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Small-Cap Confidential
Undiscovered stocks that can make you rich

November 10, 2020

We have four earnings reports from last night to get to today (ARNA, APPF, RPAY, SPT). Right now, I’m getting the first two out and will follow up with the other two shortly.

ARNA and APPF Report

We have four earnings reports from last night to get to today (ARNA, APPF, RPAY, SPT). Right now, I’m getting the first two out and will follow up with the other two shortly.

Arena Pharmaceuticals (ARNA) – Messy Trial Results But Long-Term Story Intact

Arena (ARNA) reported Q3 results yesterday that included mixed results on the ADVISE phase 2b trial evaluating etrasimod in atopic dermatitis (AD). That news hammered the stock after hours (down as much as 20%).

The headline is that the phase 2 ADVISE topline data showed etrasimod (oral, 2 mg) missed the primary endpoint (Eczema Area and Severity Index, or EASI, change from baseline at week 12). However, it did achieve statistically significant separation on validated Investigator Global Assessment (vIGA), which is the main measurement scale dermatologists use to measure improvement in clinical signs of AD, and which is the FDA’s key regulatory endpoint. That alone means Arena is moving on to a Phase 3 trial, with design discussions starting now. The baseline assumption seems to be that the drug will work, it just may not work as well as hoped.

But, and this is a big but, there was a wrinkle in the data that seems to make it look worse than it otherwise should have been. Nine patients (19% of the study total) were taken off drug dosing at one site between weeks four and eight. This was not only inconsistent with trial design, but also limited EASI improvement. The reason for dose interruption was low lymphocytes, which has happened with etrasimod in other trials, but which doesn’t require interruption. In fact, stripping out these dose interrupted patients’ data shows that 2 mg etrasimod drove statistically significant improvements on EASI and vIGA throughout the 12 week trial period. It’s unclear to me if the dermatologists that called off treatment for those nine patients screwed up or were just being overly cautious (the latter being more likely). But the bottom line here is that management is moving forward with a phase 3, likely to start in 2021, and which could have higher dosing. While the market reaction was harsh afterhours and in early trade Tuesday the reality is this is not a failure, but not a resounding success either. We would much prefer a clean win for sure, but there are enough positives here to move forward on AD. Analysts will take down their price targets some but mostly on higher risks and NOT DUE TO LOWER PERCENTAGE CHANCE OF EVENTUAL SUCCESS. I hate writing in all caps, but that last point is key.

In other news … Arena has a lot of other trials going on. The really big carrot is etrasimod in UC and the ELEVATE UC 12 and 52 trials should be enrolled by the end of 2020, meaning data readout in early 2022. A Phase 2 study for moderate UC (GLADIATOR) should start in early 2021 and the Crohn’s Disease Phase 2/3 trial (CULTIVATE) is ongoing with data coming in 2021. Arena also has a Phase 2 trial for alopecia areata (AA) with data due late in 2021. And the Phase 2 study with olorinab in abdominal pain related to IBS should yield data by March 2021. There are other things in the works as well, and more to come, but those are the major programs right now. Arena has $1.2 billion in cash and equivalents as of September 30 and could be generating revenue in 2022.

The takeaway from all the news is this – short term pain but long-term intact. I’m sticking with Arena and suggest buying a little on the weakness if you’re in it for long term too. BUY

AppFolio (APPF) reported Q3 results yesterday that were roughly in line with expectations. Revenue was up 24% to $84 million while GAAP EPS of $3.86 was pushed higher by the sale of MyCase, which generated a pre-tax gain of $187.6 million. Core solution revenue was up 21% while Value Plus services revenue was up 28%. AppFolio ended the quarter with $182 million in cash and no debt since it paid off its remaining $97.2 million during the quarter. Management did not give guidance as it cited Covid-19 uncertainty and as is the norm for them, but not for most other companies, no questions were fielded on the conference call.

Stepping back, AppFolio is a company that’s pushing digital technologies for the property management market, and it’s been very successful doing so. Even in the pandemic management has steered the company well and its solutions have helped property managers and tenants thorough tough times. As for the stock, it peaked back in early June and has spent the last five months trading in the 134 to 178 zone, with little input from management on what’s going on and what we can expect. With all that’s going on this disconnected sense has been a little frustrating. The big question on my mind is this; where does AppFolio go from here? I like the sale of the MyCase business as that seemed a rather odd marriage, and AppFolio is a more streamlined business now. In many ways it looks to me like the type of business that could be taken private, or merged with one of the others in this market. Looking at RealPage (RP) we see that stock has also stagnated since July. Maybe these two would be stronger together.

At the end of the day the reality is that I’ve held on to AppFolio since June 2017 because the stock has served us well and has always come back from the big corrections with renewed vigor. But I’ve been hesitant to keep it at buy for extended periods of time because we just don’t get much from management in terms of their growth strategy. Now, with a full portfolio and a likely tumultuous period ahead for growth stocks, in part due to high valuations and breakthrough vaccine developments, this feels like a stock which it is now time to part company from. Let’s do it while everyone is still happy. We have a gain of around 370%. SELL