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Vivus' Qnexa Is Not Guaranteed Approval. Remember Provenge?

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Dear Vivus (NASDAQ: VVUS) investors: You are paying $2.5 billion for a company with zero profits in a market space valued at only $3.5 billion annually. Yes, the FDA advisory committee recommended Qnexa be granted approval in a 20-to-2 vote, but remember that Provenge had a unanimous safety vote and was still denied approval in 2007. It might be healthy to step off the bandwagon for a couple of seconds to run the numbers on a reality check.

With concerns of obesity rising and the race to bring a weight-loss drug to the market intensifying, investors and analysts have understandably been paying attention to the high-flying weight-loss sector. The darling among them is a pharmaceutical company pursuing a panel-recommended obesity treatment: Vivus. Vivus' proposed treatment for obesity is called Qnexa, and it has been through Phase III trials with a positive recommendation from the FDA panel for approval. Qnexa accounts for the majority of Vivus' market capitalization of $2.5 billion.

Although the FDA almost always votes in agreement with panel recommendations, weight-loss pills are notorious for failing to achieve approval. The last time a pill was approved for the market was over 13 years ago. Many investors have already jumped on the Vivus bandwagon and have built up the market capitalization of the company to over 70% of the market it seeks to enter, despite the fact that the company presently generates zero revenues. Vivus' market capitalization is based on the future earning potential of the company, all of which is highly dependent on final FDA approvals, packaging and labeling restrictions, and Vivus' pricing power in the marketplace.

If Qnexa fails to gain FDA approval on July 17th, competitors like Arena Pharmaceuticals (NASDAQ: ARNA) and Orexigen Therapeutics (NASDAQ: OREX) may come out on top, sending investors far away from Vivus as share prices plummet.

On February 23rd, shares of Vivus nearly doubled after an FDA panel voted 20-to-2 in favor of the company's weight loss drug, Qnexa. The drug has come a long way from its previous panel appearance a few months prior, at which time the drug suffered a 9-to-5 vote against recommendation.

Two-thirds of Americans are overweight, and half of those are affected by obesity. Expensive treatments for the population have prompted Wall Street analysts to predict that Qnexa would be prescribed to millions of people upon approval. Although Qnexa would operate in a high-revenue market, it is not clear how much of that market it would command given its uncertain approval and competition with larger companies.

Vivus will have to compete against the largest on-the-market weight-loss treatment, Xenical, while also racing against Arena for FDA approval this summer. Vivus has an advantage, but is not guaranteed approval and has a later FDA decision date than Arena. Vivus' treatment showed higher efficacy rates than Arena's treatment, with the majority of Vivus' enrolled patients showing a minimum 5% decrease in weight over the life of the study. This metric influenced the FDA's decision to allow Vivus to conduct a post-approval study to determine the severity of potential side effects, such as birth defects and heart conditions, rather than complete a study prior to approval.

It is important to remember that Vivus has two main treatments: Qnexa for weight loss and Stendra for Erectile Dysfunction (ED). Year-to-date, Vivus is trading up over 150%, with approximately $1.5 billion of its market capitalization attributed to Stendra and the remaining $2 billion to Qnexa. On April 27th, the FDA announced its approval of Stendra tablets for ED. The immediate reaction to the approval was only a small percentage change in share price and paled in comparison to the market's reaction to the FDA panel's recommendation for Qnexa approval.

Currently, the entire anti-obesity drug market is $1.5 billion and the entire ED market is about $2 billion, leaving the total market space that Vivus looks to capture at about $3.5 billion. At current prices, Vivus' market cap is about $2.5 billion, which is over 70% of the entire market potential. However, Vivus does not make a profit. Vivus does not even have any revenues. Sure, it can earn multiple years of revenue and trade at a multiple of annual earnings, but companies also trade at fractional multiples, making a steep drop in Vivus shares a legitimate possibility if we are merely basing capitalization on an arbitrary price-to-sales multiple.

The $2 billion market for ED is highly competitive, as well, full of large pharmaceutical companies like Eli Lily (NYSE: LLY), Pfizer (NYSE: PFE), and Bayer (PINK: BAYRY). Their drugs include such household names as Cialis, Viagra, and Levitra, respectively. Therefore, it will be unquestionably difficult for Vivus to compete in this market with players that already have established brand names and billion-dollar marketing budgets.

Lastly, it is worth reiterating that Vivus' Qnexa will also have competition in the weight-loss market from Xenical (already on the market), Lorcaserin (pending approval), and naturally derived treatments such as Weight Watchers (NYSE: WTW) lifestyle formulas, weight-loss vitamins from ChromaDex (OTCBB: CDXC), or USANA Health (NYSE: USNA) products. On May 10th, the FDA voted 18-4 to recommend Arena's Lorcaserin for approval. Arena's stock also shot up on its recommendation date, but still lacks the market capitalization of Vivus. Arena is expected to hear back from the FDA by June 27th, while Vivus will hear back by July 17th.

Orexigen failed to bring its weigh-loss drug Contrave to the market multiple times, most recently in early 2011. The company has committed funds to massive safety and efficacy to its flagship product Contrave, which it still hopes will reach the U.S. market by 2014. While that may be a far ways off, if both Vivus and Arena are denied approval, Orexigen could again pose a market challenge to both companies.

Beyond synthetic diet drugs, some companies have even moved toward natural alternatives. Weight Watchers and other lifestyle brands obviously compete in the weight-loss industry, and vitamin makers also offer natural competition to synthetic treatments. ChromaDex Corporation is currently waiting on results that will be released within a few weeks from the University of Mississippi, which is testing their patented drug pterostilbene in a human study. If the results are positive and reveal weight-loss potential, the market for Vivus' drug may become shaken up even more with natural product competitors. USANA Health also makes Nutrimeal and other weight-loss products that will take market share from Vivus.

Currently, most investors are leaning hard on Vivus' Qnexa, giving the company approximately 70% of the entire obesity market's annual revenues in market capitalization. This is a healthy premium based solely on Vivus' future potential. As mentioned above, however, investors should use caution on an unapproved drug, with many competitors lined up to battle for market share: Arena, Eli Lilly, Pfizer, Roche, Bayer, ChromaDex, Orexigen, Weight Watchers, and USANA. Still, if Vivus shares fell as low as $10, it would still command a $1 billion market capitalization in a market only twice that size and with many other competitors.

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