Are Arena and Affymax Underdogs or Just Dogs?

Short-sellers and hedge funds may be shadowy, but sometimes they are the smartest guys in the room. They've done their homework, and they're willing to bet their capital against the crowd -- an investing strategy that can be as lucrative as it is contrarian.

On Motley Fool CAPS, we also have leading analysts who find the chinks in a company's armor and correctly call its fall. Our "Underdogs" have earned 100 or more CAPS points by correctly predicting that one or more stocks would underperform the market.

Today I'm looking at two biotech stocks that have been beaten down by the market and carry low two-star CAPS ratings -- highlighting their underdog status against the market averages. Yet in both cases, Arena Pharmaceuticals (NAS: ARNA) and Affymax (NAS: AFFY) recently received the thumbs-up from at least one All-Star member with an "underdog" label. If these CAPS investors have scored big by correctly predicting which stocks will fail, it may be worth our while to see which others they think will succeed.

Of course, not every short sale goes as planned, which makes shorting a risky proposition. Stock prices can be irrational longer than you have money to stay in the game. And you don't want to end up with fleas by lying down with dogs, so do your homework.

Room enough for two
Where I used to work, there was often a mindset at play that said, "It's not so much that I succeed but that you should fail." That seems to be the way the market is treating the development of the two fat-fighting drugs that recently received FDA approval.

Being first out of the starting gate with Belviq gave Arena a bit of a head start in the obesity-fighting drug wars, but VIVUS (NAS: VVUS) closed the gap pretty quickly following its approval of Qsymia. Not only did VIVUS see a pop, but Arena plunged. Really? The market was taken by surprise by this development? Geez, what will happen if Orexigen Therapeutics (NAS: OREX) ever makes it so far with its weight-loss therapy?

Even after a widely known short seller published a damaging report on Arena's rival -- Citron Research says, among other things, that one of the key compounds in Qsymia is protected by patents of another company -- Arena's stock has not rebounded. Both stocks are down now, and both drugs have their advantages and disadvantages. While Qsymia will slightly beat Arena's Belviq to market, labeling issues, limited ability to take off excess weight, and questions about pricing linger. Had it not been for the short seller's report, VIVUS was marked as the clear winner when the Fool's resident expert Brian Orelli said it will be a while before one drug is considered the better bet over the other.

I'm still of the mind that Arena has a monster opportunity to capitalize on its treatment that is generally considered to have the safer profile. Even if no one drug outshines the other, obesity is a big and growing problem in the U.S., and both companies can succeed without having to damage the other.

Let me know in the comments section below if you think Arena Pharmaceuticals is a dog riddled with fleas simply because it needs to wait for drug scheduling to make it to market.

Take it to the max
Unlike Arena, biotech Affymax has been riding high following the approval of its once-a-month anemia drug Omontys. It doesn't have the benefit of an open playing field, as it is going up against industry titan Amgen (NAS: AMGN) , whose Epogen treatment has been the standard of care for decades. Precisely because it is a monthly regimen for patients, the field of play actually tilts in Affymax's favor: Epogen is a twice-weekly treatment, and the drastic reduction in scheduling is a big plus in its favor.

Hey, doctors aren't quick to adopt anything new, being perhaps some of the most conservative folks when it comes to change. And you don't lightly alter what has proved to be a hugely successful. Over the past two and a half decades, Epogen has generated $40 billion in sales for Amgen, with Johnson & Johnson selling it under the name Procrit for treating anemia resulting from chronic kidney failure, chemotherapy, zidovudine treatment for HIV, or surgery. But safety concerns suddenly arose, and sales of Epogen fell 20% in 2011 to $2 billion.

I'm late to the Affymax game, having rated it only last month to outperform the broad market averages, but I still think it will be a successful pitch, though not necessarily a smooth ride. Affymax will be supplying Fresenius Medical Care with Omontys through an agreement with Japanese pharmaceutical Takeda, but Amgen has signed on DaVita to an unprecedented long-term supply contract.

As I've noted, though, "A more patient-friendly regimen, a lower price, and the potential for more such partnerships such as that inked with Takeda and Fresenius means that whatever the short-term pitfalls may be, the future is looking up."

So does taking on one of the big dogs put this underdog in the big leagues? Give me your view in the comments box below on what you think is the right regimen for Affymax.

There's no need to fear ...
Underdogs often shine brightest with their backs against the wall, so investors will definitely be interested in a new premium report on Arena Pharmaceuticals, where our top biotech analyst details everything you need to know about the company. Claim your copy -- and a full year of updates!

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Fool contributorRich Dupreyholds no position in any company mentioned. Check out hisholdings and a short bio. The Motley Fool owns shares of Johnson & Johnson.Motley Fool newsletter serviceshave recommended buying shares of Johnson & Johnson and creating a diagonal call position in Johnson & Johnson. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days. The Motley Fool has adisclosure policy.

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