ARNA: Analysis of Risk and Reward

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

The last year has been an interesting one in the Bio Technology industry, as a number of drugs have gained FDA approval. The Food and Drug Administration has given its nod of approval to a number of drugs, including Vivus' (NASDAQ: VVUS) Qsymia, Arena Pharmaceutical's (NASDAQ: ARNA) Belviq, Gilead Science's (NASDAQ: GILD) Stribild, Pfizer's (NYSE: PFE) Xeljanz, etc. Amarin's (NASDAQ: AMRN) Vascepa also received FDA approval last year. The obesity drug approvals are by far the most interesting development in the Bio Technology industry this year.

As the chart below shows Arena has been relatively stable and Vivus has slumped after its September launch of Qsymia. The huge 50% decline in Vivus after Qsymia launch is an indication that Arena can also suffer after Belviq’s launch. This is why the short ratio on Arena is 6.5 and 34% of  the float is currently short. The stock is trading at only 10% to mean target price from sell side analysts. Due to this low upside and high uncertainty, I advise new investors to stay away from Arena. I do not recommend a short position because as my discussion below shows, Belviq is a good drug and is compared safer than its rival Qsymia.

As the chart below shows, Vascepa, Qsymia and Belviq pushed their respective stock prices to new highs. A look at the chart also reveals that the stock price has plummeted after the initial hype diminished. The stock which has suffered the most has been VVUS, followed by AMRN and the least affected has been Arena. Arena has suffered the least primarily because of the following two reasons:

  1. Belviq is safer as compared to Vivus's Qsymia. Trail results have shown that Qsymia can cause birth defects and is therefore not allowed for pregnant women. The side effects of Qsymia are not only limited to pregnant women, as some subjects in clinical trials suffered from increase in heart rate and a condition called metabolic acidosis. Metabolic acidosis can lead to hyperventilation, fatigue and anorexia. However, Qsymia was also more affective as during the trails, patients on Qsymia went from an average 227 pounds to 204 pounds; on Belviq, the average weight dropped from 220 to 207.
  2. As the chart below shows, ARNA's rise after the approval was less dramatic as compared to Vivus because Vivus's drug was the first drug to get FDA approval; the approval of Belviq caused depreciation in Vivus’s stock price.

Hold Arena

The stock depreciation has been much lower in ARNA as compared to VVUS; ARNA has depreciated only 25% from its peak price in July. The lower price depreciation, is attractive for existing investors, it is not so for new investors because there is comparatively lesser upside potential. ARNA is currently trading at $8.67 and the mean target price by sell side analysts is $9.6, which represents 10% upside. Belviq has a lower success ratio as compared to its primary competitor, but a better safety rating.

ARNA data by YCharts

Launch Uncertainty

As I have explained above, Arena has been a less volatile stock because VIVUS was already there to curb expectations from Arena. The investors got very excited about the obesity market after FDA gave its nod to Qsymia, but shares slumped once Belviq also received approval. The share price of Arena did not see highs similar to Vivus because the market was already expecting a post approval fall in price, therefore the stock remained stable. Vivus launched Qsymia in mid-September; the stock has lost approximately 50% of its value since then. ANRA has, approximately 61 million shares short (34% of float) and a short ratio of 6.5. This shows that investors are expecting the drug launch to be below expectations and result in a share price decline.

Conclusion

I believe the stock is trading at near or equal to its target price (also shown by mean sell side target price above). Arena and Eisai are expected to launch Belviq in the 1H2013, and the future of Belviq depends on this launch; as the future sales of ARNA depend on Belviq. The short ratio is already very high, which shows investors expect the launch to bring the price down. Therefore I will recommend current investors to hold and advise new investors to stay away from Arena in light of limited upside and high launch uncertainty.

 


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