No One's Losing the Diet Pill Battle

07/03/2012 11:45 am EST

Focus: STOCKS

James Fink

Editor, Jim Fink's Options for Income and Stocks to Watch

While the stocks of the biotechs with new diet pills gain volatility here, there's still plenty of value, reports Jim Fink of Investing Daily.

As a person whose body mass index (BMI) has routinely been measured above 30—the threshold definition of “obese”—I was glad to read that on June 27, the Food and Drug Administration (FDA) had approved a new diet pill for the first time in the last 13 years.

Shareholders in Arena Pharmaceuticals (ARNA), the developer of the “Belviq” drug, have been amply rewarded; the stock is up almost sixfold since March.

According to Janet Woodcock, director of the FDA’s Center for Drug Evaluation and Research: "The approval of this drug, used responsibly in combination with a healthy diet and lifestyle, provides a treatment option for Americans who are obese or are overweight and have at least one weight-related comorbid condition."

A comorbid condition is something like high blood pressure, high cholesterol, or type 2 diabetes. Since I fortunately don’t suffer from any of these conditions (yet), the approval doesn’t directly apply to me, but it is within a doctor’s discretion to prescribe drugs “off label” for conditions other than what the FDA approved the drug for, so I still have a shot.

The drug was approved because patients who took it for one or two years combined with diet and exercise lost between 3% and 3.7% more weight than those who took a placebo with diet and exercise. About half of the patients (47%) taking the drug lost at least 5% of their body weight.

If these percentages don’t thrill you, I agree, they are pretty insignificant. The difference between losing ten pounds and 10.3 pounds isn’t going to change anyone’s quality of life. But slightly effective is better than nothing and deserves FDA approval.

The twice-a-day treatment costs $4 per day ($1,460 per year)—which isn’t cheap, especially if health insurers refuse to cover it because its weight-loss effect is so muted.

Arena’s stock has performed so well because the market opportunity is immense. According to the Centers for Disease Control and Prevention, more than one-third of adults in the United States are obese (i.e., more than 78 million people). By 2030, the obese percentage in the US is forecast to rise even higher, to 42%.

Worldwide, 500 million people are obese. Based on these sad demographic trends, analysts expect that annual sales of Belviq could reach $2 billion by 2020.

Even after the stock’s huge run-up, Arena’s current enterprise value is only $2.08 billion, which amounts to about 2.1 times projected 2020 sales. Since biotech stocks trade on average for 4.3 times sales and buyouts are done at 20 times sales, one can quickly see how easily Arena’s stock price could double or triple over the next eight years if sales projections are anywhere near accurate.

So why is the stock down 10% last Thursday? I can think of a few reasons:

  • Buy the rumor, sell the news. A little profit taking is understandable after a 600% run-up!
  • FDA approval does not mean the drug can immediately be marketed. A four- to six-month review by the Drug Enforcement Agency (DEA) must be completed before selling can begin.
  • Belviq may cause health problems, including cancer, heart valve damage (remember Fen-Phen?) and serotonin syndrome, which is an overdose of a neurotransmitter in the brain that can cause hallucinations, rapid heartbeat, and anxiety).
  • Competing diet drugs may soon be approved, which would reduce Arena’s sales potential.

One potential loser from the Belviq approval is Weight Watchers (WTW). Why count calorie points when you can just pop a pill? Weight Watchers initially sold off on the FDA news, but rebounded today when investors remembered that Belviq only works in conjunction with diet and exercise, and is not meant as a standalone therapy.

Next up on the FDA’s diet-pill approval calendar is VIVUS (VVUS), which has a diet pill named “Qnexa.” An FDA decision is expected by July 17. An FDA advisory panel voted in favor of Qnexa approval back in February by a lop-sided vote of 20-2. In contrast, a similar advisory panel vote on Belviq was only in favor by a narrower margin of 18-4. Bottom line: approval of Qnexa is highly likely, which may mean that Arena’s stock price has topped out in the short term.

A third diet pill called “Contrave” is the brain child of Orexigen Therapeutics (OREX), but it is not up for FDA approval until 2014. The delay has not stopped traders from bidding up Orexigen’s stock price by 20% last week and by almost four-fold since the beginning of 2012.

With the news out on Arena, the obvious short-term play going forward is VIVUS because of the upcoming FDA vote on July 17th. The stock probably has little downside before the FDA vote, but huge downside potential after the vote.

One way to gamble is to take advantage of the speculative fury—and expensive option prices—by selling a VIVUS July put option with a strike price in the low $20s. Implied volatility of July options is an astronomical 160%, which means option traders expect the stock price to rise 160% or fall 100% over the next year (asymmetry caused by the fact that a stock can’t fall below zero).

With July option expiration on Friday July 20, holding this short put all the way to expiration could be dangerous to your health. “Buying to close” the short put prior to the expected July 17 FDA vote date is safer, but there are no guarantees.

Since each put option represents 100 shares of stock, only sell as many put options as you would feel comfortable having converted into 100-share blocks of stock. Caveat emptor!

I’m hungry. Where is that Nutella?

Read more from Investing Daily here...

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