Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, co-editor of Morningstar OptionInvestor, and today it's my great pleasure to welcome Karen Andersen, who's a senior analyst in charge of biotechnology stocks. Karen, thanks for coming.
Karen Andersen: Pleasure to be here.
Kobayashi-Solomon: Now, Karen, back in November I did something a little unusual. Ours is an options newsletter but there were no options on Lexicon, so I said Lexicon stock is basically an option, and recommended to readers that they buy the stock. It's appreciated by 40% since then, so I hope our viewers are pretty happy with that. But I want to ask you a little bit about Lexicon.
Kobayashi-Solomon: When I first started reading about it there was all this stuff about knockout mice and genetic engineering, and it sounds crazy to me. I wonder, is Lexicon a real company or is it just a science experiment? I mean, is there something economic that we can invest in here?
Andersen: Sure. Well, you know, the knockout mouse technology is actually fairly widely used in the biotech industry. A knockout mouse is just a way of designing a mouse that lacks a specific gene. Looking at that mouse is sort of a window into what would happen if we designed a drug that targeted this gene.Read Full Transcript
Kobayashi-Solomon: I see.
Andersen: So it can be a very useful way of kind of previewing what would happen if we designed a drug around that.
Kobayashi-Solomon: This is really like a way to speed their research and development, a way to speed their testing process, is that right?
Andersen: Yes and it's a way that makes sure that they're sort of on the right track, because 99% of human genes have a counterpart in a mouse's genes.
Kobayashi-Solomon: Is that right?
Andersen: So it's considered very valuable to just look at what happens to this mouse? Are there certain side effects that we weren't anticipating? Or maybe there's a gene that looked promising in one way and then they find out that it has some great other characteristic that's really beneficial, that really kind of boosts the importance of studying that gene. That can be very informative, and Lexicon's whole focus has been to--they had these Genome 5,000 project where they studied 5,000 different promising genes just as an effort to sort of cull through those and find the most promising ones that it's actually worth designing a drug around.
Kobayashi-Solomon: I see. OK. So Lexicon is not just a science experiment, it's actually doing something. Now are there other companies that are doing something similar? I read in my research that there's some kind of similar technologies. Is there room enough in the marketplace for two similar things?
Andersen: Right, well, there is another method of knocking out or knocking down, reducing the number of the amount that a gene has expressed. So, for example, RNA interference, it's a method that is used by one of the companies that I cover, Alnylam Pharmaceuticals. They've managed to sign several very lucrative partnerships with large pharmaceutical companies based on their kind of patented state in this area. RNA interference just really involves directly blocking a gene sequence. So if you're studying a mouse, you can take a normal mouse and inject genetic material into them, and it blocks the gene directly.
Kobayashi-Solomon: They basically create a knockout mouse on-the-fly, so to speak.
Andersen: Right. Right. No, that's a good way of looking at it.
Kobayashi-Solomon: I see. Alnylam has this competitive technology. Is there room for Lexicon?
Andersen: You know, I definitely think there's room. I mean, I think it's just sort of two different ways of getting to the same goal of finding a new drug target. So, for example Alnylam, they use this genetic material, that genetic material would actually be the drug in the end. Where a company like Lexicon, they might do a mouse knockout and then they're going to design a more traditional drug, something like a small molecule drug that pharmaceutical companies might make or an antibody that a biotech might make.
So I think it's just two different approaches, two different ways of getting at the same goal, and I think there are plenty of very interesting targets out there to go around.
Kobayashi-Solomon: Now, we have to get to the mercenary point and the mercenary point is this: I recommended buying this stock when it was $1.52, it's now well over $2.00. A 40% increase in just a couple of months. Somebody who is holding this, should they hold out for more price appreciation or is it time to kind of cut there? I mean, put the money off the table, so to speak?
Andersen: I think it depends on the risk tolerance of an investor. Another way I see it, the worst case scenario, Lexicon did have their first drug candidate for cognitive disorders fail in a phase two trial. Right now there are four phase II drug candidates--this is sort of the mid-stage of drug development--if all of those were to fail, the company would probably start to run out of cash and may be forced to lay off additional employees, kind of put its programs on hold. There is definitely a worst case scenario.
Kobayashi-Solomon: I see.
Andersen: On the other hand I think, based on what we've seen so far, these four phase II drug candidates have a lot of promise and we've already seen some preliminary positive data from two of them. One of them being a diabetes drug.
Kobayashi-Solomon: So this is just recently, right?
Andersen: Just recently. We actually saw some data that was kind of surprising. I mean, it looks like just over a very short period of time it's able to lower blood glucose levels and it also has some very positive cardiovascular effects that they really weren't anticipating. So I think that this kind of puts Lexicon on the map in terms of potential future partnerships as well as maybe an acquisition.
Kobayashi-Solomon: Oh, is that right? I was talking to [Morningstar analyst] Damien [Conover] the other day about the Healthcare Observer and you're about to publish another Healthcare Observer about M&A.
Kobayashi-Solomon: Lexicon is featured in this?
Andersen: Yes, Lexicon is going to be one of the companies on our biotech take-out list. We do a ranking of all of the biotech and the specialty pharmaceutical companies we cover. We have four different criteria we look at in terms ofhow likely are these going to be taken out in 2010.
Kobayashi-Solomon: So to summarize, it sounds like there is a scenario where things go bad and maybe the stock goes south for a while, but we're seeing some really good things.
Andersen: Right. My fair value estimate is significantly above where it's trading right now and that already does incorporate the probability adjustment of there is a very big chance that these candidates could fail. So I think that any one of these four can somehow make it to the market. I think investors are in a very good position right now.
Kobayashi-Solomon: Sounds like a very good story.
Andersen: Yes, I think so.
Kobayashi-Solomon: Karen, thanks for coming in.
Andersen: Thank you.
Kobayashi-Solomon: And thank you for joining us. Please stop by the Morningstar OptionInvestor site. We've got lots more articles about adding these options in your investing life.