Staying Neutral on Arena Pharma

Arena Pharmaceuticals, Inc.'s (ARNA - Analyst Report) leading pipeline candidate, lorcaserin for obesity, is in phase III trials. Although we remain somewhat skeptical of the drug's sales potential, the stock is beginning to look attractive on a long-term basis given its likelihood of signing a commercialization partnership for lorcaserin after March 2009.  Additionally, Arena is well capitalized in the near-term.

Both the obesity and insomnia markets are enormous and highly under-served.  As such, the idea of lorcaserin for obesity and APD125 for insomnia is fantastic, but both products fall short of blockbusters in our view, given the data presented so far.  For lorcaserin to compete effectively against other late-stage obesity candidates, and attract a sizable partnership from a large-cap pharmaceutical company, the phase III data must show a significant improvement in weight loss at the 24 week and 48 week timeframe versus what we have seen so far after 12 weeks in the phase IIb program. 

Unfortunately, this phase III data on lorcaserin will not be available until March 2009.  Until then, we do not believe the stock will rally or the company will be able to form a partnership for commercialization.  This is the big event most investors are waiting for.  And, as for APD125, with the market flooded with generic Ambien and Ambien CR in 2009, we do not believe large-cap pharma will be interested in co-developing the drug.

Interestingly enough, the product with potentially the biggest market opportunity at Arena is APD791 for arterial thrombosis. The management just released positive phase Ib safety, pK and pD data in July 2008.  A partnership on APD791 could push development forward into phase II trials in 2009.

We believe that the company's pioneering research into G protein-coupled receptors will eventually lead to significant advantages in developing commercially viable drugs for various diseases.  The company also has a strong cash position and two high profile collaborations with J&J and Merck.  Our model assumes the launch of lorcaserin in late 2010.  However, we do not predict profitability before 2012. 

That said, we note that our current model assumes only modest upfront collaboration milestones and little expense reimbursement.  This could change greatly after March 2009 with a lorcaserin deal.  This may be just what the stock needs to find that bottom and begin to head back up to our $10 price target.

Read the full analyst report on ARNA