Lexicon Pushes On To Phase III

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Lexicon Pharmaceuticals (NASDAQ:LXRX) still isn't what I'd call a household name in biotech, even though the company has over $1 billion in market capitalization and at least two solid drug product candidates. With Friday's news of a successful Phase II study in carcinoid syndrome and the launch of a Phase III study, Lexicon investors have good reason for a little cheer going into the weekend.

Good Data, But A Small Study

Lexicon announced results of a Phase II study of LX1032 (oral telotristat etiprate) in patients with carcinoid syndrome. This was a small open-label study (15 patients), but the participants were all refractory and the results looked solid. LX1032 delivered a statistically significant 46% median decline in bowel movements (severe diarrhea is a symptom of carcinoid) and 75% of patients self-reported improvements on week 12. Safety data has remained clean, and tolerability doesn't appear to be a major problem.

With this data, the company also announced the start of a Phase III study. This study will enroll 105 refractory patients into a 12-week double-blind study that will investigate two different dosages of LX1032 against a placebo. A 36-week open-label extension will follow the 12-week trial period.

Warming Up To LX1032 As A Meaningful Drug

I've always found it most profitable to take an Eeyore-like perspective to biotechs, as I believe there's almost always too much hype and hope with biotech stocks and their pipelines. Accordingly, I haven't thought too highly of Lexicon's prospects for making LX1032 a worthwhile drug. That said, I'm warming up to the idea that LX1032 could actually be meaningful to the valuation at Lexicon and an underappreciated asset.

About 85% of the 10,000 or so carcinoid patients in the U.S. are "well-controlled" on generic octreotide (that's the doctor's classification, not the patients). Those responses are not always durable, though, and patients often find themselves going up through the dosage levels before ultimately seeing less and less benefit. LX1032 not only offers the promise of treating those patients who eventually stop responding to octreotide, but it also offers a more convenient dosing option (oral instead of injected).

Depending upon the dose involved, it looks like octreotide therapy costs about $30,000 to nearly $60,000. If Lexicon can charge $48,000 (a premium to the two most common injected dosages) and get just one-quarter of the treatment population (2,500), this is a drug with some worthwhile per-share potential.

In terms of per-share value, I'm going to go with that $48K per year price estimate and a patient population estimate of 3,500. I'm also going to use an elevated discount rate (40%) to account for the risks tied to the small size of the trials done to date. Go through those steps and a $1.40 per-share value estimate comes out.

LX1032 Still Just The Appetizer

Whether I'm too skeptical on the prospects of LX1032 or not (as well as the prospects of drugs for irritable bowel, glaucoma, and rheumatoid arthritis), I don't think Lexicon bulls will argue with me that LX4211 remains the crown jewel for Lexicon.

SGLT2 inhibitors have been getting a lot of favorable attention at recent diabetes medical meetings (including the most recent American Diabetes Association and European Association for the Study of Diabetes meetings), and sell-side analysts expect Johnson & Johnson's (NYSE:JNJ) recently-filed canaglifliozin to be a blockbuster. Moreover, big things are expected from Eli Lilly's (NYSE:LLY) empagliflozin (partnered from Boehringer) and AstraZeneca (NYSE:AZN) and Bristol-Myers (NYSE:BMY) may not yet throw in the towel on dapagliflozin in the U.S.

LX4211 is a rare asset in many respects. Not only is it a dual SGLT1/2 inhibitor, but it is also an unpartnered diabetes drug with over $1 billion in potential sales. While the pace of biotech partnerships has slowed a bit recently, I still believe the odds are very good that Lexicon will secure a Big Pharma partner. Roche (OTCQX:RHHBY) and GlaxoSmithKline (NYSE:GSK) both had setbacks with their SGLT2 programs and Sanofi (NYSE:SNY) is almost always an interested party when it comes to new diabetes medications. All in all, I still think that this drug is worth more than $3 per share to Lexicon and that a partnership announcement is a "when, not if" event.

The Bottom Line

Since I really wasn't explicitly including any value for LX1032 before now, doing so does bump up my fair value on Lexicon shares to a meaningful degree. In addition to the $3.50 in estimated value for LX4211 (based upon $1B in revenue in six years), I'm adding the $1.40 for LX1032. That suggests a price target of nearly $5, and includes no value for the company's pipeline or core technology.

With Phase II programs often carrying an average enterprise value of about $150 million, I'd be inclined to add about $200 million (or about $0.40/share) in estimated value for these other programs at Lexicon - a level that I'm sure will be decried as overly conservative.

All in all, then, with a fair value of close to $5.25 per share, a current price of about $2.65 and a sell-side average price target of $3.33, I'd say these shares remain significantly undervalued. Amidst all of the hoopla and debate over Amarin's (NASDAQ:AMRN) fish oil, obesity drugs from Arena (NASDAQ:ARNA) and Vivus (NASDAQ:VVUS), and any number of small-cap oncology biotechs, this seems like an underappreciated diamond in the rough today, even though the shares have been strong so far this year.

Disclosure: I am long LXRX, OTCQX:RHHBY. 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.