Analyst Debate: Is Arena Pharmaceuticals a Top Stock?

The Motley Fool has been making successful stock picks for many years, but we don't always agree on what a great stock looks like. That's what makes us "motley," and it's one of our core values. We can disagree respectfully, as we often do. Investors do better when they share their knowledge.

In that spirit, we three Fools have banded together to find the market's best and worst stocks, which we'll rate on The Motley Fool's CAPS system as outperformers or underperformers. We'll be accountable for every pick based on the sum of our knowledge and the balance of our decisions. Today, we'll be discussing Arena Pharmaceuticals (ARNA +0.00%), a biotechnology company that recently received Food and Drug Administration approval for its anti-obesity drug, Belviq.

Arena Pharmaceuticals by the numbers
Here's a quick snapshot of the company's most important numbers, but also keep in mind that because it's a clinical-stage company, these figures will be skewed.

Sources: Yahoo! Finance, Arena Pharmaceuticals investor relations. 

Sean's take
It hasn't been an easy road by any means for weight-loss drug companies. Both Arena Pharmaceuticals' Belviq and VIVUS' Qsymia were denied approval by the FDA in 2010 because of safety concerns about each drug. Following rigorous safety testing and late-stage results that showed moderate effectiveness for each drug, both were approved by the FDA over the summer, ending a 13-year drought of new anti-obesity drugs.

Previously, the only long-term chronic weight management choice was Roche's Xenical, but sales of the weight-loss drug have been poor because of its unpleasant digestive side effects. Both VIVUS' Qsymia and Arena's Belviq look poised to push Xenical out of the way and run away from Orexigen Therapeutics, whose drug, Contrave, is still likely two years away from marketing approval given the need to run safety trials and procure late-stage data. But between the two, which one is the better choice?

As I've laid out in recent months, I've placed my faith solely behind Arena. In trials, VIVUS' Qsymia showed a greater weight-loss reduction and was effective in procuring 5% weight loss (or more) in 83% of patients compared to Belviq's average weight loss of 3%-3.7% -- but it's more than just about the numbers.

Qsymia has no marketing partner, and sales of the drug -- which hit pharmacy shelves quicker than Belviq (it's still waiting for its DEA classification) -- have disappointed. Some of this may change now that Aetna (AET +0.00%) has granted coverage to both Qsymia and Belviq (once it reaches market), as VIVUS' chief marketing officer has admitted that his company was losing sales to patients who simply chose not to pick up their prescription because of out-of-pocket costs. Qsymia also failed to garner the support of the European Medicines Agency (Europe's FDA), which denied approval of the fat-busting drug.

Belviq, on the other hand, has all of its ducks in a row and could become the clear winner among long-term weight-control drugs. First, it has a strong marketing partner in Eisai (ESALY +0.00%). You may think having to give up potential revenue to Eisai is a negative for the company, but Eisai is covering the remaining costs of Arena's final six safety trials, and it brings an experienced marketing team to the table. 

To make a long story short, I feel Belviq will be approved in Europe, and it looks like it'll be every bit the blockbuster that Wall Street investors are expecting.

Alex's take
Let's assume that Belviq's health risks are not dangerous enough to have the drug eventually pulled from the market -- Wyeth's (now part of Pfizer (PFE +1.24%) ) Fen-Phen, Sanofi's (SNY 1.58%) Acomplia, and Abbot Labs' (ABT 1.46%) Meridia were all taken off the market over the past 15 years. That assumption may be a tall order, as Sean has already pointed out that Belviq was rejected in the past, and all three of the promising weight-loss drugs (including Orexigen's) have raised concerns at the FDA.

Now, let's break the numbers down on the obesity epidemic.

• 149.3 million Americans age 20 or older are overweight or obese.
  • 78.0 million men.
  • 71.3 million women.
• 75.0 million Americans are obese.
  • 34.9 million men.
  • 40.1 million women.

Precise statistics on European populations are much harder to find, but let's assume that roughly the same population exists as a target for the drug as exists in the U.S.

Arena CEO Jack Lief has said on CNBC that a dose of Belviq would cost about the same as a Starbucks (SBUX 0.87%) venti latte in New York City -- roughly $3.50, according to several sources. Let's assume that this is the expected retail price, and the wholesale price will be closer to $2.50 per dose. This is on the conservative side of a high-demand drug that may not make pharmacies a lot of money, as has been the case with such blockbusters as Pfizer's Viagra and Lipitor. Let's assume also that the average dosing schedule will be daily for six months. Some will stop taking it after 12 weeks as the labeling recommends, if they don't lose 5% of their body weight. Some will take it for a longer period of time.

Now that we've got that data gathered, it's table time!

All figures are assumed to be annual. *P/E calculations assume a $2 billion market cap.

Keep in mind that these are just rough calculations, not based on insurance coverage or marketing revenue splits or any other really granular statistic. And if the "latte pricing" is actually the price per pill, not per-day dosing, then you can double all of these numbers.

The only other notable prescription-strength weight-loss drug that's still available (not a new drug) is Xenical, marketed over the counter by GlaxoSmithKline (GSK 2.17%) as Alli, and that over-the-counter drug's estimated annual sales are less than $1 billion. If an over-the-counter weight-loss pill can't crack $1 billion in global sales, can Belviq? Arena's drug doesn't have the unpleasant rear-end side effects that prevented Xenical's wider adoption, but the bigger problem is that it's trying to fight a battle that many people never win.

Either users lose weight and no longer need the drug, get frustrated and no longer want to take it, or wind up with health issues. This is a very difficult call for me, because I've helped people who've struggled to lose weight in the past, and I know that the "magic pill" is a very compelling thought for the overweight. However, losing 5% of one's body weight doesn't really amount to much. For a 250-lb. woman, that brings her down to about 238 lbs. Half of Belviq's users lost 5% after a year? For many obese people, 5% weight loss is a readily attainable goal in two months tops, with a good diet and exercise program.

If the EU approves Belviq, I can see Arena reaching my high-end numbers early in the drug's life cycle. But to remain viable for the long term, Arena simply must create a new blockbuster drug, because no weight-loss drug has held a high level of sales for very long. My vote comes down to speculating on a pop from EU approval and an intense level of interest from Western consumers that's never really been seen before in the obesity-drug market.

With so much of Arena's future sales seemingly baked into its stock price now, I don't feel comfortable enough to speculate on future growth to place an outperform call. I think it has potential, but I'd rather invest in something confidently than roll the dice uncertainly. I'll sit this one out.

Travis' take
I've long been wary of any pharmaceutical stock because as investors we're really just speculating about a potential opportunity that's at the mercy of the FDA and other factors out of our control. As a member of the 10% Promise team, I've had the pleasure of covering some of these pops and plunges, including one big plunge from Arena Pharmaceuticals, and they scare me to no end.

So, when I look at Arena's $27.7 million in revenue and $1.93 billion market cap, I have red lights going off in my head. We have no idea how successful Belviq or any of Arena's other pipeline drugs will be, and we have no idea when the payoff will come.

Sure, the opportunity is big. There are a lot of overweight people around the world, but if we're talking about a potential of 5% weight loss after a year, I simply don't see this being a blockbuster.

As Alex's table points out, even if you reach an incredibly high percentage of the population with Belviq, the upside isn't all that high for investors. I'd like to see better than an 11.8 P/E ratio with rosy assumptions in a risky stock.

I've seen too many pharmaceutical stocks crash and burn to gamble the 195 points we've beaten the market by with this stock. Arena may be a smashing success, but I'm with Alex, and I'll leave it alone just based on the potential downside.

Final call
Following our discussion, we've decided that it'd be much safer to let Arena Pharmaceuticals prove it's worthy of its valuation down the road rather than chase the company any higher here. I (Sean) have stated my case for the positives, but Alex and Travis have also noted that a lack of additional current blockbusters and an almost "approval euphoria" may have pushed the share price up well in advance of tangible sales. For now, we're going to pass on Arena.

Don't let that stop you, however, from heading to our TMFYoungGuns CAPS portfolio, where you can check out our past selections -- including our selection of Green Mountain Coffee Roasters that has more than doubled.