The FDA's Upcoming Decision On Zynquista Is Key To Lexicon's Performance

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About: Lexicon Pharmaceuticals, Inc. (LXRX), Includes: SNY
by: Stephen Simpson, CFA
Summary

Xermelo continues to generate lackluster revenue for Lexicon, though prescriptions are growing and insurance coverage is improving.

The FDA is due to decide on the approval of Zynquista in Type I diabetes next weak (March 22); I believe the FDA will approve the drug (with warnings).

Phase III read-outs for Zynquista in Type 2 diabetes and commercialization over the next two years could unlock over $300 million in milestone payments.

Lexicon shares look undervalued, but highly risky given the uncertainty over Zynquista in T1D and a crowded future market in T2D.

Lexicon Pharmaceuticals (LXRX) has long been a volatile stock, even by the standards of biotech, and whether it can move out of its current doldrums has everything to do with next week’s FDA decision on Zynquista for Type 1 diabetes (or T1D). With Xermelo relegated to an “is what it is” disappointment in carcinoid-related diarrhea and other clinical candidates in early stages of development, Zynquista is the key value-driver now.

I’m still guardedly optimistic that the FDA will approve Zynquista, albeit with warnings and risk mitigation strategies, but I don’t exclude the possibility of a rejection on procedural grounds or a requirement for a risk mitigation study. Still, with what I regard as overly-discounted expectations for Zynquista in both T1D and Type 2 diabetes (or T2D), these shares still look undervalued, albeit very risky, to me.

Some Progress With Xermelo, But Not Enough

Lexicon’s fourth quarter earnings release was relatively uneventful in terms of the financials. Sales of Xermelo in the U.S. rose 16% sequentially and came in more or less expected, which given the track record of this disappointing drug may be something you could regard as good news. Daily prescriptions increased 13% sequentially and the company is seeing a gradual improvement in the number/percentage of patients covered by insurance, while compliance remains steady at around 80%.

Management’s guidance for 20%-plus growth in Xermelo sales for 2019 was weak relative to expectations, coming in close to the low end of the prior sell-side range. As I said, this is an “is what it is” situation with this drug, and at this point peak global revenue may well end up somewhere around $150 million a year unless there is a significant shift in prescribing trends and/or insurance coverage.

Lexicon ended the year with $160 million in cash and between expected milestone payments and the profitability of Xermelo, Lexicon shouldn’t need to raise capital in the foreseeable future.

Zynquista’s Future Hanging In The Balance

Lexicon and its shareholders will find out on March 22 whether the FDA has decided to grant approval to Zynquista for T1D. As a reminder, the FDA’s advisory panel split 50/50 on the question of whether or not the drug should be approved, and the FDA has historically leaned more conservative with diabetes drugs than with drugs for other diseases, particularly given the belief (wrong though it may be) that insulin is “good enough”.

Lexicon did get some incremental good news on March 4 when Europe’s CHMP recommended approval of Zynquista (both the 200mg and 400mg doses) in T1D patients with BMIs above 27. While that certainly falls short of a best-case endorsement scenario, it should still pave the way for European approval and once approved, doctors may well prescribe it more liberally than that recommendation specifies.

Given the FDA’s past practices with diabetes medications, I see three outcomes next week. The first is outright approval, most likely with a black box warning related to the risk of diabetic ketoacidosis and a risk management strategy. The FDA could reject the drug in lieu of a more stringent/better-defined risk management strategy (what I meant earlier by “procedural grounds”), which I believe Lexicon and Sanofi could address in around six months, leaving the door open to an eventual approval before the end of 2019. Last and worst would be a rejection that demands a trial of the risk management strategy before reconsidering approval.

Beyond the T1D indication, Sanofi (SNY) continues to work on a broad clinical program for Zynquista in T2D. Some of these studies will report out this year, with data in the second, third, and fourth quarters and an expected filing with the FDA in 2020. As a reminder, Lexicon is entitled to over $100 million in Phase III-related milestones and over $200 million in commercialization milestones that could pay out over the next two years or so (as well as $100 million tied to longer-term outcome studies).

Sanofi’s Phase III program has focused on the potential benefits of Zynquista in T2D patients with renal disease. With upwards of 40% of the T2D market experiencing some level of renal impairment (and around 16% to 20% at Grade 3/4), this is a sound strategy to differentiate this late-to-market SGLT-1/2 inhibitor, and one where prior clinical data do suggest that the drug can distinguish itself positively.

The Outlook

Zynquista’s fate in T1D will soon be known and approval would add about $3.50/share in value relative to my current probability-adjusted value for the drug. All told, I continue to value the Zynquista program at around $11 on a risk-adjusted basis. Xermelo in carcinoid-related diarrhea adds in another $2.50, while the company’s early-stage pipeline (Xermelo in biliary tract cancer and NET, LX9211 in pain, and LX2761 in diabetes) adds about $1.50. As far as the early-stage pipeline goes, management has started a Phase II combo study of Xermelo in BTC and will soon be starting a Phase Ib study of LX9211. Development of LX2761 appears to be on hold for now, with management waiting for combo results from Zynquista studies to guide further development.

The Bottom Line

Long-term Lexicon shareholders have been through a lot, and a lot is still riding on the FDA’s decision regarding Zynquista. While FDA approval for the T1D indication and strong clinical data from Sanofi on the T2D indication should drive a higher share price, there’s still a lot of risk in this name (including regulatory, developmental, and execution/commercialization risk) and it’s not suitable for more risk-averse investors.

Disclosure: I am/we are 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.