Arena Keeps Burning the Cash

Clinical-stage drug developer Arena Pharmaceuticals (NASDAQ:ARNA) reported its second-quarter earnings yesterday. With the company's cash-burn rate having more than doubled over the past year, from $19 million to $39.1 million, I have to use the word "earnings" pretty loosely, but given what the money is being used for, it's hard for investors to complain.

Specifically, most of the increase was due to increased research and development costs associated with two trials -- phase 3 clinical trials for lorcaserin in treating obesity, and phase 2 trial testing for APD125 in treating insomnia. Investors won't have to wait too long to see what they've been paying for, either: Results from both trials are expected in the third quarter.

Early indications from locaserin's phase 2 trial are that the drug works quite well in reducing weight in obese patients. The company plans to start two additional clinical trials later this year, so it will be a while before Arena files a New Drug Application with the FDA.

Arena has collaborations with Johnson & Johnson's (NYSE:JNJ) Ortho-McNeil Pharmaceutical subsidiary and with Merck (NYSE:MRK), from which it receives some revenue from milestone payments. But those collaborations are for compounds in early-stage development. Its two most promising drugs, lorcaserin and APD125, were developed in-house and don't currently have partners, so Arena is footing the entire bill for their development.

Fortunately, the company does have some time before it runs out of money. It has $371 million in the bank from two follow-on stock offerings in 2006, resulting in a $334 million cash infusion. It also increased its cash position this quarter by selling and leasing back a building it owned for $48 million. At the end of the year, Arena expects to have $259 million to $271 million in cash and equivalents -- sill plenty of money to get it through the development of lorcaserin.

That's crucial, because Arena will live and die by the results of the lorcaserin trial. If the first trial is successful, the company should consider bringing in a marketing partner -- not so much because it needs the cash, but because it will allow Arena to share the financial risk of later trials and the FDA approval process. Sanofi-Aventis' (NYSE:SNY) recent FDA troubles with its anti-obesity drug rimonabant should stand as a warning. While Sanofi can afford to take a hit, Arena is too small to play that game alone.

As Motley Fool CAPS player skat5 sums it up, "I expect [more than a] double [in the stock price] if it gets approval and a similar drop if it does not."

That's biotech for you -- you live and die by the FDA's rulings.

Participants in Motley Fool CAPS have given Arena a four-star rating, with bulls outnumbering bears 193 to 10. If you've got an opinion on the company, open up a free account and play along! Or check out Motley Fool Rule Breakers, where the best high-growth stocks get our seal of approval. It's free for the first 30 days.

Johnson & Johnson is an Income Investor recommendation.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. He blogs about small biotech companies at BabyBiotechs.com. The Fool's disclosure policy is rock-solid.