Lexicon Pharmaceuticals, Inc. (LXRX) has been badly pummeled this week. It has dropped from last week’s close of $5.69 to $1.35 on Wednesday after Sanofi (SNY) terminated its collaboration with it to develop, manufacture and commercialize Zynquista for diabetes and Q2 results that reported mediocre 24% net sales growth in Lexicon’s flagship drug XERMELO. LXRX has seen its market cap decline by $460 million to $143 million in three trading days on these two pieces of news and its enterprise value is down to $290 million.
Stifel analyst Stephen Willey downgraded LXRX from a buy to hold and cut his price target from $10.00 to $4.00. Despite the cut, this still represents a 200% upside compared to LXRX’s close on Wednesday. Now that Lexicon is beaten down with all of the bad news out and sentiment at its worst, it may be a good time to buy in hopes of some good news to come and shorts covering in order to lock in their massive profits.
Buy in hopes of a Sanofi settlement and a short squeeze
When taking a look at the recent news and Lexicon’s unenviable financial position, investors are left wondering what exactly the long investment thesis is on LXRX. Biotech shareholders are hard-pressed to find value in Lexicon as XERMELO isn’t performing as first hoped and the mixed results on the three clinical studies that caused Sanofi to drop the partnership has Zynquista’s future in doubt. LXRX has $106 million in cash, $245 million in debt and had a net loss of $23 million in Q2. These are not very good numbers for a company with one niche drug in the market and a terminated partnership. Unless it significantly slows down its burn rate, LXRX may have about a year of cash plus debt on its books with no way to pay it back.
What Lexicon may have, however, is grounds to extract a material amount of money from Sanofi, either voluntarily or through litigation. Reviewing the initial agreement between the two parties:
Prior to completion of the core development activities for type 2 diabetes specified in the development plan, Sanofi may terminate the Agreement on a country-by-country and licensed product-by-licensed product basis, in the event of [A] notification of a material safety issue relating to the licensed product or the class of sodium-glucose cotransporters type 1 or type 2 inhibitors resulting in a recommendation or requirement that we or Sanofi cease development, [B] failure to achieve positive results with respect to certain clinical trial results, [C] the occurrence of specified fundamental adverse events or [D] the exploitation of the licensed product infringing third party intellectual property rights in specified major markets and Sanofi is unable to obtain a license to such third party intellectual property rights.
Sanofi appears to be attempting to end the partnership based on clause B, failure to achieve positive clinical trial results. Lexicon disputes this claim, as two of the three trials indicate at least partial success. Sanofi reneging on this deal may have more to do with its own change in direction rather than the success of the trials. This $1.7 billion deal was signed under outgoing CEO Olivier Brandicourt, and is now conveniently terminated a little over a month before his retirement. Pascale Witz, who was Executive Vice President at Sanofi, was to lead the Global Diabetes and Cardiovascular Care Business Unit at the time the agreement was signed. She left Sanofi in 2016.
Lexicon intends to review the data once it is received to draw its own conclusion. At a minimum, Lexicon noted that “Sanofi has continuing contractual obligations to transition rights to sotagliflozin and continue to fund ongoing clinical trials for a contractually specified period of time following termination”. Sanofi stated that it wants a smooth transition of the studies back to Lexicon, so it appears open to some amount of break fee.
According to Lexicon, it was eligible to receive up to $210 million upon the achievement of specified clinical development milestones, up to $220 million upon the achievement of specified regulatory milestones and up to $990 million upon the achievement of specified commercial milestones within the agreement. Lexicon spent $100 million to fund a portion of the type 2 diabetes development costs.
I believe that Lexicon has the ability to extract a material payment out of Sanofi. It acted in good faith by funding its portion of the studies to the tune of $100 million, and the trials resulted in statistically significant data. It was always ultimately up to Sanofi if it actually wanted to market the drug. So the $990 million upon achievement of commercial milestones appears out of Lexicon’s reach. However, at least some of that $210 million for achievement of specified clinical development milestones and/or $220 million for regulatory milestones may be within reach.
The actual amount of any settlement may matter less for a short term trading opportunity than the change in sentiment that news of any kind of settlement may provide. Short interest on LXRX was 9.3 million shares as of July 15. Until recently, that was about a month’s worth of volume on LXRX. In other words, it seems impossible to cover without some kind of catalyst to bring volume into the stock. LXRX’s float is 41 million shares so the short interest as a percentage of the float is a fairly squeeze-inducing 35%. Shorts have an incentive to cover fairly aggressively now that it is trading at volumes large enough to do so. If the average short has an open position at $8.00, covering at $1.50 or $2.00 is not going to make a huge percentage difference to those traders. However, someone who buys at $1.50 and sells at $2.00 manages to come away with 33%. That is why there are often so many major dead cat bounces off of stocks that have lost most of their value.
Stifel believes that $4.00 is a fair target price on LXRX after Sanofi terminated the partnership. I would settle for a bounce to $2.00 or $3.00 on some good news over the Sanofi settlement and a short squeeze.
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.