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September 07, 2010 – Comments (5) | RELATED TICKERS: ARNA

This is my latest effort to create a bidirectional trading strategy so as not to rely excessively on upward price movement in a sideways market. Shorting biotech is simply too dangerous for me – I can tolerate 50% or even 100% losses in a long investment but not 200% or 300% losses from a short gone bad. Psychologically I prefer to buy puts ahead of binary events – I know exactly how much money I’m placing at risk and almost exactly what I stand to gain. Win or lose, it’s over and I can move on.

My recent record with binary events has been abysmal. I lost $2000 betting against phase III data for Delcath and maintained green thumbs on Vivus and Jazz through negative FDA advisory panel votes. So follow me into this strategy at your own risk.

Background:

Arena (ARNA) has developed Lorqess (lorcaserin) serotonin receptor agonist to treat obesity. Lorcaserin was inspired by fenfluramine, a similar compound remembered for being the first half of the fen-phen drug that was recalled from the market due to an unacceptable incidence of heart valve damage. Lorcaserin was developed to bind selectively to the 5HT2C serotonin receptor rather than the 5HT2B receptor implicated in cardiac valvulopathy or the 5HT2A receptor responsible for certain psychiatric side effects that were also observed. The excitement for lorcaserin has always been predicated on the concept of fen-phen efficacy without adverse effects.

In 2007, when I started watching the stock, the share price hung out in the low teens with a market cap of nearly a billion dollars. The stub suffered the indignities of the financial meltdown poorly and fell below 3 even before any phase III data was released for lorcaserin. The share price was extremely volatile in advance of the results of the first phase III trial (BLOOM) and then rapidly degraded from 4.5 down to 2.3 after weakly positive data were released: 5.8% weight loss for lorcaserin vs 2.2% weight loss for placebo.

With the broad market rebound and optimism for the second phase III trial, the share price climbed back over 5 only to journey back under 3 yet again after results of the second phase III trial (BLOSSOM) were similar to BLOOM. In July of this year, the stock suddenly catapulted from 3 to as high as 8, a rise barely impacted by the negative FDA panel vote for Vivus’ Qnexa in mid-July. This classic Bottle Imp effect was nicely predicted by Donnernv in the Chimpconest while my own Bottle Imp candidate Biodel has languished thus far.

Now all the data is in and the foxholes have been dug. The FDA Advisory Panel is set to meet and vote on September 16, one day ahead of September options expiration, and the vote is almost certain to move the share price massively. I’m estimating a 60% likelihood of a negative vote based on limited efficacy, which will send the share price back below 3 and possibly below 2.

I’ve looked at the mindset of the Arena bulls, or Areniacs, and this is my impression. Most of them fall into two categories. One is long-term Arena bulls who are deep in the red thanks to a horrendous 2008 for the stock, and are locked into the "fen-phen with no side effects" mindset they had before the BLOOM and BLOSSOM data was released. The other is short-term momentum traders who were drawn in by the 100%+ jump in July and don’t have much experience with biotech and small pharma. One group wants their losses erased, the other is slavering for another short-term 100% gain.

The crux of the bull argument is that lorcaserin technically meets the FDA  efficacy standard for anti-obesity drugs as outlined here:

In general, a product can be considered effective for weight management if after 1 year of treatment either of the following occurs:
• The difference in mean weight loss between the active-product and placebo-treated groups is at least 5 percent and the difference is statistically significant
• The proportion of subjects who lose greater than or equal to 5 percent of baseline body weight in the active-product group is at least 35 percent, is approximately double the proportion in the placebo-treated group, and the difference between groups is statistically significant

Neither BLOOM nor BLOSSOM displayed lorcaserin efficacy that met the first criterion. However, the second criterion appears to have been met in that the 5% losers were 48% vs 20% in BLOOM and 47% vs 25% in BLOSSOM.

As far as the bulls are concerned, the standard of efficacy has been met and that side of the equation can be ignored. They would rather fight the battle on the safety side where lorcaserin appears to be on solid ground. The problem with this is that the FDA standard is a guideline, not legislation. If all approval decisions were made based on numerical guidelines then Advisory Panels would not be convened and approvals would be made by a computer. As long-time pharma groupies know, nothing could be further from the truth.

The Qnexa situation was obviously very different from lorcaserin. Qnexa showed stronger efficacy but also what turned out to be unacceptable side effects. The negative vote didn’t impact Arena’s rise because observers focused exclusively on the issue of adverse effects. My interpretation is that experts in the field are not desperate for an obesity drug and are not looking for ways to rationalize approval. Side effects are certainly one reason to dismiss a drug, but marginal efficacy is just as legitimate. 5% may be an FDA standard, but is a 300 pound guy going to 285 lbs after a year really a strong justification for a new drug when non-pharmacologic lifestyle modifications have been shown to be more effective?

I think the panel is going to want the pharma companies to go back to the drawing board a find a drug that really makes a strong, safe impact on obesity before they begin throwing out approvals for marginally effective compounds. A negative vote on Arena would likely request a new phase III trial of lorcaserin and would almost certainly kill the program. Lorcaserin simply is what it is, unless possibly they run a trial combining it with phentermine. Given that the entire market cap of Arena is enterprise value and the weakness of the remaining pipeline, a share price below 1 is conceivable with this outcome.

The other factor that gives me a pessimistic perspective on lorcaserin approval is the behavior of the share price over the last couple of years. Both phase III data releases were followed by steep declines. Was that a stampede of scared sheep misinterpreting positive data? Or was it the smart money headed for the exits? On the other hand, most of Arena’s current market cap can be attributed to the July price explosion which was not predicated on any new information. Does smart money suddenly pile into a stock ahead of a binary catalyst without any justification for a price change? Or was this a momentum-driven Bottle Imp effect?

I’ve spent a little time looking at the put prices for September expiration. The one I like right now is the 6 strike, with an ask of 1.55 at the close on Friday. The break-even price would be 4.45. If I buy $2000 worth, I’ll reap $1870 with a drop to 3 and $3160 with a drop to 2 (more likely). I’ll also have a little bit of insulation if a close vote doesn’t move the price as much as expected. By comparison, the 5 strike is at 1.15 with a break even of 3.85. $2000 worth of puts would render profits of $1480 with a drop to 3 and $3220 with a drop to 2.  I don’t want to be dependent on a drop below 2 to come out ahead.

If I’m right in my 60/40 assessment, the September 6 puts are a good deal. But I couldn’t have been more wrong about Jazz and Xyrem last month. The panelist remarks seemed to me like they were coming from another planet, and I had absolutely no clue about the outcome of that vote. So I think I’ll hold out a little longer, hoping for another upward surge in Arena’s share price before the vote (8 would be nice) and a drop in the put price to 1.4 or lower. Also, a last minute postponement of the panel would be a lousy reason to lose $2000.

OK, let the hate flow …       

5 Comments – Post Your Own

#1) On September 07, 2010 at 8:04 PM, drmanand (67.11) wrote:

Hi

Very well analysed.

I would like to add while approving a drug for weightloss the side effects are paramount ,because of millions and millions using them. I think FDA will likely approve it even though efficasy  is low because of no other alternatives.The other alternatives like surgery has way too many complications and risks.  

The other main advantage with the drug is no weight gain.The drug even if does not help 40% to loose weight it atleast helps them from not gaining extra pounds each year 

 

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#2) On September 08, 2010 at 4:15 AM, clawmann (< 20) wrote:

I am long ARNA, and have been so for about a year. So I am not in the red, nor am I a momentum trader.  I have read almost everything published about  lorcaserin over the past three months.  Quite frankly, I think the chances of a positive panel recommendation are much higher than you have estimated.  The efficacy numbers are actually quite good, when one considers that obesity physicians are saying that even a 5% weight loss can "have a significant impact" on the health of their patients.  And a significant percentage (I believe 25%) of the clinical trial patients lost in excess of 10%.  So I really don't think the panel is going to focus too much on the efficacy issue.

Lorcaserin actually demonstrated a modest positive effect on CV biomarkers  (in contrast to to the negative effects demonstrated by nearly every other weight loss product that has been approved or is seeking approval).

The main question will be do the benefits (although not fantastic) outweigh the rsiks?  And the side effects have been shown to be very very modest.The main issue here will be about valvuopathy, as you indicated; and ARNA's clinical trials involved regular monitoring for this, and there was no statistically significant difference with the placebo group.   The "valvuopathy" question came up because lorcaserin is chemically related to the dangerous "fen" component of fen-phen.  But lorcaserin demonstrated a 104X selectivity for the  5HT2C receptor over the 5HT2B receptor in vitro (in the test tube), which is good but not great.  However in vitro results are often very different than in vivo (in a living organism) results, which is why clinical trials are conducted.  The results of the clinical trials seem to strongly suggest that the in vivo selectivity is much bettter than the in vitro selectivity.

I suggest you take a read of the July 2010 peer-reviewed article on loracserin in the New England Journal of Medicine.  http://www.nejm.org/doi/pdf/10.1056/NEJMoa0909809   The last paragraph of the article reads: "In conclusion, lorcaserin used in conjunction with behavioral modification was associated with significant weight loss and improved maintenance of weight loss. Lorcaserin was also associated with improved values for biomarkers that may be predictors of future cardiovascular events, including lipid levels, insulin resistance, levels of inflammatory markers, and blood pressure." 

Qnexa did not have such an article.

Furthermore, the American Society of Baritaric Physicians has written a letter to the advisory panel and the FDA urging the approval of lorcaserin.

Nothing like this was written on behalf of qnexa. Indeed, qnexa's failure to get approval was attributable, I think, to the criticsms leveled at it during the panel by Dr. Sidney Wolfe of Public Citizen. 

So when comparing VVUS to ARNA, it is necessary to highlight the very stark differences in the science and the support of the medical community.  One more point: ARNA is coming to the panel with two years of robust data. VVUS came in with one. One is not good enough for a long-term obesity drug, and the panel said as much in July at qnexa's review.   

Piper Jaffray came out with a note yesterday saying the ARNA is a buy through the FDA PDUFA date of October 22.  JPM has conservatively put lorcasein's chances of approval at 65%.

I hold a significant amount of ARNA shares, but have appropriately hedged against the possibility that things may not go ARNA's way next week, but if I had to estimate lorc's chances at approval, I would put them at about 80% right now. If lorcaserin gets a decidedly positive rec next week from the panel, that number will got to at least 90%.  In the world of small biotechs with potential blockbuster drugs up for approval, it really does not get any better.

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#3) On September 09, 2010 at 6:21 AM, clawmann (< 20) wrote:

One more thing: in doing my resarch on lorcaserin, I heavily discounted any article that mentioned Arena's stock symbol. The truly scientific reviews barely mention Arena, much less the stock symbol.  That's the kind of information that I find most trustworthy; the stock-related stuff is almost always selling something.  

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#4) On September 09, 2010 at 7:13 AM, 1337172979 wrote:

Good article, ZZ. I was lucky and took advantage of the 100% revalorization of ARNA in july and exited with the same gain percentage in my account. I thought of holding some shares to go through the panel next week but finally decided not to do so. Why? well, I used to be an Arena maniac myself until I read the NEJM paper right at the end when it mentions that the study -BLOOM- itself does not rule out the risk of valvulopathy. I had a light bulb moment and decided to go research deeper and see what was going on. Turns out that supposedly, if we pooled both ph III trials, BLOOM and BLOSSOM, we'd get statistical power enough to rule out such adverse event, but I haven't found the numbers anywhere besides others Areniacs comments and a press release by Arena.

Like you well mentioned, when both trials results were released a year ago, the price dropped and even some institutional investment firms downgraded the stock. What has changed since then? yes, nothing at all apart from an FDA panel date and massive speculation.

 A final comment: one may have a load of reasons on the Yes side or on the no side, but remember: playing FDA panels and PDFUAs is just that, a play, a gamble. You never know what´s gonna happen at the end of the day, so if you're long ARNA, try to reduce at least 75% of your stake, cover your gamble with some puts or simply play the call/put game.

 PS I also thought Vivus' Qnexa was going to get a positive recommendation and that the efficacy was going to outweigh the risks...c'est la vie.

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#5) On September 16, 2010 at 7:06 PM, zzlangerhans (99.80) wrote:

@ #4 - congratulations on being open-minded and being one of the minority to profit from Arena. My goal as a biotech investor is to remain completely objective and unattached to any story. I believe those of us who adopt this approach will continuously siphon money from the masses who cling to their formed opinions with white knuckles.

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