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Morningstar | Zynquista's Risks Highlighted in FDA Advisory Committee Meeting; Lowering Our FVE to $5.80

After a very mixed view of Zynquista's value in Type 1 diabetes from a U.S. Food and Drug Administration advisory committee on Jan. 17, we are lowering our fair value estimate for Lexicon to $5.80 per share. We reduced our assumed probability of approval for the drug in this indication from 70% to 40% after the meeting, reduced our peak market share assumption, and slightly increased research and development spending in 2019 and beyond to account for the potential need for additional clinical data. While we think the drug's efficacy looks strong enough to outweigh risks (the risk of diabetic ketoacidosis is most notable among side effects), half of the committee voted that benefits did not outweigh risks, and at least two other committee members who supported approval wanted additional data on mitigating the risk of DKA. Even if Zynquista is approved on schedule in March, we expect post-approval studies may need to be conducted, and Lexicon would be on the hook for funding them. In addition, our lower probability lowers the size of probability-weighted milestones expected from Sanofi in 2019 (for Zynquista's approval).

Lexicon has yet to establish an economic moat, given its one approved drug and one key pipeline therapy. We see very high uncertainty surrounding the value of Lexicon shares, largely due to a tough competitive landscape with SGLT2 inhibitors approved in Type 2 diabetes and progressing in Type 1 diabetes. Lexicon’s $187 million in cash at the end of the third quarter of 2018 should be sufficient to get through the Zynquista launch, if this proceeds on schedule, but if additional trials in Type 1 diabetes are required, we think Lexicon could be forced to raise cash later this year.

We continue to use a 50% probability of approval for the drug in Type 2 diabetes, and pivotal data is expected this year. We don't see evidence that Zynquista's safety profile differs substantially from approved SGLT2 therapies in this indication. However, the Type 2 diabetes market is already quite competitive (established competitor Jardiance also has strong cardiovascular outcomes data), and Lexicon will only receive low-double-digit royalties from partner Sanofi. Type 1 diabetes is a larger opportunity; although there are fewer patients than Type 2, Zynquista would be the first oral treatment for Type 1 patients, and Lexicon would receive 30%-40% royalties.