Will the FDA Approve Arena's Obesity Drug?

I'm never one from shying away from giving my opinion, but I have no idea whether the Food and Drug Administration will approve Arena Pharmaceuticals' (Nasdaq: ARNA  ) obesity drug lorcaserin tomorrow.

Not being 100% certain about a binary event isn't necessarily a deal-breaker for buying ahead of the event. The fair value of a company is described by this fairly simple formula:

Fair value = Expected price if positive * Likelihood of success Expected price if negative * Likelihood of failure

If a drug has a 75% chance at success and the shares will be $10 if successful and $4 if unsuccessful, then the fair value is $8.50 (10*0.75+4*0.25). If shares are trading below that price, and you're willing to risk the 25% chance of it going to $4, buying shares makes empirical sense.

Good luck filling out the formula for loracserin
First of all, you probably have to add another layer to the formula, because there are two potentials for negative events. The FDA could reject the drug, asking for something extreme, or it could reject the drug for a minor issue that would have a negligible effect on the price.

Calculating the potential price after the events is a little hard with share prices whipping around widely, but options can give you some clues.

Determining the likelihood of success or failure is more difficult. If you look at the advisory committee minutes, it's fairly clear the panel was content with the risk-benefit analysis given the current body of information, but many panel members wanted the drug studied further after it's put on the market.

Everything since then is a black box
Did the FDA follow the panel's advice and ask for post-approval commitments? And if it did, did Arena have enough time to submit documents and have the FDA review them? The FDA delayed a decision on VIVUS' (Nasdaq: VVUS  ) obesity drug Qnexa after it turned in post-panel paperwork, but Arena seems to have a date with destiny tomorrow, which could be a bad sign.

There's a real possibility that the FDA doesn't want to deal with post-approval issues because it plans to reject the drug. In the briefing documents for the advisory panel, one FDA reviewer was worried that compiled data that included patient information added after the first review had pushed the potential risk of heart valve issues beyond an acceptable level.

The advisory committee wasn't worried about it, but that doesn't necessarily mean the agency won't ignore the advice as it did with Orexigen Therapeutics' (Nasdaq: OREX  ) Contrave. The company went from leader of the pack to trailing wildly when the agency made the biotech run a large preapproval trial to study potential heart problems.

A similar requirement would sink Arena. If it fell to Orexigen's market cap, Arena would lose more than 80% of its value. What's the likelihood of that? There's no way to know for certain without being in the FDA meetings. I tend to think it's pretty low, but putting an exact number on it is difficult. Plugging in 5% versus 25% in my formula gives wildly different valuations because it has so far to potentially fall.

Most investors would be best off waiting until after the FDA makes its decision and then base the valuation on potential sales of the drug, which is certainly less opaque and a little more straightforward.

But that's no fun
Then buy it or short it. It's your money. Just realize that you're investing into a black box and anyone who tells you with certainty that the drug will or won't be approved is delusional. I'd strongly suggest you keep your investment to a reasonable portion of your portfolio.

Think I'm being too cautious? Have it all figured out? Take our poll below and talk to us in the comment box.

Fool contributor Brian Orelli holds no position in any company mentioned. Check out his holdings and a short bio. The Motley Fool has a disclosure policy. We Fools don't 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 (11) | Recommend This Article (19)

Comments from our Foolish Readers

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 26, 2012, at 8:29 PM, genesis667 wrote:

    The one that most likely will be rejected is Qnexa. Having birth defects as one of the side effects is simply not acceptable. Lorcaserin will be approved tomorrow. Watch and see!

  • Report this Comment On June 26, 2012, at 8:34 PM, helpmesav wrote:

    You are so far off. This is preposterous: "There's a real possibility that the FDA doesn't want to deal with post-approval issues because it plans to reject the drug"

  • Report this Comment On June 26, 2012, at 8:42 PM, dambruoso wrote:

    what's changedBrian????.....you were more upbeat about approval 7 days ago.....than you are now......what has changed??......the PPS dip???......has something leaked???......you've know all along about all of this........why now are you not sure???......please respond.

  • Report this Comment On June 26, 2012, at 9:25 PM, dmsrz8 wrote:

    truly, based on the safety profile alone, I would say that this has a decent shot. Though, Brian is correct that the panel did ask for or at least recommend post-approval studies to be done. They would not have done that were there no concerns with the side-effects. So, seeing as they were effects related to the heart, and obese individuals often have heart conditions to begin with, the concern is pretty valid. Anything else and I would say this was a sure thing, but the two do not exactly work well together.

  • Report this Comment On June 26, 2012, at 9:31 PM, bigperformer wrote:

    I dont know how you came up with a formula? I dont understand your logic beyond your formula. ARNA is superior than VVUS. I would never recommend FDA to approve VVUS because its confirmed that it causes birth defect problem whereas with ARNA nothing is confirmed and everything shows evidence of no issues.

    Let me ask you how you guys were allowed to write an article like this from respected website like Motley Fool. whats happening here. I am very dissapointed.

  • Report this Comment On June 26, 2012, at 9:32 PM, lgcret wrote:

    non approval means more obesity and that is as has been said before UNACCEPTABLE. Surely the first voters wouldn't lie, just to give the American people a new hope only to be led astray again, right?

    It will be approved, but on the shelf is the bigger question.

  • Report this Comment On June 26, 2012, at 10:16 PM, steamoil wrote:

    While I can't wait for the FDA decision already, the anticipation level is at its peak. To make matters worse I just finished reading one of the FiercePharm articles published today called Pharma's Top Ten Marketing Settlements. IMO I think the FDA could be on the side of caution in approving new drugs where they feel there may be litigation down the road if a drug or drugs causes injury or worse. I want to see ARNA approved just like everyone else, but the FDA may have other ideas.It's amazing how all of us investors have become versed in various aspects of the medical profession.Have we all become "Brain Surgeons" LOL GLTUA

  • Report this Comment On June 26, 2012, at 10:50 PM, rshive34 wrote:

    If the drug is approved tomorrow what does everyone expect it to go to. I owned it before it got the thumbs up from the approval committee and doubled my money. I bought back in after that. Does everyone expect the stock to double again if it is approved?

  • Report this Comment On June 26, 2012, at 11:38 PM, morningstara wrote:

    Just as an FYI, as a physician myself I RARELY Rx a new drug BECAUSE of the litigation/side effects that come down the pike w/in the first few years. I'm going to WAIT on this one. Too. Even if it is approved, any litigation about adverse effects will be disastrous, as the drug has a mechanism of action that has the potential....perhaps I err on the side of caution...

  • Report this Comment On June 27, 2012, at 6:35 AM, corvettjett wrote:

    GO ARNA !! It will be approve , people talk about it just they own opinion ,they are not FDA panel .

  • Report this Comment On June 27, 2012, at 6:48 AM, life43 wrote:

    Even doctors know that the FDA will approve the drug!

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