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Shares of small biotech Lexicon Pharmaceuticals (NASDAQ:LXRX) sold off sharply in the wake of news that the FDA issued it's much-expected rejection letter to Bristol-Myers Squibb (NYSE:BMY) and AstraZeneca (NYSE:AZN) for their experimental diabetes drug, dapaglifozin ("dapa"). Although there are certainly similarities between dapaglifozin and LX4211, arguably the key compound in Lexicon's pipeline, it is the differences that will ultimately decide this contest.

Bad News, As Expected

It interests me how analysts and financial commentators will talk about an event occurring "as expected" and nevertheless still managing to surprise a few investors. In this case, the rejection of dapa was hardly surprising. When Bristol-Myers and AstraZeneca had their panel meeting, the panel voted 9-6 to recommend rejecting the application. Although the FDA has been known to override these votes and grant approval anyway, the safety issues raised by the panel and the FDA's generally very conservative stance on diabetes drug made rejection a virtual no-brainer.

And yet, Lexicon shares still sold off some 10% on the news - perhaps because the FDA specifically cited worries about safety and wanted more data to establish the risk/benefit trade-off.

LX4211 ≠ Dapa

Why does the market tie these drugs together? Dapa is an SGLT-2 inhibitor, while LX4211 is a dual SGLT-1/SGLT-2 inhibitor. The thinking, then, is pretty straightforward - if SGLT-2 inhibitors are potentially unsafe and one half of LX4211 is an SGLT-2 inhibitor, then LX4211 may well be unsafe too.

It sounds logical when put that way, but actual in-the-body performance is quite a different thing. For starters, LX4211 is a dual inhibitor, and that could make a big difference - it may be the case that it doesn't inhibit SGLT-2 as strongly or that simultaneous SGLT-1 inhibition somehow mitigates the more unpleasant effects.

It's also well worth noting that different drugs in the same broad class can have very different effects. Actos, Avandia, and Rezulin were all PPAR-gamma modulators developed to treat diabetes. Avandia became a problem for GlaxoSmithKline (NYSE:GSK) ten years after approval on concerns of elevated cardiovascular risk, while Daiichi-Sankyo's Rezulin was pulled three years after approval for liver toxicity. Although Takeda's Actos has been implicated in elevated risk of bladder cancer, it's still on the market and is one of the all-time best sellers among diabetes drugs.

Early Results Encouraging, Not Definitive

While LX4211 is very early in its clinical development process, the early data has been encouraging. In very limited early studies, LX4211 has shown efficacy nearly double that of dapaglifozin, without showing serious events. That's a significant contrast to dapa's Phase 3 study where 60% of patients had an adverse event and 10% had a serious adverse event.

Now this is extremely important - comparing these two drugs on the trials done to date is unfair, unscientific, and potentially very misleading. The studies were not head-to-head studies; they did not have the same entry criteria, nor the same protocols. All the same, biotech investing means reading tea leaves and the first steepings from LX4211 suggest a better, safer risk-benefit profile.

More Info To Come

Lexicon will be releasing top-line data from a Phase 2 study on LX4211 around midyear of 2012. Suffice it to say, this will be a big deal for the company and the stock, and it's a certainty now that analysts will be looking hard at the safety data.

Assuming that the data is good, management intends to start a Phase 3 study in the first quarter of 2013. All told, Lexicon intends to run 7 trials that will enroll 9,000 patients in total, including a large (6,000-patient) CV outcomes study that (if properly designed) should be pretty illustrative on the safety and side-effect profile.

Keep in mind, the company does not intend to run the Phase 3 trials itself - the Lexicon will hope to take strong Phase 2 data and use that to form a partnership.

Sometimes First Isn't Best

Being the first to market with a new drug is not a lot of fun these days, and that's especially true in diabetes. While Bristol-Myers and AstraZeneca have made no decisions yet on how to proceed with dapa, Eli Lilly (NYSE:LLY) and Johnson & Johnson (NYSE:JNJ) have their own SGLT-2 inhibitors in trials (Lilly's having been licensed from Boehringer Ingelheim).

As more data comes out on these studies, it stands to reason that Lexicon shares will react. Further troubling safety data on SGLT-2 inhibitors (including risks of bladder cancer, liver damage and higher rates of genital infections) won't help the shares, but then again, slam-dunk perfect data from a rival would not exactly be good news either.

The Bottom Line

Lexicon and its future partner have the advantage of walking a trail already blazed by Bristol-Myers and AstraZeneca and they have the advantage of designing their trials to meet FDA concerns about this new class of drugs. Of course, this assumes that LX4211 is safe and efficacious - something nobody knows today. For Lexicon holders, this news on dapa is really no news at all; for prospective owners it could represent a decent buying opportunity.

As for Bristol-Myers and AstraZeneca, this is definitely a setback for AstraZeneca, a company that really needs its pipeline to generate some winners to replace drugs going off-patient. For Bristol-Myers, this is unfortunate, but not crushing. Dapa could have been a $1 billion drug, but Bristol-Myers has a good pipeline beyond this, and it's not as though dapa is done for good just yet.

Source: FDA Rejection Of Dapaglifozin Means Little For Lexicon