Will More Good Data From Lexicon Finally Bring In A Partner?

I've owned quite a few biotechs over the years, but Lexicon Pharmaceuticals (LXRX) is maybe one of the most frustrating I've owned. Forget about the company's prior business model of selling gene knockout data to drug developers and its near-death experience about five years ago - the simple fact that the company has some very interesting clinical candidates but can't get much love or attention from prospective partners is plenty frustrating in its own right.

Well, here we go again. Lexicon announced very encouraging data on its lead compound for diabetes ('4211), with the company's proprietary SGLT 1/2 inhibitor showing solid glucose control in diabetes patients with significant renal impairment. I don't really think this study is surprising to Lexicon bulls, but the Street is clearly cheered by the news and I suspect part of that enthusiasm is the hope/expectation that the last real obstacle to a partnership agreement may now be in the past.

Strong Data, But Was It Really So Surprising?

Lexicon announced Tuesday morning that its small (30 pts) proof-of-concept study of '4211 in type 2 diabetics with moderate-to-severe renal impairment was a success. The company didn't offer up much information, other than to say that the company met its primary endpoint of statistically significant glucose reduction in patients with stage three or four kidney disease. The company also noted that the drug led to elevated levels of GLP-1 - a significant hormone in glucose control, and the focus of Novo Nordisk's (NVO) very successful Victoza GLP-1 agonist.

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I'm honestly a little surprised to see that the stock is up as much as it is (at least as of this writing) on this news. While it's very easy to fall into an echo-chamber of bullishness when you own a biotech, it seemed like even the doubters/bears on Lexicon expected this trial to be successful. Then again, about ! 30% of Type 2 diabetics have renal impairment and anything that helps to differentiate '4211 and/or bulk up its efficacy and safety data package can only help at this point.

Now Will A Partner Finally Step Up?

Whether or not the stock is up because the data were better-than-expected (hard to argue, as this release only gave bare-bones top-line data), I think the implications on Lexicon's efforts to partner the drug are not insignificant.

Lexicon has reiterated time and time again that it expects to secure a partnership with a major drug company before moving '4211 into Phase III studies. Given the expense of Phase III diabetes studies (due in large part to the FDA's ever-more stringent requirements for new diabetes medications), that's a smart move. Unfortunately, Lexicon management has tested investors' patience by repeatedly referring to ongoing discussions, with the implication being that a deal would be coming before too long.

With this renal impairment study in hand, there really aren't any obvious remaining obstacles. Yes, there have been some worries and questions about whether SGLT 1 inhibition could lead to dangerous side effects, but nothing has appeared in the data Lexicon have released to date. On the other hand, trials have consistently suggested that '4211 is a powerful and effective drug with the possibility of showing meaningful differentiation (though it will take Phase III studies to really establish that).

If there's a downside to Lexicon's partnering opportunities, it's that there aren't many obvious partners left. Unless one of the existing companies in the SGLT space chose to abandon an existing partnership, Novo Nordisk, Roche (RHHBY.OB), and Takeda may be the best candidates to partner with Lexicon, and that's the sort of limited pool that can lead to hard bargaining. Sanofi (SNY) may also belong in this pool as well, though. While the company did reach a licensing agreement with Chugai for an SGLT2 inhibitor in Japan, that agreement was limited in s! cope and ! the drug does not appear on Sanofi's August 2013 pipeline chart.

A partnership for '4211 could take any of several forms. While a co-marketing agreement (not unlike what Amylin had with Lilly (LLY) at one point) could be an option, I frankly believe co-marketing agreements are often more trouble than they're worth. As a shareholder, I'd be more pleased to see a conventional milestone-plus-royalties arrangement, with the partner picking up the tab for the remaining clinical development expenses.

Generally speaking, you'd expect a drug with $1 billion-plus potential going into Phase III studies to produce a deal with at least $50 million to $100 million or more in upfront payments, hundreds of millions more in available additional milestones, and tiered royalties from the high single digits up into the 20%'s or higher (depending upon the details of the milestones, cost-sharing, and so on).

That may be a hard deal model for Lexicon to get, though, given that its drug will be arriving late to the SGLT party. The company may have to instead settle for an arrangement more like the ones Arena (ARNA) and Orexigen (OREX) negotiated for their obesity drugs where there was less money upfront, but a more generous split on the back end.

In any case, a partner would appear to be a must-have for Lexicon at this point given the cost of developing a Phase III diabetes drug. I think it would be pretty aggressive to estimate $200 million in total costs to get '4211 through Phase III development, and the real total could perhaps be double that figure (or more) depending on what the FDA is demanding in terms of trial size and content. Also remember that it's not just clinical trials that cost money - without a partner, Lexicon would also need to establish its own sales infrastructure, and that would mean still more money flowing out the door before registering a dollar of revenue.

While Lexicon's primary investor (Invus/Artal) could perhaps help the company raise funds on affordable terms, it w! ould be h! ard to see how this wouldn't ultimately be dilutive to other current shareholders. At a minimum, I don't think there's any chance that Lexicon could advance its other pipeline candidates beyond Phase II if they had to self-fund a Phase III study and I likewise believe going it alone in diabetes would risk even more delays as Lexicon doesn't have the infrastructure to establish and run multiple Phase III studies as efficiently as a larger pharmaceutical company.

Still An Attractive Collection Of Assets, With More Data Coming Soon

I still believe Lexicon is an undervalued and often overlooked biotech (there are relatively few other authors writing about it on Seeking Alpha, for instance).

SGLT inhibitors hold the potential to be one of the rare diabetes medications that work in both Type 2 and Type 1 diabetics, and I know several Type 1 diabetics currently taking an SGLT-2 inhibitor on an off-label basis. More to the point with Lexicon, I believe '4211 can be a winner in the space even though it will be late to arrive, with revenue potential in excess of $1 billion.

I'm also looking forward to upcoming data from the company's GI drug programs. Data on '1032 in carcinoid (Phase III) won't likely be available until the second half of 2014, but data on ulcerative colitis (Phase II) should come out fairly soon, while Phase II data on '1033 in irritable bowel syndrome should be available sometime in the fourth quarter of this year. While I've been slow to work these drugs into my valuation (due in part to the difficult development histories of other compounds targeting these conditions), strong data could certainly add more than $2 per share in fair value.

The Bottom Line

Because of its sub-$5 stock price, I think some investors are surprised that Lexicon is not a tiny biotech - with over 500 million shares outstanding, the market cap is around $1.5 billion. Even still, I believe '4211 is worth almost $4 per share on its own merits, with the company's efforts in carcinoid, u! lcerative! colitis, and IBD chipping in more than $1.50 in potential value today.

These estimates are all based on Lexicon securing a partner for '4211. Were Lexicon to try going it alone, I would nearly halve my estimate for '4211's value today due to greater dilution (to fund the trials), a longer time to approval (due to limited infrastructure), and a longer sales ramp (due to the lack of an established diabetes sales force and market presence. I would also likely have to trim the value of Lexicon's other pipeline candidates as the timelines to their approvals would likely extend as the company moved to conserve cash and prioritize the clinical development of '4211.

This is still a risky opportunity. It is entirely possible that Big Pharma views '4211 as "too little, too late" in the SGLT market and/or believes that the mechanism of action and risk/benefit profile are not promising enough to merit a partnership. Likewise, there are the boilerplate biotech risks that the company's other clinical compounds simply don't work and/or that the company will need to raise further rounds of capital and dilute shareholders. Even so, I continue to believe that Lexicon is undervalued, and I will continue to hold my shares.

Source: Will More Good Data From Lexicon Finally Bring In A Partner?

Disclosure: I am long LXRX, RHHBY.OB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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