3 Things to Watch at Lexicon

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Lexicon Pharmaceuticals (Nasdaq: LXRX  ) has an important year ahead. The small-cap biotech will have two drugs in late-stage trials, the final step before a run at approval from the Food and Drug Administration. One medication concerns a rare cancer-related condition currently treated by Novartis (NYSE: NVS  ) , while the other seeks to enter a growing diabetes class led by Bristol-Myers Squibb (NYSE: BMY  ) and AstraZeneca (NYSE: AZN  ) . Lexicon's share price surged upon positive phase 2 data and fell after a secondary offering.

With that in mind, here are three things to keep in mind for investors considering Lexicon.

1. Lead candidate, small market
Phase 3 small molecule drug telotristat etiprate treats carcinoid syndrome, a condition in which rare gastrointestinal or lung tumors flood the body with the chemical serotonin. Symptoms include abdominal pain, diarrhea, and difficulty breathing; left untreated, this can lead to heart disease and death.

Few patients occupy this market. The rarity of carcinoid syndrome led the FDA to grant the drug orphan status, meaning it treats a condition with fewer than 200,000 cases in the United States. The American Cancer Society puts the actual incidence at about half that number.

The newly launched phase 3 study tests telotristat etiprate's efficacy in patients who haven't responded well to currently available treatments, including Ipsen's Lanreotide and Novartis' Sandostatin. The latter earned $374 million last quarter. Telotristat etiprate would offer a treatment option for those resistant to prior medications and those preferring an oral medication, as opposed to the current treatments' injections.

Telotristat etiprate has fast track designation, meaning Lexicon can submit its new drug application paperwork on a rolling basis and potentially receive a faster review time. The phase 3 data report next year will form its own catalyst leading up to the NDA completion and potential approval.

2. Potential blockbuster in the wings
Even as that drug moves through the pipeline, Lexicon has a secondary contender waiting in the wings. Phase 3 trials will begin in the first half of next year for diabetes treatment LX4211, the first dual inhibitor of SGLT1 and SGLT2. The combination approach would give the drug two lines of defense against the body's absorption of excess insulin, with the SGLT2 inhibitor blocking absorption in the kidneys while SGLT1 covers the gastrointestinal tract.

Diabetes is a booming market, expected to reach $58 billion total within the next 20 years. Competition is diverse and fierce, particularly in the upcoming SGLT2 class led by Bristol-Myers Squibb and AstraZeneca. Overcrowding isn't as big a problem in type 2 diabetes treatments; since the disease is progressive, patients often have to experiment with numerous drugs.

Investors are watching this product closely. Telotristat etiprate's importance to the company lies more in getting a product out and established. But LX4211 has the blockbuster potential because diabetes has a much larger market that can accommodate more competition.

Cost poses a potential problem for Lexicon, as diabetes drugs notoriously carry hefty development and marketing price tags. Lexicon would really benefit from a big pharma partner on LX4211, but most of the larger players are already well invested in this market.

3. Financial mixed bag
Lexicon had $206.8 million in cash and equivalents as of September, which the company expects to ride on through the end of next year. On average, the company's burning through $25 million per quarter. These numbers aren't awe-inspiring, but they're also not surprising from a company with no marketed product.

Like many other small biotech stocks, Lexicon has historically been a fan of public offerings. The most recent one, in September, sent share prices on the decline, but the company didn't dilute shareholders too badly; the sale represented less than 4% of shares outstanding.

Foolish final thoughts
Lexicon has a few other drugs in the pipeline -- including treatments for irritable bowel syndrome and rheumatoid arthritis -- but the two drugs covered here matter most right now. 

After Lexicon's steep sell-off, there's time to wait for more results and still get in at a good entry price. The phase 3 data announcement for LX4211 is the catalyst I'll be watching, but that likely won't arrive until years in the future.

While you can certainly make huge gains in biotech and pharmaceuticals, the best investing approach is to choose great companies and stick with them for the long term. In our free report "3 Stocks That Will Help You Retire Rich," we name stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

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