Making the Case: The Reality

Obesity is epidemic in the U.S. and is becoming epidemic in the developed world. My visit to Paris this summer tells me the French have repealed their longstanding prohibition against citizens having large hips and buttocks.

The English are building larger airplane seats and barstools to accommodate its "larger" population and the Japanese are now addicted to the trans fats that we in the U.S. have been addicted to. In the U.S. there are 58 million people overweight, 40 million obese people and 3 million of us who are morbidly obese.

ChangeWave Alliance surveys have followed this trend for almost four years, with the most recent survey showing that 75% of responding physicians see an increase in the number of obese patients.

Diet and exercise continue to be the best solutions for obese people. More drastic measures such as gastric bypass surgery or gastric belts are more appropriate for the morbidly obese (those whose obesity can kill them). Weight loss drugs have little credibility with doctors or patients and less than $500 million dollars worth are sold each year.

How did we get so fat?

Don't blame fast food companies or the "super-size" marketing geniuses. The answer lies in human evolution. For the million or so years that we learning to stand upright, we were using our increasing mobility to find and eat food. Until the mid-nineteenth century in North America and the mid-twentieth century in Europe, the greatest concern an individual still had was getting enough to eat. In an effort to help us survive our bodies have evolved to protect us from starvation, which makes serious dieting without medical assistance almost impossible for more than 90% of the population.

To examine the problem let's return to France — a place that bakes and serves fresh bread all day and offers 100 kinds of cheese. If you need to knock off a few pounds, it's no big deal — cut back on eating/calories for a short time or increase exercise. But if you are more than 10% or 20% overweight, and have been for some time, then your body's response to a diet is going to be different.

If you lose 10% of your body weight something in your body happens and the body says, "Whoa, I am starving!" And all of a sudden your metabolism slows to prevent weight loss and accomplishing weight loss becomes an order-of-magnitude effort that is that much more difficult. You will very likely fail to lose weight unless you are in the under-10% of the population able to beat back your own metabolism.

The Bottom Line: Most people need medical assistance to diet and there is not a single product to date that works.

Really.

Appetite suppressants work for a limited period of time (typically no longer than 48 weeks) and generate a limited amount of weight loss (generally no more than 10% of body weight). Then the magic pill fails and it is back to regulating food intake on your own, and adding exercise to stimulate metabolism.

That is why the sale of diet pills is roughly $500 million a year — probably less than McDonalds spends on ketchup and trans fats during the same period of time. That is also why the morbidly obese (life-threatening obesity) surgical intervention (gastric bypass surgery and gastric belts) is the fastest-growing choice.

On the Horizon: Not much worth mentioning — mostly new appetite suppressants without the side affects of Phen-fen, the appetite suppressant that worked (and killed people), and almost drove Wyeth into bankruptcy. To date, the only treatment either on the market or in trial that induces weight loss (and yet to plateau in measured clinical trials) is diabetes drug Byetta from Buy List company Amylin.

Two Buy List companies have current or potential obesity treatments.

Allergan (AGN): AGN entered this market with the acquisition of Inamed, the inventor and 100% market share leader in gastric belts. These belts are used to restrict the stomach and, therefore, the ability to consume food. The installation of these belts is reversible making the procedure increasingly popular as a treatment for morbid obesity compared to traditional gastric bypass surgery, which is not reversible and has far more complications.

Amylin (AMLN): Amylin's diabetes drug Byetta is a marvel in that it is the first and only diabetes drug that induces weight loss. The company is now in trial with a pure weight loss product that (if it works) will probably be targeted toward the morbidly obese, because it will likely require injections with pen cartridges similar to the procedure for Byetta. It is too early to say if this drug will advance to a point of commercial success.

The following companies bear watching because they have either appetite suppressants or a real chance of managing the metabolic aspects of weight loss. You will note that four of the five are penny stocks and only one that trades actively in the U.S. (Manhattan Pharmaceuticals). The only company of any size or market capitalization is Arena and its stock is not for the faint of heart.

Alizyme (AZM.L): This small British biotech start-up is working on an appetite suppressant similar to Phen-fen, but without the side affects — an approach similar to Sanofi's Accomplia. The drug is Cetilistat and it's in mid-stage trial. The company has several other drugs in mid-stage trial and has a little cash — AZM.L will probably find a partner for Phase III trials for Cetilistat.

Arena Pharmaceuticals (ARNA): The company is beginning late-stage trials for an appetite suppressant (technically: something that works on the serotonin receptor) lorcaserin, a drug that produced modest results in trial. This is one of a family of products in its pipeline. It has partnerships for treatments for other diseases with Ortho-McNeil (part of Johnson & Johnson) and Merck.

Bio-Light (BOLT.TSE): This Israeli outfit is a parent holding and investment company for four little start-up companies. One of them is working on obesity and is called OBEcure. In March 2006, OBEcure was cleared by the FDA to conduct Phase II trials of a generic that was reformulated for obesity, and that had previously been used (ineffectively) for vertigo in the U.S. in the '60s. The drug works on the histamine receptors of the brain, which are involved in appetite control and suppression. Earlier trials, which establish the drug's safety, showed weight loss in 20 women during a one month time period.

Manhattan Pharmaceuticals (MHA): Located in (you guessed it) Manhattan, N.Y. this company is in early stage trials with a drug called oleoyl-estrone (OE), a compound that has caused significant weight loss in laboratory animals without side effects and with no dietary changes.

Metabolic Pharma (MBP.ASX): An Australian company fiddling with human growth hormone to control weight and it is pretty far along. One hundred out of 536 patients have completed a Phase II trial for the company's drug AOD9604. Unlike other treatments, this is not an appetite suppressant. AOD9604 is, according to the company, "The only obesity drug in advanced development with a primarily metabolic mode of action."

DIABETES

Now let's take a look at diabetes — a disease that is sometimes the result of obesity.

Recommended Stocks: Alkermes (ALKS), Amylin Pharmaceuticals (AMLN), (Emisphere EMIS), Nektar (NKTR) and OSI Pharmaceuticals (OSIP)

Stocks to Watch: I will do it for you, but there is one exception: you should keep an eye MicroIslet, because the company is working on technology and treatments to facilitate transplantation as a treatment of choice for insulin-dependent diabetics.

Upcoming Market Catalysts: Catalysts are company specific and among the five companies in our portfolio, near-term catalysts include: the results of an oral insulin trial by Emisphere (EMIS), the formal national launch of Exubera by Pfizer (with Nektar), and more trial data on the long-lasting version of Byetta from Amylin.

I have written many times about diabetes and our five companies. They have major or minor exposure to the disease. Diabetes is epidemic, is a huge market opportunity, and drugs, other treatments and testing products in this space are potential blockbusters.

Diabetes occurs when the body, due to pancreatic problems, can no longer regulate the amount of glucose in the body through the use of its insulin —requiring externally supplied medications and (eventually) insulin — to patients. These medications and insulin are not a cure and over time — even with perfect regimen compliance (a rarity) of diet, exercise, testing and timely treatment — the patient deteriorates.

Diabetes is epidemic in the U.S. and Europe and will be in any country where the population has turned away from worrying about starvation and the well-balanced management of food, to a life of good and plenty — pun intended for those of you old enough to remember Choo Choo Charlie — Google it if you don't get it.

The American Diabetes Association estimates more than 213,000 people died from diabetes and related illnesses in 2005. The estimated cost is more than $150 billion — roughly 1-in-10 of the healthcare dollars spent in the U.S. Some salient facts show how harmful this "supposedly treatable" disease is today:

• Roughly 18%-19% of Americans over the age of 60 have diabetes in some form.
• More than two-thirds of people with diabetes die of heart disease or stroke — yes, diabetes and heart disease are cousins. Diabetics' chances of having heart disease are 2-to-4 times greater than non-diabetics and the same is true for stroke.
• The leading cause of blindness in people age 20-74 in the U.S. is diabetic retinopathy, a disease that attacks the retina and stems directly from diabetes.
• A kidney disease called diabetic nephropathy affects 10%-21% of diabetes patients. It is responsible for more than 40% of all new renal patients and is a leading cause of the need for dialysis in the U.S. In 2005, it is estimated between 140,000 people and 150,000 people with diabetes had dialysis or kidney transplants.
• Diabetes is the most frequent cause of non-accident induced amputations in the U.S. — just under 100,000 people per year lose a foot or leg to diabetes.

How did we get so sick? We eat too much! We eat too much of the wrong food! We exercise too little! That's it. For the most part it's that simple!

Obesity is the No.1 contributing factor to diabetes. Excessive glucose consumption over time does not help either, but is less of a factor in thin or moderate-weight people than in the obese.

If you think you don't eat too much then consider a family trip to Denny's for breakfast: You're hungry and you eat the "whole" thing: orange juice, three eggs (that's the good food, although two will do), two slices of toast with butter and jelly, hash-brown potatoes, and sugar and cream in your coffee. You should have stopped at the eggs, one piece of toast and no potatoes — in fact nothing else. And then you go home and sit down to watch the weekend sports on the tube. Great lifestyle!

Diet (along with exercise) is the primary tool to prevent diabetes and help you avoid it when you are diagnosed as "pre-diabetic." It also helps you manage diabetes when you have it. And we are not just talking about knocking off the jelly donuts — not just the "obvious" bad stuff — there is glucose in everything and the first thing diabetics learn is that the healthy breakfast of cereal in milk with a banana is loaded with glucose and off limits for a diabetic — fuhgeddaboutit!

The problem — and the investment opportunity — is the lack of a cure and the surge in baby boomers with their surging waistlines. But both are secondary to the inability of patients to comply with diet, exercise and treatment regimens to prevent or treat their illness.

Conclusion: The best products are those making adherence to a regimen easier for a patient: 65% of patients who should be taking insulin are not. On average, Americans test themselves less than four times a week and should be doing it four times a day.

Potential cures include the transplantation of islets (the Islets of Langerhans in the pancreas produce the insulin we need) and that is many years away. But you gotta invest because the market for diabetes treatments, testing and related products and services is estimated by some on Wall Street to reach $30 billion by 2009 — take my word for it that the market will be closer to $35 billion.

On the Horizon: There are lots of promising drugs to slow the slide into diabetes — and two revolutionary forms of insulin that will greatly increase patient compliance. One is Exubera — an inhaled insulin invented by Buy List company Nektar and approved this year to be marketed nationally by Pfizer in January.

The other, in mid-stage trial, is oral insulin from Buy List company Emisphere. If oral insulin works — and it is still years away if it does work — it will revolutionize treatment for millions of people unable (or unwilling) to inject themselves. In theory, oral insulin works totally differently from other forms and will be able to regulate glucose independent of meal times and without the glycemic spikes associated with insulin treatment. Insulin pumps, which test and inject insulin, are also a good possibility but are as far off as oral insulin.

On The Buy List: Five ChangeWave Biotech Investor companies are exposed to diabetes markets.

Alkermes (ALKS): This drug-delivery company is working on a long-lasting (one-shot-per-week rather than twice-a-day) version of Amylin's blockbuster Byetta, and a form of inhalable insulin with Eli Lilly. Long-lasting Byetta is actually more effective than the current drug and if approved will hit the market in 2009 or 2010. Nektar has broken ground for all other forms of inhalable insulin and Alkermes' version could be on the market in 2010 or 2011.

Amylin Pharmaceuticals (AMLN): The company got two drug approvals last year for diabetes — Symlin and Byetta — and Byetta is on the way to blockbuster status. Don't worry about the new drugs from Merck, et al, because Byetta is proving very effective and is even being given to pre-diabetics.

Emisphere (EMIS): EMIS has a drug-delivery technology creating oral formulations of previously injectable drugs, and is by far the riskiest of these stocks. That said, if it can get oral insulin to work, it is a $15 billion (!) product and EMIS would get considerable royalties. If the current Phase II trial produces positive results (we will know in just days), EMIS will license the product to another company to perform Phase III trials and bring the insulin to market. EMIS is not a one-trick pony and has a good pipeline, but a lot is riding on the outcome of this Phase II trial.

Nektar (NKTR): The company and stock are in "wait and see" mode about sales of inhalable insulin, which will begin in earnest in the early part of the Q1 2007. Analysts (and a manic newsletter editor) are pounding the drum that the product will not sell and the delay is due to manufacturing problems and sales force problems. I have spent hours with the head of the Exubera team at Pfizer and all is going as planned.

ChangeWave Alliance surveys tell us this will be a blockbuster, and with Pfizer needing products, its sales force will be successful with the product. NKTR has a rich product pipeline, but the stock price is heavily dependent on Exubera sales.

OSI Pharmaceuticals (OSIP): The company's Prosidion subsidiary is responsible for diabetes treatments and its lead drug is in early trials. The drug, PSN010, is called a DP-IV inhibitor, and that is important because it is similar to the recently approved diabetes drug Januvia, which means the regulatory pathway is quite clear. The product is not currently material to forecasts for the company.

On the Watch List: I'm keeping one eye trained on this company:

MicroIslet (MII): MII is working in the area of transplanting porcine (pig) islet cells to repair human pancreases incapable of regulating the flow of insulin and glucose in the body. This is an early, early, early stage company —perhaps 10 years away from a treatment, but worth us watching.

Conclusions

You have to invest in obesity and diabetes. It's a large, double-digit growth market with many companies, but tie what you do to your appetite for risk. Among our Buy List companies, the best new-money investment also has by far the highest risk: Emisphere. If the Phase II oral insulin trial results are strong, then it is perhaps an easy double. If they are weak, the stock could lose 30%-50% of its value.

For less risky plays, Alkermes and Nektar are very solid companies loaded with cash. ALKS has a large product pipeline and several products on the market, while Nektar will have to wait until Pfizer's sales force hits its stride, perhaps as late as Q2 of next year. Both are seriously undervalued — with one caveat — a very strong result for EMIS will hit NKTR hard.

For a comprehensive play invest in Amylin, the best performer on the Buy List — up 175% in 18 months. The company is a play on diabetes and could have a serious treatment for obesity on the market in four years or so.

Be sure to avoid the guys selling appetite suppressants — Sanofi's Acomplia, if approved, will dominate this market and what's left of the market will just be scraps for others.

And finally, if you really cannot make up your mind then create a "disease basket" — one-third Amylin, one-third Alkermes and one-third Emisphere. Let the three companies together comprise a standard-size position (one holding) in your portfolio.