Exelixis: Uncovering Value

| About: Exelixis, Inc. (EXEL)

While Exelixis (NASDAQ:EXEL) has 10 partnered programs and a number of other earlier stage assets, the focus for most investors is Cabozantinib (Cabo). In addition, while EXEL is currently filing Cabo for advance medullary thyroid carcinoma (MTC), it is the effect of Cabo in metastatic castration-resistant prostate cancer (mCRPC) that offers significant upside. In general, prostate cancer assets are highly valued as the market for these drugs is quite larger and growing. For instance, Medivation (NASDAQ:MDVN) has recently traded at $75/share, putting its market capitalization of $2.7 billion. In addition, Dendreon (NASDAQ:DNDN) is valued at $1.5 billion and actually had a market cap of well over $4 billion before questions arose as to the commercial success of Provenge. In contrast to these multi-billion dollar valuations, EXEL has a market capitalization of only $717 million. So why is the market discount EXEL so heavily?

Before getting into valuation, it is important to understand the drug and its mechanism of action. Cabo is a tyrosine kinase inhibitor that has the ability to inhibit two critical pathways: MET and VEGFR2 (see company description). MET and VEGFR2 are quite important for mCRPC in that they act on the growth factors that allow cancer to expand (for more information about MEt and VEGFR2 see). What is interesting about Cabo is its ability to inhibit both pathways. It has been found that when VEGFR2 is inhibited cancer cells upregulate MET to compensate. As such, simply targeting VEGFR2 or MET individually is not likely to have a sustained effect but dual inhibition likely has an interactive benefit (for details on this see the "dual mechanism" slides). In addition, it has been found that MET plays a role in bone metastases as activated MET has been found in osteoblasts and osteoclasts (see following for details). As such, Cabo has a mechanism of action that should lead to both an important effect on the cancer as well as bone metastases.

In general, the early clinical data on Cabo shows what one would expect and that is an effect on both the cancer and the bone metastases. In particular, in its most recent trial Cabo generated a progression free survival (PFS) of 21 weeks as compared with 6 weeks for the control group. This corresponds to a stunningly low hazard ratio of 0.13, which was clearly statistically significant (see slide 12 in ASCO 2011 presentation - pdf). In addition, the effect on the bone scans was just as impressive in that 85% has at least a partial response and another 13% showed stable disease (see slide 14 in ASCO 2011 presentation - pdf). Finally, treatment with Cabo had significant quality of life improvements in that it significantly decreased pain and this was demonstrated by the observation that 56% of the patients either decreased or discontinued their narcotics use, which included 25% that stopped narcotics use completely (see slide 17 in ASCO 2011 presentation (pdf) and slide 48 in investor presenation - pdf). So why does the market discount Cabo so heavily?

The major overhang with Cabo is that it has yet to demonstrate an overall survival (OS) benefit and bears questions the utility of the bone metastases effect. This is important as the mCRPC market is starting to get crowded with a set of compounds that have all produced an OS benefit (Provenge, Jevtana, Zytiga, MDV3100, and Alpharadin). To be fair, EXEL has yet to complete a trial designed to measure the overall survival benefit of Cabo but the bears argue that this simply demonstrates that Cabo is late to the party. EXEL has designed a phase III trial (COMET 1) to demonstrate an OS advantage, which will be complemented by the another phase III trial (COMET II) designed to show pain palliation. The problem for investors is that COMET I will not read out data until the first half of 2014, but there will be a number of data points between now and then that should provide increased confidence in the COMET I results. Each data point that increases confidence that an OS effect will be seen will derisk Cabo and reduce the valuation gap seen between EXEL and other companies in this space (DNDN and MDVN for instance).

The upcoming ASCO meeting has great potential to begin the value unlocking process. The company has 4 oral presentations and 4 posters around this single asset. The presentations will highlight results from an additional 150 patients, which will provide additional evidence of the underlying effect of Cabo. In general, then, investors should look at three critical points. First, does the effect on bone scans maintain? While the previous trials showed a clear effect, it was a relatively small number and needs to be confirmed. Keeping in mind that bone metastases are a large co-morbidity in mCRPC, a continued effect on this bodes well for an ultimate effect on OS. Second, what effect does Cabo have on circulating tumor cells (CTCs)? A large number of CTCs are correlated with decreased survival in mCRPC (recent Abitrone data has confirmed this relationship) and while in previous trials Cabo decreased the number of CTCs by more than 30% in over 90% of the patients (this included converting 43% to less than 5 CTCs), this again needs to be corroborated in larger trials. Finally, it is important to see that the PFS effect maintains. While it is difficult to read from PFS to OS in prostate cancer, it remains important to see a continued effect in terms of PFS.

As a final note, it seems that expectations going into ASCO are relatively low for EXEL and this actually makes it a better risk/reward profile. For instance, the May $4 call options are trading at virtually no premium despite covering the period where the ASCO abstract will be released. Using the close of the markets on April 20, the May $4 call options had a bid price of $0.90 where EXEL closed at $4.83. So the buyers of those options are essentially giving EXEL a $0.07 premium. In contrast, CLDX (a popular ASCO play) was trading at $4.17 and its May $4 calls had a bid of $0.55, which represents a $0.38 premium. While any number of factors go into those premiums, the point is that if expectations were high for EXEL, traders would be bidding up the calls and you certainly do not see that in EXEL. As such, EXEL represents both a long term value play and has a good chance to surprise investors with their data presentations at ASCO.

Disclosure: I am long EXEL.

Additional disclosure: I own the May $4 EXEL calls.