Lexicon’s Stock Offering; In Biotech, it’s “Raise When You Can”

Despite a stash of cash and liquid investments, Lexicon Pharmaceuticals (NASDAQ:LXRX) caught investors off guard two weeks ago by initiating a capital raise. The company had more than $225M in cash, equivalents, and short-term investments as of June 30 and burns approximately $25M quarterly, putting shareholders’ minds at ease that LXRX was at least safe from the dilutive qualities of a stock offering. Unfortunately, the biotech rule of thumb is to raise when you can; Lexicon took advantage of share prices just short of their 52-week high and offered up roughly $40M in common stock. Shares have tumbled almost 20% since.

Lexicon’s pipeline is lead by telotristat etiprate (LX1032), an oral tryptophan hydroxylase inhibitor in development as a treatment for carcinoid syndrome and ulcerative colitis. Carcinoid syndrome is a rare disorder – LX1032 has Orphan Drug and Fast-Track designation – that occurs when gastrointestinal tumors release large amounts of serotonin, causing diarrhea, bronchial restriction, abdominal pain, and flushing. LX1032 works by inhibiting tryptophan hydroxylase and subsequently reducing peripheral serotonin levels. Earlier this month, Lexicon initiated a Phase 3 study for patients with carcinoid syndrome who have become refractory to standard somatostatin analog therapies. Existing treatments include Novartis’ (NYSE:NVS) Sandostatin (octreotide) and Ipsen’s Somatuline® Depot (lanreotide), which is in a Phase 3 trial for carcinoid syndrome; both are injectable compounds.

Analysts are concerned that generic octreotide may make LX1032 less substantive in the market. While Sandostatin’s immediate release formulation is available generically, Sandostatin’s long-acting formulation, injected once-monthly, is still exclusive, and prescribers usually move patients to the long-acting version as soon as tolerance is determined through the immediate release formulation. That formulation is injected 2 or 3 times daily, and the advantages of a long-acting or oral formulation are obvious. Sandostatin generated $1.44B in worldwide sales last year, suggesting that an equivalent oral drug stands to peel off a significant portion of the patient population, specifically those who become refractory to somatostatin therapies.

Most analyst, however, are focused on Lexicon’s second candidate, the dual SGLT1/SGLT2 inhibitor LX4211 for type-2 diabetes. Sodium-glucose co-transporter 1 (SGLT1) is the major intestinal glucose and galactose transporter, while SGLT2 is responsible for glucose reabsorption in the kidney. SGLT2 inhibition is commonly pursued for its ability to improve glucose excretion in urine, and adding the SGLT1 inhibitor may help stop or slow gastrointestinal reabsorption. Investors are well-aware of the opportunity for an effective SGLT1/SGLT2 inhibitor; LXRX set a new 52-week high just after releasing Phase 2b data in June, and the industry is pursuing the mechanism’s opportunity as well. Johnson and Johnson (NYSE:JNJ) develops the SGLT2 inhibitor canagliflozin, Eli Lilly (NYSE:LLY) has empagliflozin, while AstraZeneca (NYSE:AZN) and Bristol-Myers Squibb (NYSE:BMY) co-develop dapagliflozin. The space is obviously crowding, but if LXRX can set itself apart with a dual inhibitor with improved safety and efficacy, it stands to benefit from the immense market for diabetes products. The company released Phase 2b data in June and expects to initiate a Phase 3 trial in the first half of 2013.

In the short-term, LXRX is supported by its 200-day Simple Moving Average around $2.00, and the 14-day RSI suggests that the stock is oversold following the capital raise, and is likely preparing for a bounce; the stock may move to cover those previous gaps. The company plans to initiate a trial for LX4211 as a Type 1 diabetes treatment in the near-term, and plans to partner LX4211 before advancing into a Phase 3, type 2 diabetes trial. Both could happen before the end of the year, and news on either front will lift the shares higher.

LX4211 presents a significant opportunity if successful in its next trial. It’s already demonstrated a favorable safety profile despite the shortcomings of some competition. And LX1032 could become a major value-driver for Lexicon if it achieves approval as an orphan drug, although the market opportunity has not been fully explored. Additionally, Lexicon develops LX1033 for Irritable Bowel Syndrome, and LX2931 for Rheumatoid Arthritis, both in Phase 2 development. It’s important to note that while Lexicon is still a development-stage company, upside is somewhat limited by LXRX’s $1.03B market capitalization; the market is certainly taking the value of this burgeoning pipeline into consideration. Recent weakness, however, may present an opportunistic entrance point into a compelling pipeline.