX), a familiar story on Wall Street despite heavy insider sales (Arena’s CEO hasn’t sold a single share, ever), while the increase in CS’s holding in both Vivus and Orexigen was less than their accumulation of Arena for the same period! And not to mention that Orexigen’s drug Contrave is still a long way from being approved if it ever does, and both Contrave and Vivus’ Qsymia have serious side effects and a poor safety profile compared to Arena’s Belviq, and that is precisely why so many doctors prefer Arena's Belviq. Of the numerous doctors that we have talked to every single one has said they prefer Belviq and some have said they would never use Vivus' Qsymia; and Orexigen's Contrave isn't and may never be an option.

CS's report has raised questions in some investors' minds about CS’s intentions, motivation, and at the very least competence in analysis and the quality of advice they provide to a large number of investors who rely on them and trust them in providing fair, impartial, intelligent, well-researched advice. Some investors have also questioned the timing of the report. It was released just as Arena began a spree of high profile investor conferences in the US and Europe which could have potentially helped the stock rally. Many investors attribute the drop in the stock following the CS report to the report since no other news was out, the stock was on the rise, and market indices were rising.

We also know nothing about Credit Suisse’s clients, if and how many ARNA shorts are their clients, and whether any clients or CS itself wants to accumulate ARNA. The record of some players in the industry when it comes to games and disregard for truth is not good. We know from the great work of my hero Dr. Patrick Byrne of Overstock.com (NASDAQ: OSTK) and his team including Deepcapture.com, and through other sources, that some banks and brokers do indeed tailor their research to suit their clients. Overstock.com won the Gold Stevie Award for Company of the Year; and Dr. Byrne won Executive of the Year award.

We know from other companies’ experience that some analysts put a ridiculously low price target and publish bearish arguments against a company when they have clients who are short that company. We have recorded comments from Jim Cramer admitting to manipulative practices when "in hedge fund mode". Main Street knows that when big hedge funds go wrong they try to shift truth to their favor and build a fiction and promote that instead of facing up to truth and stop trying to destroy great companies like Arena who've spent 10 years and a billion dollars to help people live a better life --  these hedge funds are destroying the very innovation that make America a global economic leader. To these hedge funds money is more important and higher than all values and virtues.

Wall Street’s policeman, the SEC, while much better in the current administration than in the previous one, could do more to tie up the hands of crooks who spread misinformation, “short & distort”, market makers who engage in abusive naked shorting, etc. The SEC in fact protects large short sellers by allowing their identity to be hidden from the public (unlike longs) and the companies they attack so innovative hard working companies never know who their enemies are. Watching the Republican speeches recently I was appalled to hear they want to abolish the little regulation there is so that Wall Street crooks have it completely their way. On a positive note, the SEC has prosecuted a few abusive naked shorting cases in the last few years, something that was never done before.

The bad news for shorts is that Arena has $143 Million in cash, will receive another $65 Million in royalty payment from Eisai by the end of the year assuming shorts don't corrupt the DEA in delaying Arena which should get a scheduling announcement any day (when Congress can legally pass on tips to hedge fund managers, I have no faith in any part of the financial system). But hedgies lost the FDA battle so I have faith that the DEA will act according to science not the fictions that some of these powerful short sellers have been propagating. The science shows that not only does Belviq have a low potential for abuse and should not be classified as a controlled substance, and is not prone to abuse, it in fact helps people get off addictions. More milestone payments from Eisai are in the pipeline for Arena.

Every doctor I've heard talking about Belviq talks positively about it. One such doctor is Dr. Louis J. Aronne, who was part of an obesity panel today. He's been part of the clinical investigations of all three obesity drugs. He spoke very highly of Belviq today especially with regards to its efficacy which is much higher than typically quoted by analysts and journalists who either don't understand or don't want to understand that placebo adjusted weight loss is meaningless.

Dr. Ed Hendricks who was part of the FDA's AdComm supported that view:

"I don't think placebo adjusted weight loss from a clinical perspective is a valid measure. I look at people who are true responders. There are plenty of people who are responders. There are 200 million people in this country could benefit from a drug like this... even 1/4 of them translates to 50 million people".

But analysts and journalists who do not understand this continue comparing apples with oranges. 

The potential market is so huge that even if Arena taps a fraction of the market it easily justifies the stock being several dollars higher than what it is now. I hope other analysts do a much better job in providing their clients a fair, comprehensive assessment of Arena and its true potential, rooted in understanding and facts, instead of on fiction and elimination of important facts. Although because Arena has reiterated it does not need to raise funds I don't expect stellar coverage by sell-side analysts whose firms often prefer to cater and "pump" companies who will need to raise funds as a way of getting their business. But I believe buy-side analysts are taking a much more objective look at Arena as evidenced by the fact that institutional ownership has been rising in ARNA while declining for VVUS & OREX. Arena will reach valuations it deserves which in my opinion is far greater than $8.60/share.

APPENDIX: These are some of the issues with the Credit Suisse report as analyzed by a good friend:

• It completely discounts the health benefit of 5%-10% weight loss, waiting for proof from outcomes trials. We already have abundant medical evidence that 5%-10% weight loss has significant cardiovascular and glycemic benefits, as well as reducing cancer risk and arthritis risk, and improving quality of life.
• It assumes that patients will discontinue the drug after they reach a weight loss plateau. That is wrong. Patients will need to stay on the drug to preserve their weight loss, and Belviq has a high tolerability which the report largely ignores.
• 11% weight loss after 1 year among responders on Belviq in the phase 3 trials was not appreciably different from the results obtained by patients taking the other, less tolerable drugs, especially if the recommended medium dose of Qsymia is considered (the label advises that patients should only be placed on the high dose of Qsymia if they fail to lose 3% in 12 weeks). If doctors try Belviq first and keep patients on it if they meet the 12-week 5% milestone, then Belviq’s market penetration could exceed that of Qsymia or Contrave. This possibility is ignored by the authors who rank the expected market share based only on average weight loss, including responders and non-responders.
• They dismiss the possibility of increased insurance coverage, but fail to note that since November of 2011 most plans, including Medicare, have covered obesity measurement, counseling, and monitoring. This recognition of the value of treating obesity could easily be extended to include pharmacotherapy, especially as new evidence accumulates.
• The assertion that “both companies [Vivus and Arena/Eisai] appear to have some sort of a ‘gentleman’s agreement’ with FDA that the launches will be ‘targeted’ with relatively small sales forces,” is completely unsupported. Both Vivus and Eisai have expressed plans to broaden sales coverage and there is no evidence of any “gentleman’s agreement,” which would be unenforceable in any case.
• The statement that “either generic substitution is an entire category issue or it’s not an issue at all” is illogical. A doctor who chooses to prescribe Belviq over Qsymia will not be heavily influenced by the fact that generic versions of the Qsymia ingredients are available.
• The authors discuss the addressable market as if it were composed only of the obese. But the approved indications include those who are merely overweight with a comorbidity. That additional indication significantly expands the size of the market. In addition, Belviq’s label includes data from the BLOOM-DM trial, showing significant improvements in HbA1c and fasting glucose among diabetics on Belviq. This glycemic effect was seen early in the trial, before much weight had been lost, and was seen even in patients who did not lose much weight.
• The possibility that Belviq benefits glycemic control through a mechanism that is partially independent of weight loss is ignored by the authors, as are other possible off-label indications with pre-clinical support, such as therapy for nicotine and cocaine withdrawal.
• Ultimately, the many pages of background and analysis presented in this report boil down to only three key parameters in projecting sales for each of the drugs: the overall size of the market, the share that will be won by each competitor, and the duration of therapy for patients on each drug. The authors' justification for their estimates on these three key parameters is very weak.
• Market projections are based on a multiple of current sales, even though the addition of 3 new drugs will completely disrupt the market. Even when considering the total size of the addressable market, the authors ignore the very large segment of overweight, but not obese, patients with comorbidities.
• The projected relative success of each drug is based purely on mean efficacy figures, without regard to adverse effects and tolerability. Belviq is unfairly rated lowest due to mean placebo-adjusted weight loss in its trials. However, because the trial designs and protocols were so different such cross-trial analysis is invalid -- for example, the weight loss for subjects on placebo in the Belviq trials was much higher than for subjects on placebo in the other trials, resulting in lower apparent placebo-adjusted efficacy for Belviq. High tolerability and safety will be key to Belviq's success despite its ostensibly lower efficacy, and the efficacy of Belviq is actually quite comparable to efficacy of the recommended doses of the other drugs when only responders are considered.
• The authors make a very questionable assumption about how long patients will stay on each of the drugs. They assume that patients will terminate therapy after achieving a weight loss plateau. This reasoning would never be applied to other indications such as hyperlipidemia or hypertension. Patients are expected to stay on cholesterol and blood pressure medication to preserve beneficial improvements, and the same will be true for weight loss medications. The key differentiators will be the extent to which weight loss is preserved with continued use and the tolerability of the drugs. The authors did not compare the drugs according to these key differentiators, which would have favored Belviq.

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