Orexigen Therapeutics: Light at the End of the Tunnel?

Orexigen Therapeutics (NASDAQ: OREX  ) has recently announced that the interim analysis of its Light Study for its lead obesity drug candidate Contrave has clearly achieved the goal set by the Food and Drug Administration.

Since the FDA has previously agreed that if the interim analysis meets the specified criteria to exclude cardiovascular risk Contrave could be approved, Orexigen intends to submit a new drug application for the product in the next few weeks and expects possible approval by June.

Right on the heels of the announced good news, Orexigen declared its intention to raise $100 million in convertible senior notes offering that matures in 2020 and carries 2.75% in annual interest. Orexigen shares, which rose on the positive Light Study interim news, slightly declined following the announcement of the convertible notes offer.

Contrave potential
The obesity market is potentially huge; however, Orexigen's Contrave is not a revolutionary new product but rather a combination of two old generic active ingredients, Bupropion and Naltrexone, in a slow-release formulation.

Orexigen has partnered with Takeda -- which will market the product, once approved, in the North American market -- and is actively looking for a partner to help with marketing the product in Europe.

Given the elusive nature of the obesity market and the limitations of a generics combination product, Contrave may prove to be an interesting brand but does not have blockbuster potential.

Competing Brands
Once approved and launched, Contrave will have to compete with Genentech's Xenical, Arena Pharmaceuticals'  (NASDAQ: ARNA  ) Belviq and VIVUS' (NASDAQ: VVUS  ) Qsymia. Of the three, Qsymia bears the most resemblance to Contrave. 

Qsymia, which was launched in September 2012, is also composed of two old generic active ingredients, Phentermine and Topiramate, in a slow-release formulation. However, Qsymia has performed disappointingly since launch and has generated only $16 million in sales during the first nine months of 2013, causing Vivus shares to tank. 

Belviq, which was launched in late June in partnership with Eisai Pharmaceuticals, is designed to stimulate serotonin receptors in the brain linked with feelings of satiety. During its limited time on the market, Belviq proved to be a slow grower, partly due to a Schedule IV controlled substance classification and partly due to minimal insurance coverage. Since Arena's shareholders expected a faster growth rate, Arena's shares took a hit and are currently trading 34% lower than their levels in mid-June, before Belviq's launch.

Orexigen financials
At the end of September, Orexigen had cash and cash equivalents of approximately $49 million, achieved less than $1 million in revenue for the quarter while posting approximately $19 million in loss.

A simple back-of-the-envelope calculation would tell that, at current cash burn rate, Orexigen had slightly more than half a year to go on its current cash. As a result, Orexigen had to go back to the street for more cash and the company issued a $100 million convertible senior notes offering.

The notes, which will mature on December 1, 2020, will pay interest semi-annually at a rate of 2.75% per year. Initial conversion price of the notes is approximately $8.19 per share of common stock and represents a premium of approximately 32.5% to the $6.18 per share closing price of the Company's common stock on Dec. 2.

Orexigen estimates that the net proceeds from the offering will be approximately $96 million and intends to use the proceeds for working capital and other general corporate purposes.

Orexigen Valuation

Orexigen started the year at $5.25 and currently trades at more than $6.10, down from its $7.66 peak but with a gain of 16% for the year. If Orexigen were a true medical biotech company, its current valuation could be justified; however, given the fact that its lead product candidate is a combination product of two generic ingredients, I believe Orexigen's current valuation is rather excessive.

Foolish takeaway
Orexigen's $100 million convertible senior notes offering is potentially dilutive. Given the fact that Orexigen current valuation is $620 million such a note could be dilutive to the tune of 14%. I might be interested in investing in the notes and getting 2.75% per year for risk taken but would not suggest entering Orexigen at the current price.

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