Lexicon's Long Shot Getting Even Longer

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It has been a frustrating ride for Lexicon Pharmaceuticals (NASDAQ:LXRX) shareholders. Between never-ending (and so far completely fruitless) talk of a diabetes partnership just around the corner and clinical failures in ulcerative colitis and irritable bowel, there hasn't been much good news in a while outside of steadily strong data from 4211 (the diabetes drug).

Now matters get even dicier. Lexicon announced Monday that it was shuttering its early/development-stage R&D efforts to focus on maximizing the value of telotristat etiprate (carcinoid) and LX4211 (diabetes). With this, half of the workforce is being fired and the CEO will also be leaving. While management continues to repeat the mantra that it is talking to partners about the diabetes program, it's harder and harder to have faith in this company or its prospects.

A New Model

After telotristat etiprate failed in ulcerative colitis and LX1033 failed in irritable bowel, management has chosen to effectively scrap its early stage research and development efforts. Management will instead focus all of the company's assets and efforts on the late-stage development and commercialization of telotristat etiprate in carcinoid syndrome and LX4211 in Type 1 and Type 2 diabetes.

With this move, the company will be firing close to half (45%) of its workforce. Management believes that these moves will save $14 million in 2014 and $22 million on an annual basis. Assuming that all of those costs are cash-based (which may be a bit generous), these moves will save about one-quarter of the company's 2013 cash burn. Even so, with just about $150 million in cash at the end of the third quarter, it's not going to make a thesis-changing amount of difference.

The company also announced that CEO Dr. Arthur Sands will be leaving his position, pending the development of a succession plan with the board of directors. Given Dr. Sands' failure to secure a partner for the diabetes program, I believe this departure is appropriate.

Same Song, New Verse?

Lexicon being Lexicon, of course the company took the opportunity to remind us all that the company "expects to continue to progress its ongoing business development discussions, specifically including those relating to LX4211 for diabetes".

As a reminder, it's going on close to two years that the company has been talking about finding a partner to take LX4211 into late-stage testing for diabetes. I don't know what constitutes an "ongoing discussion", but maybe it includes leaving phone messages that go unanswered.

With that cynicism comes some unpleasant realities about where LX4211 may fit into the SGLT-1/2 market. If you look at the recent trends in GLP-1 drugs with Novo Nordisk (NYSE:NVO) and Bristol-Myers (NYSE:BMY) / AstraZeneca (NYSE:AZN) or DDP-IV drugs with Merck (NYSE:MRK), Novartis (NYSE:NVS) and Bristol-Myers/AstraZeneca, it is painfully difficult to make serious headway as the follower. By the time LX4211 gets to market, Johnson & Johnson (NYSE:JNJ) will likely have a head start of at least five years with Invokana and AstraZeneca will likewise have been on the market for years with Farxiga, to say nothing of Lilly (NYSE:LLY) and Astellas.

Now I've been quite bullish about LX 4211, and I still think it's a good drug. I think the efficacy compares quite well with Invokana and Astellas's ipragliflozin, and the drug may get favorable labeling with respect to safety concerns like renal function.

The question is how long this all takes. I don't know how Lexicon could raise the capital to fully fund the $1 billion or so it will require to do a complete run of Phase III studies in Type 2 diabetics, and I don't think doing it on the cheap is a viable option. I suppose that Lexicon could raise the capital necessary to put LX 4211 through Phase III studies for Type 1 diabetes, but that would be a risky and highly unconventional approach. It's not a completely ridiculous idea, though, as SGLT-2 inhibitors like Invokana are already being used off-label in Type 1 diabetics.

Still Waiting. Still Hoping

Because of the small number of patients with carcinoid syndrome, Lexicon could probably fund a pivotal trial here on their own. I'm not sure the revenue and profits that this indication would generate ($150 million to maybe $300 million on the very high end) would make enough of a difference in terms of funding LX 4211 studies.

With that, I feel like the success of Lexicon still revolves around the company finding some way to secure a partner to develop LX 4211. With the failure of fasiglifam, Takeda (OTCPK:TKPYY) could definitely use another potential blockbuster diabetes drug, but I have to assume that the two companies have already been in touch. At the risk of getting repetitive, I just don't know how Lexicon goes forward with LX 4211 alone unless they want to try the very unconventional approach of getting approval in Type 1 and then hoping that can fund studies in Type 2.

Adjusting The Value To Reflect More Pessimism

Lexicon is a case in point why, despite recurrent objections from biotech bulls, I very seldom ever give a company any valuation for its preclinical pipeline. With basically a press release, Lexicon's preclinical value has vanished - those assets don't disappear entirely and could theoretically come back again far in the future, but likely not until we're talking about 202X.

I am maintaining my nearly $1 per share fair value for telostristat etiprate in carcinoid syndrome. I am reducing my fair value estimate for LX4211 by $1.30 to $2.60 per share. This stems from a reduction in my peak sales estimate to $1.2 billion and an increase in my time to peak sales by 1.5 years (to 10.5 years). Without a partner, and without a ready source of cash, it's going to take this drug longer to reach the market and I do believe time is money when it concerns LX 4211's timeline to the market.

The Bottom Line

With those changes, I now project a fair value of $3.50 for Lexicon. That's still substantial upside relative to the current price around $2, but the reality is that this is almost a binary outcome at this point - the company finds a credible partner for LX4211 or they do not. There is the third option of going forward in Type 1 diabetes solo, but that's a murky and treacherous path.

Lexicon has never been a large position for me and I'm actually not that badly down on these shares (around 25%). With that, I'm inclined to let it ride and see how this all plays out. I don't advise others to follow me, though, unless they appreciate Lexicon for what it is - a high-risk speculative biotech stock that has been long on promises and short on delivery, but with a highly promising asset in a large therapeutic class.

Disclosure: I am long LXRX. 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.