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3 Reasons to Buy Arena Pharma

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Arena Pharmaceuticals' (Nasdaq: ARNA  ) obesity drug lorcaserin is currently under review, with a Food and Drug Administration decision expected on or around June 27. Buying in front of such binary events can provide substantial gains, as witnessed by the post-approval jumps following the FDA decisions on Amylin Pharmaceuticals' (Nasdaq: AMLN  ) Bydureon and Discovery Laboratories' (Nasdaq: DSCO  ) Surfaxin. Here are three reasons you might want to buy Arena.

FDA advisory committee vote
Last month, a panel of outside experts reviewed the drug and recommended approving it by an 18 to four margin. The advisory panel vote is important, but the FDA doesn’t have to follow the panel’s advice. Orexigen, for example, received a positive advisory committee vote for its obesity drug, Contrave, but was ultimately rejected by the agency. But Orexigen’s smaller margin of victory, at 11 to eight, should give investors confidence that Arena won't follow in its footsteps.

In addition to getting outside expert's options, the advisory committee provides an opportunity for investors to sneak a peek at what the agency is thinking in public briefing documents provided for the panel. Based on those documents, it seems the FDA is no longer worried about issues around cancer risk. As long as the agency buys the advisory committee’s view that heart risks can be dealt with post-approval, lorcaserin should be approved.

Potential market
In case you haven't noticed, Americans are getting fatter, and most people are too lazy to do anything about it. If empirical observations aren't good enough, check out the graphs in this article, with cold hard data to prove we're getting fatter. Now, of course, we could shed those pounds with diet and exercise, but we won’t. When given the choice, most people will take the easy way out, opting to pop a pill daily rather than suffering to shed the pounds.

It’s hard to know what the potential market size for obesity drugs is, because earlier offerings have been hampered by poor risk-to-benefit ratios, which led to Abbott Labs' (NYSE: ABT  ) Meridia and Wyeth's Fen-Phen getting pulled off the market.

The only remaining prescription obesity drug on the market, Roche’s Xenical, hasn’t been a big seller, because it works by blocking the absorption of fat, which then passes through the body. As you can imagine, adding fat to excrement creates an undesirable side effect.

Even if Arena has immediate competition from VIVUS's (Nasdaq: VVUS  ) Qnexa, the market still appears large enough to support both drugs. Vivus is scheduled to hear back from the FDA next month. Neither drug is going to be able to help all patients, leaving plenty of market share for Arena to feast on. And even when the drugs help patients lose weight, there’s often a plateau. We may see patients yo-yoing back and forth between the two drugs.

Pharma backer
Arena isn't in this alone. Japanese drug maker Eisai Pharmaceuticals is backing it, and will be in charge of marketing the drug in North and South America.

I wouldn’t put much emphasis on Eisai licensing the drug as an endorsement of the product. The pharma only paid $50 million for the U.S. rights back in 2010 and is only on the hook for $90 million when the drug is approved. Eisai set up the deal so that Arena gets paid well if the drug sells well. In addition to earning a percentage of net sales, there are $1.2 billion in potential milestone payments that are triggered if the drug is a commercial success.

Getting there will be a lot easier with the marketing muscle that Eisai will provide. Having a partner in place should allow the company to hit the ground running once it launches, something VIVUS might have trouble doing because it doesn't have a big-pharma partner.

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Fool contributor Brian Orelli if off to the gym after filing this story. He holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Abbott Laboratories. The Fool's disclosure policy is skinny but packs a punch.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (1) | Recommend This Article (21)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 15, 2012, at 9:29 PM, DeleteTheAccount wrote:

    Thanks for the contribution and have fun at the gym!

    I think that Arena needs more credit for the deal it struck with Eisai. It gets a good percentage of net sales, potentially over one third. It's not front-end loaded, so when it was announced, some expressed disappointment. Once the drug is approved, I think Jack Lief will be praised for his farsightedness. He also built a small-scale manufacturing facility in San Diego, which is something practically unheard of among emerging biotech companies. He also struck a deal to secure a finish dosage form manufacturing facility in Switzerland, which is now looking like a clever move.

    Of course, the downside is that if the drug is a blockbuster--a big if--it makes sense for Eisai to write a check for $3 or $4 billion and buy Arena outright. I don't expect it to happen, but I do expect Arena to have a steady flow of cash from the deal, which will be used to beef up its pipeline further.

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