Vivus (VVUS)' shares slid down ~12% after the company announced that chances of the EMA's committee for Medicinal Products for Human Use giving an advice against the approval of the company's drug, Qsymia, are high. Should the official decision weigh down against Vivus, the company retains the right to appeal or resubmit an application after it does a bit more work on the drug. Arena will benefit from the recent setback, and will strengthen its outlook in the U.S. We have a negative outlook for Vivus, and strongly believe that the latest development will only strengthen Arena's (ARNA) outlook.

Reasons for the negativity surrounding the drug may be attributed to the fact that obesity isn't as big a problem in Europe as in the U.S. A more likely explanation for the expectations relate to the drug's high risk. As highlighted in our previous article, Vivus is a mixture of the stimulant phentermine and topiramate ]used in Johnson & Johnson's (JNJ)Topamax, which had the side effects of birth defects and suicidal ideations]. A questionable ingredient in the drug is Phentermine, which triggers catecholamine, causing tachucardia (increased heart rate) and high blood pressure. Vivus earlier eased FDA concerns by establishing a system to track doctors prescribing the drug, and by limiting the sale of the drug through mail-order pharmacies.

How this could eventually play out for Vivus' competitor is uncertain. If in fact the issues, which are supposed to lead to the rejection of Qsiva in Europe, are Vivus-specific (given the risks), then Arena will gain, since it has a better safety profile for its drug, Belviq. However, things could turn out differently for obesity drugs in general if the EMA simply does not have confidence in the drugs' efficacy; side effect ratio. This also casts doubts on U.S. doctors' willingness to prescribe Qsymia once it is rejected by the European authority, dampening the already weak sales outlook for the drug. Do note that this news come at a time when Vivus is participating in the Obesity Society's 30th Annual Scientific Meeting. As of now, Arena, with its better drug, seems poised to win European approval and grab a larger market share in the absence of its sole competitor.

Arena also has access to a well experienced Esai sales team, who will now aggressively market Belviq. Doctors already had concerns with Qsymia, and the recent hurdles will only confirm their initial thoughts. Arena will also probably join hands with European partners (more good news for the company and a catalyst for the stock). Orexigen Therapeutics (OREX)' drug Contrave is not going to come into the market anytime soon (expected decision in 2014), but strong issues surrounding its safety have already been cited.

Valuations

Earlier, we had discounted Vivus' sales by a factor of 30%. With the advent of the news coming from Europe, and the multiplier effect it will have on its sales in the U.S., we discount the projected figures by 45%, and with an average P/S multiple of 4x, we estimate a price target of $24. However, Vivus increasingly looks like it will under-achieve its targets, despite being an early starter in the market; the negativity surrounding the drug will lead to a lackluster performance. We therefore recommend that investors avoid this stock. We will not discount the sales figures for Arena, and based on a 2016E sales figure, we estimate a price target of $10. Arena's approval in Europe and its partnership in the continent will be catalysts for the stock in the future. We recommend Arena as a buy.