In the Biotech "Arena"

05/12/2006 12:00 am EST

Focus:

John McCamant

Editor, Medical Technology Stock Letter

Exclusively focused on biotechnology, The Medical Technology Stock Letter is an essential resource for those who invest in the biotech arena. Here, editor John McCamant discusses his latest buy--Arena Pharmaceuticals, a player in small molecule therapeutics.

“We are initiating coverage of Arena Pharmaceuticals (ARNA NASDAQ) with a buy recommendation. ARNA is an exciting development-stage biotech company that we have been tracking for quite awhile now. They are focusing their efforts on the development of orally-available, small molecule therapeutics in four significant disease areas: metabolic, central nervous system, cardiovascular, and inflammatory diseases.

“To this end, they currently have four clinical-stage drug candidates. Lead amongst these is their intriguing drug candidate, ADP356, which recently produced positive results in a Phase IIb trial for obesity, and is slated to enter Phase III testing in the second half of this year. ADP356 is still unpartnered, and as such, we believe a marketing partnership for this drug candidate could provide just one of multiple potential catalysts for ARNA's stock.

“And, in addition to a promising portfolio of drug candidates, ARNA is also well capitalized. They ended 2005 with nearly $130 million in the bank, and thanks to a well placed stock offering in January, raised an additional $170 million. Based on their current burn rate, this would represent roughly three years of cash, and that figure does not include any funding from potential partners.

“ARNA's stock had been on quite an upward ride through the first half of March. However, since that time, the stock has now corrected over 25% from its mid-March high, and is now well below the January offering price of $16.90. As a result, the company now has a market cap of under $500 million--a valuation which we believe is providing an excellent entry point for purchase (and at even more attractive levels than for those who participated in the offering).

“In the firm’s recent conference call, they noted that the Phase III trial for lorcaserin hydrochloride (the nonproprietary name selected for APD356) for obesity treatment is still on track to start in the second half of this year, and ARNA indicated that the Phase II trial for APD125 for insomnia treatment is most likely going to start in the fourth quarter. However, we believe that the call served a much larger purpose in that it set investors at ease that things are progressing well at ARNA.

“They also indicated that they continue to have discussions with potential partners for lorcaserin. As we have stated, we believe that there has to be a lot of interest in this product candidate, given the enormous size of the obesity market, combined with the results on lorcaserin produced thus far. However, based on management's comments, we don't expect them to settle for anything but the most lucrative of terms.

"To that end, we get the sense that if they cannot attract terms which are acceptable for them and their shareholders, then they are fully prepared to fund future development on their own--and their recent $169 million follow-on offering will certainly help them in that regard.

“In the meantime, we look forward to the presentation of the positive results from the Phase IIb trial for lorcaserin on June 12 at the annual ADA meeting. This forum will definitely serve as a showcase for potential lorcaserin partners. ARNA also expects to present the positive Phase I data on APD125 at the annual APSS meeting on June 21. Additionally, we can expect further evidence of progress from within one of ARNA's partnered programs shortly, as management anticipates that Merck will begin Phase II testing of Niacin (an elevator of HDL, or ‘good’ cholesterol) shortly.

“We believe that the recent correction in the stock price is overdone, and that buying the stock anywhere in here will produce excellent long-term returns. ARNA is a buy under $17 with an 18-24 month target of $35. In addition, we are going to buy 5,000 shares of ARNA in the Trader's Portfolio.”

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