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XOMA: a Value Gem or a Failing Penny Stock?

|Includes: ARNA, BMY, GSK, LLY, OREX, TTHI, XOMA Corporation (XOMA)

XOMA Ltd. is a small biotech company that specializes in antibody-based therapeutics for diabetes and biodefense. It caught my eye last summer when it announced its Phase I trial result for its leading product candidate, XOMA 052 for the treatment of diabetes. The result was pretty encouraging (more detail on this later); however its stock price didn’t move much and actually started a slow downward slide. I have been following it since then because it really intrigues me. It has a revenue stream; balance sheet is getting better; lead drug candidate looks good so far, so why does it continue to suffer in the market? XOMA just released its 2009 full year financial results and the earning call transcript is out too, so I’ll try to break everything down to see if it is truly a value gem.

Comparative value analysis
2009 total revenue was $98.4 million, an increase of ~45% over that of 2008 mainly due to an increase in license fees. Net income was $0.6 million, a big improvement over last year's loss of $45 million. Xoma repaid its Goldman Sachs loan of $47 million; that leaves the only long-term debt of $13.3 million to Novartis which is due in 2015. With its public offering of $21 million earlier last month, it currently has a book value (NASDAQ:BV) of $36 million. As of 3/12/10 its market capitalization was $112 million, so that's 1.2X of trailing revenue, 3X of BV. Below is the comparison to a few other non-profitable biotech companies with a focus on the metabolic disease market.

Ticker Price Mkt Cap ($M) 09 Rev ($M) Net Inc ($M) Cap/Rev BV ($M) Cap/BV
XOMA 0.56 112 98 0.6 1.14 36 3.11
ARNA 3 279 10 -153 27.9 74 3.77
AMLN 20.26 2900 758 -186 3.83 422 6.87
OREX 6.55 308 0.09 -67 3422 76 4.05
TTHI 2.61 60 3.8 -24 16 34 1.76

From this exercise of financial analysis, it's pretty clear that XOMA is undervalued. Unlike many other biotech firms, it has a steady stream of license and royalty revenues to help offset cash burns funding its R&D. This company has been around since 1981, which shows its resilience. The question is why the market hasn't recognized its value and if there is a catalyst that can propel it out of the penny stock territory.

Pipeline and latest trial results
Pipeline to a biotech company is like milk to a baby, providing the essential nutrients for the company to grow. A deep and promising pipeline can make a biotech company fly despite many years of red inks. In this respect, XOMA is indeed on the very risky side of the spectrum, it essentially only has one clinical stage drug candidate. However, this Interleukin-1 (IL-1) beta antibody (XOMA 052) is in a pathway with proven clinical utility for inflammation, and diabetes has been gradually recognized in the biomedical community as a chronic inflammatory disease. Novartis has a similar antibody called Canakinumab that was approved in the US for the cryopyrin-associated periodic syndrome (OTCQB:CAPS) last June. Novartis has ongoing trials for other indications including Type 1 diabetes (T1D) and Type 2 diabetes (T2D) in Phase II/III trials. Eli Lilly also has an IL-1 beta antibody in Phase II trial for T2D. The fact that two big pharmas are in the same race validates XOMA’s strategy, but at the same time it does put on competitive pressure on this little firm.

Novartis and Lilly haven’t released any of their trial data on T2D, but XOMA’s own Phase I result looks encouraging. In a nutshell, the Phase I study enrolled 98 patients with T2D for 84 days at most. XOMA 052 (0.03mg/kg) 3 doses in every 2 weeks produced a placebo-adjusted reduction of 0.5% in HbA1c (the primary end point for all diabetic treatment) 56 days after the last dose. The most effective therapy on the market right now can reduce HbA1c by ~1% in about 6 months with daily dosing. So to be able to position as a monotherapy agent, XOMA 052 has to improve its efficacy in late stage trials. However, the reported Phase I efficacy could still make it a candidate for combination therapy especially since its mechanism of action is different from anything that is currently on the market and that its infrequent dosing makes it more convenient for patients.

There are at least two caveats from this trial that I think why the market was not impressed. First, trial size, although typical of a Phase I trail, was pretty small with only 5 patients in each multiple dosing-arm. Whether the results can be replicated in larger trials is still in question. Second, the higher dose did not produce any efficacy in HbA1c despite of some improvement on secondary end points like fasting glucose.

The planned two Phase II trials for T2D have started enrolling patients. The IIa trail will enroll about 80 patients for a 6-month study with the result from the first three months expected by the end of this year. The IIb trail will enroll 325 patients who will receive monthly treatment for 6 months with top-line results expected in 2011. As with many clinical trials, the results may differ substantially from earlier small-sized trials. If XOMA 052 can demonstrate equal or better efficacy in these trials, it will most certainly propel the stock to another level. If the converse was to happen, XOMA will be severely punished since it doesn’t have anything else in the pipeline to fill the void.

Potential partnership with big pharmas
The general strategy employed by many small biotech companies is to find a big pharma partner who is willing to shoulder the cost i.e. risk of developing a novel therapy. XOMA has been actively pursuing a deep-pocketed suitor for at least a year now, but the progress seems to be slow. My personal take is that Novartis and Eli Lilly probably are not wholeheartedly interested since both of them have their own internal IL-1 beta Ab programs. Novo Nordisk, Sanofi-Aventis and Merck have the biggest shares in the anti-diabetic market, and all are increasing their investments in developing biologics. I think the front-runners could be GlaxoSmithKline (NYSE:GSK) and/or Takeda. Due to the much publicized cardiovascular risks of its oral insulin sensitizer Avandia, GSK is rapidly losing market share in the diabetes space. It is desperately in need of a blockbuster to revive its diabetes franchise. However, XOMA 052 even succeeds in the late-stage trial, would be too late for GSK. Takeda currently has the best-selling oral anti-diabetic drug in the world, Actos which will lose patent protection in 2011. Takeda doesn’t currently have a biologic agent in its diabetes pipeline. More importantly, Takeda has an existing relationship with XOMA, licensing the latter’s antibody production technology. A marriage between these two would be ideal. An outright buy-out from Takeda may not be impossible, since it will acquire both a proven technology platform and an interesting drug candidate.

Of course, the XOMA management, in anticipation of good results, may themselves want to engineer the deal after the completion of the Phase IIb trial, so they can bring in much more cash and milestone payments. In some cases, it does make sense to hold out for a better deal.

Opportunities and challenges
In summary, with fair amount of revenue and promising drug candidate, XOMA’s valuation looks pretty good. However, substantial risks still exist which could continue to depress its stock price:
  • Out of compliance with the $1 bid price required by NASDAQ.
  • Better results from bigger competitors like Lilly and Novartis.
  • Failure of own Phase II trials.
  • Shallow pipeline.
In my opinion, between now and the end of this year one probably won’t see big movements on XOMA’s stock price. However because of its valuation, I think the downside risk from here is also limited.

Words of Caution: Equity trading is not an exact science, no matter how good one’s analysis is, market can ignore a certain stock’s fundamentals for a long period of time. The analysis offered here is my own knowledge of the industry and of the individual companies. Some assessments are just my own opinion and may be just pure speculation to others. Please do your own due diligence before investing with your hard-earned money!

Disclosure: No position at time of writing, but intend to accumulate at <$0.5 levels.