Analysts Objectivity in Coverage of the Obesity Space

REZA is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Today Orexigen Therapeutics (NASDAQ: OREX) announced a proposed public offering of common stock. Surprise, surprise! Credit Suisse (NYSE: CS)‎ and BofA Merrill Lynch ("ML") (NYSE: BAC) are two of the three book-running managers for the offering. Both Credit Suisse and Merrill Lynch have been promoting Orexigen with what appeared to me to be inflated price targets.

By the same token, both CS & ML have been wrong in issuing bearish sentiments on Arena Pharmaceuticals (NASDAQ: ARNA) which to the disappointment of some bankers has indicated it does not plan to issue new shares. Arena's bears got a big slap back in June, and they're about to get another one.

Arena has a strong cash position and a strong stream of upcoming income with sales of Belviq starting in the next few months pending DEA scheduling which many expect should be announced any day (see letters written to the DEA). Arena therefore has no business to give to big banks. This is enough to make banks turn a cold shoulder to a company. Many people assume that coverage, and particularly good coverage, goes along with getting business.

The following two streams of demand should boost ARNA's price even without significant news:

1) Some 47 Million shares of Arena are shorted because a huge short position was established betting on non-approval but shorts lost that bet - and then they've tried to raise their sales-basis by shorting more. Perhaps a delay at the DEA is their last hope. A 47 Million share short position carries what I estimate to be close to a Billion dollar loss for shorts. That's equivalent to all the money Arena has ever spent developing Belviq! With that kind of potential loss, some hedge funds out there are not having fun watching ARNA gain in price and here's the second item:

2) Institutional ownership for ARNA is at 31.6%. It has gone up from 20 something percent before approval and I estimate it will go to over 60%. That means current institutional ownership will have to about double.

Put 1) and 2) together and you get an explosive situation for short sellers. Even if the general market goes down with a low institutional% and Arena's low Beta, shorts can't count on institutions to sell due to market weakness.

Those hedge funds who are short, and the institutions who want to double their position are clients of some brokers and those brokers need to, according to how things work on Wall Street, have a bearish sentiment on ARNA until their short clients cover and until their long clients effectively double their position. 

I am not accusing ML and CS to be doing this -- we simply do not know -- but many investors believe the analysis behind ML and CS's price targets are not sound. Here are some reasons why.

In his first research report, Credit Suisse's analyst Lee Kalowski's had so many shortcomings in his analysis that we had to write a 12-point rebuttle to correct him (see appendix).

In a subsequent note, the low quality of analysis continued with phrases such as "lower mean efficacy" and "valvulopathy" as approval risks in Europe. This shows Kalowski did not understand the receptor study data that FDA used to rule out valvulopathy risks and the fact that Belviq's efficacy is indeed very good.

While the medical community believes a modest 5% weight loss can have significant improvements on overall health, two trials of Belviq showed completers lost an average of 8% of body weight and responders lost between 11% and 12% of body weight in a year. The top 25% of weight losers lost an average of 35 pounds in one year. This is spectacular. Wall Street can go around trumpeting against Belviq's efficacy but that's simply a lie. Doctors understand Belviq's efficacy can be wonderful for responders and they ultimately determine the sales amount not many Wall Street analysts who've been consistently wrong about Arena.

While European approval is not a slam dunk I believe it is highly probable due to Belviq's superior safety profile, strong efficacy, and the unmet medical need.

Another blunder related to Credit Suisse showed up in the following phrase:

"Kalowski wrote that early sales of Qsymia and Belviq could be slow because Vivus, Arena, and Arena's partner Takeda Pharmaceutical are launching the drugs with small sales force."

Takeda might end up being Arena's partner in the future but today, a) Eisai is Arena's partner and b) Eisai's sales force size is not comparable to Vivus'! c) Eisai's sales force is much bigger and they have experience in this space and selling several blockbuster drugs and Belviq will probably become their next blockbuster! Credit Suisse's analysis again doesn't live up to the famous quality standard that Switzerland is famous for.

It is also ironic that despite their negative commentary on Arena, CS actually added to their ARNA shares. As of last reporting period, CS increased its holding of ARNA by 161%!

Cowen & Co. analyst Simos Simeonidis was on record for saying patients tolerate Qsymia better than Belviq, which is simple nonsense. He continued his FUD after a conference bashing Belviq's efficacy without providing any basis for his "survey" which can be highly unscientific specially given the confirmation biases. 

Vivus (NASDAQ: VVUS) has gotten its own share of hype for a long time by analysts and journalists while insiders sell massive number of shares. The top institutional shareholders of Vivus are two hedge funds including QVT Financial and not that it necessarily matters but its General Counsel is a cousin of one of Jim Cramer's sidekicks. Regardless, Cramer's organizations have been involved in repeatedly bashing Arena.

How much do bearish sentiment have to do with Arena's prospects vs. a) the company not needing to raise money b) shorts facing a billion dollar loss c) institutions wanting to double their position? Before FDA approval we read lots of bearish arguments too - Arena bears were all proven wrong then, they'll be proven wrong again. The stock has a lot of upside potential with many catalysts which I've discussed in my other MF articles.

Wall Street can play all the games it wants but meanwhile shorts need to cover and institutions need to buy. I got an email from an attorney-investor today who said "I have lived through several biotech short squeezes and this one will be bigger than any."

Interested in Learning More?

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The views expressed above are only opinions and are NOT investment advice and are NOT medical advice. Please always do your own research. I am long ARNA and have no positions in the other stocks mentioned above. To find out more about my interests please visit www.rezamusic.com . If you like to join my private Arena-related mailing list send an email to (info -- at -- rezamusic -- dot -- com).

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