For Lexicon Pharmaceuticals, No News Remains Bad News

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Summary

Lexicon updates investors on its second quarter results, but still has no partner to develop LX4211 in Type 2 diabetes.

Going solo in Type 1 diabetes is a risky move, but the company has little choice given that the value of the drug is otherwise stranded.

Fair value of $3.50 continues to make these shares worth consideration, but the Street will need to be convinced that the company's go-it-alone strategy can work.

The frustrating wait for the key driver at Lexicon Pharmaceuticals (NASDAQ:LXRX) - a clinical development and marketing partner for LX4211 - goes on. While management spent a lot of time on its earnings call reviewing the positive data and commercial opportunity in Type 1 diabetes, this was all pretty well known going into the call. Management believes it can go into Phase III development of LX4211 in Type 1 diabetes on its own, but these shares are likely stuck unless and until a partner emerges.

New Leadership, Old Problem

Lexicon announced a new CEO last month, naming Lionel Coats, the former head of Eisai's U.S. operations to the role. Mr. Coats does bring some relevant M&A experience to Lexicon, as he was involved in Eisai's acquisition of MGI Pharma and the somewhat unconventional licensing/marketing agreement with Arena Pharmaceuticals (NASDAQ:ARNA) for its obesity drug Belviq. Although Lexicon shareholders may regard the relatively disappointing performance of Belviq's commercial launch as a mark against Mr. Coats, I frankly feel that Eisai has done about the best that could be expected with the drug.

Bringing in a CEO with commercialization experience is a good move for Lexicon. Telotristat etiprate is in Phase III studies for carcinoid syndrome and a successful outcome could lead to an NDA filing in 2015 and a commercial launch in 2016. The carcinoid syndrome should be concentrated enough to allow Lexicon to effectively market the drug itself, so commercialization is very much a relevant factor.

All that's nice, but not enough. The biggest challenge for Lexicon remains securing a partner for its lead diabetes drug LX4211 - an oral SGLT1/2 inhibitor that has consistently shown very good efficacy and safety, but cannot seem to generate sufficient interest among would-be Big Pharma partners. Lexicon is moving forward with its own Phase III development plans in Type 1 diabetes, but the company continues to need a funding partner for Type 2 development.

Partnering Isn't Getting Easier

LX4211 is not an asset with an indefinite shelf life. Johnson & Johnson (NYSE:JNJ) has been in the market with its SGLT-2 drug canagliflozin (Invokana) since early 2013, while AstraZeneca (NYSE:AZN) has been marketing dapaglifozin (Farxiga) since earlier this year. Lilly (NYSE:LLY) is also about to get in the game, with the FDA just recently approving empagliflozin (to be marketed as Jardiance). While commercial success in the diabetes market does not rely on being first or even second to market, there is a point where even a differentiated drug (like LX4211 may be) may be looking at too much entrenched competition to carve out substantial share.

Making matters worse, AstraZeneca and Lilly are moving forward with DPP-4/SGLT-2 fixed-dose combos, with presentations at the recent ADA meeting showing superior A1c reductions to SGLT-2 drugs alone without compromising weight loss. Novo Nordisk (NYSE:NVO) and Transtech are also moving forward with oral GLP-1 compounds that could alter the addressable market even further.

One of the biggest positives to LX4211 is that it has shown solid efficacy in Type 1 diabetes, and this is both a large and exceptionally under-penetrated market. Unfortunately, AstraZeneca has announced its intention to move dapagliflozin into Phase III in Type 1 before year-end and both Johnson & Johnson and Lilly have done Phase II work here as well.

What's left to recommend LX4211? For starters, it has shown superior safety in patients with renal impairment and that could carve out about 10% of the Type 2 market for the drug. Beyond that, the drug has shown strong efficacy in Type 1 and strong efficacy and safety in Type 2 and a good marketing partner should be able to leverage that into commercial success.

In so far as partnering goes, Novo Nordisk has no SGLT platform, but has shown little interest in it. Sanofi (NYSE:SNY) and Takeda are still both potential partners, and I'd note that Takeda has a DPP-4 drug (alogliptin, marketed as Nesina in the U.S.) that could be used in a fixed-dose combo.

Going It Alone Won't Be Easy

Lexicon has made it plain that they will not wait forever to find a partner for LX4211 and the company is moving forward with plans to put the drug into pivotal Phase III studies in Type 1 diabetes. After discussions with the FDA, the company is contemplating two pivotal Phase III studies with a third Phase III study necessary if it remains a standalone program (i.e. no Type 2 program) to establish sufficient safety information.

Management was a little cagey about design plans and costs, other than to acknowledge a cost of "more than $100 million" on a standalone basis. That exceeds Lexicon's cash on hand and I would note that there is a risk that the FDA could demand a cardiovascular outcomes study. Lexicon management does not seem to believe that this will be required, but given how the FDA has dealt with other companies developing diabetes drugs (including Novo Nordisk) that expectation carries some risk. I'd also note that management stated that the FDA says it "would prefer" an integrated Type 1 and Type 2 program, likely because of concerns of off-label usage in Type 2, and going against FDA "preference" can be risky.

Can Lexicon get LX4211 through the clinic and to the market on its own? It will not be easy, and there will likely be dilution along the way, but I think the answer is "yes". With that, I do wonder if commercialized telotristat etiprate (assuming positive TELESTAR results) can generate enough cash to tide the company over to LX4211 approval in Type 1 diabetes - at which point the question then becomes about whether Lexicon reinvests those proceeds into Type 2 development (assuming a partner does not emerge along the way).

The Bottom Line

Whether or not Lexicon can go it alone is at least somewhat secondary to the reality that the Street does not want them to do so - bullish analysts (and I suspect most shareholders) really want to see a development and commercialization partnership with a "name brand" drug company. I continue to remain skeptical but hopeful; my position in Lexicon is a small one and the potential upside to a commercial partnership (not to mention the inherent value of LX4211) makes hanging around worthwhile to me.

My fair value estimate for Lexicon remains $3.50, though I've moved some numbers around a bit. I've updated the timelines for both drugs (good for the value), slightly upgraded my pricing expectations for telotristat etiprate (lifting my fair value estimate to $1/share), and slightly downgraded my sales expectations for LX4211 due to time decay in the Type 2 opportunity (reducing the value to $2.50/share). While that target suggests significant upside from here, this is a very risky biotech with a lot riding on decisions (partnering and pivotal trial design) that are not entirely within management's control.

Disclosure: The author is long LXRX. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.