2023-11-06 07:30:48 ET
Summary
- Xenon Pharmaceuticals appears undervalued heading into a pivotal phase two MDD trial readout due by the end of November.
- If XEN-1101 shows either a trend towards improvement or hits the primary endpoint, then it would translate into a massive boon for its sales potential in treating epilepsy.
- I would assign the stock a buy rating, with a $51 price target, based off on modest assumptions.
Introduction
Xenon Pharmaceuticals (XENE) is a clinical-stage biotech company focused on treating neurological disorders. Its pipeline is centered around XEN-1101, a differentiated Kv7 potassium channel opener that has already shown promising results in a phase two trial for focal onset epilepsy -- which sent shares of Xenon to all-time highs. Although the stock has receded from those peaks, another pivotal data readout that may send Xenon's stock to all-time highs is imminently approaching.
Top-line results from Xenon's proof of concept phase two trial (X-NOVA), evaluating XEN-1101 as a treatment for Major Depressive Disorder ((MDD)), are expected between late November and mid-December. A positive outcome would mark a significant turning point for Xenon, positioning XEN-1101 as a novel treatment for both seizures and MDD. The importance of this juncture cannot be understated; we stand on the brink of discovering XEN-1101's full potential.
Investment Thesis:
After evaluating the existing pre-clinical data and clinical trial results from other drugs with a similar mechanism of action to XEN-1101, I am optimistic that the phase two MDD trial will yield positive results. If the results are indeed favorable, Xenon will be well-positioned heading into 2024, unlocking another potential blockbuster commercial pathway and enhancing the sales prospects of XEN-1101 as a seizure treatment.
Xenon also has a strong balance sheet, reducing the risk of significant shareholder dilution or unfavorable credit financing to a minimum. From a valuation perspective, comparable company analysis suggests that Xenon is fundamentally undervalued. Even if Xenon's MDD trial completely fails, the stock is still slightly undervalued.
Today, Xenon is trading at a valuation that suggests the market is under-rating XEN-1101's potential as a MDD treatment. If the upcoming phase two trial succeeds -- which I believe it likely will -- then Xenon's stock is due for a re-valuation by Mr. Market; the potential for all-time highs is around the corner.
Given these reasons, I would assign Xenon Pharmaceuticals a buy rating, with a conservative price target of $51.
Why This Upcoming MDD Readout Is So Important
Before diving into XEN-1101's chances of success in its upcoming MDD trial, it is worth highlighting why this read-out is so pivotal. If XEN-1101 shows success in treating MDD, then it would also become a much more appealing anti-seizure treatment. Focal onset epilepsy and major depressive disorder are co-morbid conditions , with many linkage points. If XEN-1101 is able to treat both at the same time, then it would position itself as a grand-slam anti-epilepsy medication, greatly improving its sales potential.
XEN-1101 has already shown remarkable efficacy in reducing focal onset seizures among those diagnosed with epilepsy. In a phase 2b trial (X-TOLE) that enrolled over 300 patients , XEN-1101 successfully hit all primary and secondary endpoints with statistical significance among all three dosages.
The median (IQR) percent reduction from baseline in monthly FOS frequency was 52.8% ( P < .001 vs placebo; IQR, ?80.4% to ?16.9%) for 25 mg, 46.4% ( P < .001 vs placebo; IQR, ?76.7% to ?14.0%) for 20 mg, and 33.2% ( P = .04 vs placebo; IQR, ?61.8% to 0.0%) for 10 mg, compared with 18.2% (IQR, ?37.3% to 7.0%) for placebo. XEN1101 was generally well tolerated and TEAEs were similar to those of commonly prescribed ASMs, and no TEAEs leading to death were reported.
Source: Efficacy and Safety of XEN-1101, a Novel Potassium Opener, in Adults With Focal Epilepsy, JAMA .
Moreover, the drug was generally well-tolerated with no significant adverse events. Since the study concluded, no retinal or skin issues have been reported, which were adverse events that affected Ezogabine - an older generation KCNQ/Kv7 potassium channel opener.
Worth noting is that, unlike other anti-seizure medications, XEN-1101 requires no titration and can be taken only once a day. The effect is rapid-onset, and the patient pool in the previously mentioned phase 2b trial had tried and stopped a median of six prior anti-seizure medications. Showing success in such a difficult to treat patient sample is no small accomplishment.
Going a step further and demonstrating anti-depressive effects would be a miracle. Depression is the most frequent psychiatric co-morbidity associated with epilepsy. Treatment is especially difficult among epileptic patients given the negative drug interactions that can come from mixing anti-seizure medication with standard anti-depressants. In fact, some anti-seizure medications have been found to cause depression. Given the bi-directional nature of both indications, there is a large and unmet need for a treatment option that addresses both simultaneously; XEN-1101 has the potential to meet that massive demand.
Why I Believe XEN-1101 Will Succeed In X-NOVA
Existing XEN-1101 preclinical data and clinical data from Ezogabine (which shares a somewhat similar mechanism of action) lend credit to my faith that XEN-1101's upcoming MDD readout will be positive. X-NOVA is a 14-week trial with three dosing arms: 10 milligrams, 20 milligrams, and placebo; the primary endpoint is a statistically significant change in Montgomery-Åsberg Depression Rating Scale (MADRS) -- which is a common rating scale used to measure the severity of depression. There are two secondary endpoints: a change in the Beck Anxiety Inventory (BAI) score and a change in the Snaith-Hamilton Pleasure Scale (SHAPS) score.
It should be noted that the inclusion and exclusion criteria tip the odds in XEN-1101's favor. The inclusion criteria target those with a particularly high SHAPS score, where Ezogabine demonstrated a particularly strong improvement in its own phase 2 MDD trial. And the exclusion criteria exclude any participant that has any history of not responding to over 1 existing anti-depressant.
Also, it is important to establish that even just demonstrating that XEN-1101 does not exacerbate MDD will be a win in itself. Several existing anti-seizure medications on the market have been found to have a negative effect on mood in patients with epilepsy. If XEN-1101 is able to simply show a trend towards improvement or no effect, then I would consider the trial to already be a success in the long run.
Moreover, I believe that XEN-1101 will ultimately hit its primary endpoint because of the existing body of data relating to the mechanism of action. A phase two MDD study of Ezogabine -- which shares a similar endpoint -- found statistically significant reductions in both MADRS and SHAPS scores by week five. (p<0.001 for both measurements.)
Rat Progressive Ratio Test Of XEN1011 (Xenon Pharmaceuticals Poster)
Specific preclinical data of XEN-1101 discovered statistically significant improvements in motivation among rats too. A dose-dependent relationship was observed in rats when given XEN-1101. The higher the dosage, the greater motivation shown by rats to pursue a reward. Although it remains to be seen if and how this effect transfers over into human studies, there is no doubt in my mind that the preclinical data has shown promise.
It should also be noted that Mount Sinai is conducting its own phase two study of XEN-1101; that trial is slated to conclude in January . The primary endpoint of Mount Sinai's trial is different, as they are attempting to measure brain changes via functional magnetic resonance imaging. (SHAPS and MADRS changes are only secondary endpoints in their trial.) X-Nova's success would be a green flag for the outcome of Mount Sinai's trial too.
Valuation
There are three potential outcomes of X-NOVA on the horizon that translate into dramatically different valuations: X-NOVA fails, X-NOVA demonstrates a trend towards improvement with no statistical significance and X-NOVA succeeds by hitting its primary endpoint.
X-NOVA Fails | X-NOVA Shows Trend Towards Improvement | X-NOVA Succeeds | |
Peak MDD Sales | ~$0 | ~$0 | ~$100 Million |
Peak Epilepsy Sales | ~$1 billion | ~1.5 Billion | ~$2 billion |
Peak Sales | $1 billion | ~1.5 Billion | ~$2.1 Billion |
Current Shares Outstanding | 64,145,523 | 64,145,523 | 64,145,523 |
Shares Outstanding (Assuming 20% Dilution) | 73,374,628 | 73,374,628 | 73,374,628 |
Price To Sales Multiple | 2.5x | 2.5x | 2.5x |
Valued PPS | ~$34 | ~$51.10 | ~$71.55 |
Source: Xenon's 10-Q + Internal Calculations of Author
As of the time of writing, shares of Xenon are trading at ~$32. Even if you were to assume that X-NOVA completely fails (which is unlikely by itself) and that the outstanding share count increases by 20% to reflect potential dilution, I still believe that the common stock is still slightly undervalued.
My valuation methodology also uses a modest price-to-sales multiple of 2.5 (rather than the typical sector standard of ~5-6.) And, my most pessimistic forecast assumes that XEN-1101 will reach peak sales of just ~$1 billion. Other epilepsy drugs such as Vimpat - which posted nearly $2 billion in global peak sales - have exceeded the $1 billion mark with ease.
If X-NOVA has a positive readout in treating MDD, I believe that the sales potential of XEN-1101 can far exceed that of Vimpat and other treatment peers. Considering how significant a co-morbidity depression represents for those suffering from epilepsy, the potential value-add of an anti-depressive effect is enormous in any treatment option. So far, this potential seems to be severely underappreciated by most today.
Analysts from Needham and Raymond James both forecast peak sales in the $1 billion ballpark, but I believe that XEN-1101 can go much farther. Now is the prime time to bet on Xenon if you have the same faith in XEN-1101 that I do. Conservatively assuming that X-NOVA yields a muddled outcome by showing a trend toward improvement, I would assign a buy rating with a price target of $51.
Risks To Thesis
The risk in the thesis is two-fold: X-NOVA or either of Xenon's phase three trials may fail. If X-NOVA completely misses and shows no efficacy, then the market reaction will be swift and certainly negative. Although Xenon would still be undervalued based off on potential epilepsy sales alone, it would still greatly damage the bullish thesis behind XEN-1101.
Xenon is currently also conducting X-TOLE2 and X-ACKT, with the former evaluating XEN-1101 in focal onset seizures and the latter assessing it in primary generalized tonic-clonic seizures. Readouts are due by mid-2025 and by the end of 2025 respectively. Because XEN-1101 is their only asset in clinical trials at the moment, the downside from either trial failing is outsized.
Another acute risk is that Biohaven, which has its own epilepsy treatment with a shared mechanism of action, could post data that outshines XEN-1101. Biohaven believes that although BHV-7000 is far behind Xenon in clinical development, it has the potential to be superior in efficacy and safety. How true this is remains to be seen, but this does represent a long-term risk.
Conclusion
Xenon is fundamentally undervalued heading into a pivotal phase two clinical readout for MDD. If the trial succeeds, which I believe it will be based off on the existing evidence, then the potential upside for shareholders is enormous. Based off on my valuation assessment, I would assign Xenon a buy rating with a price target of $51, representing a return of ~60% from the current share price.
For further details see:
Xenon Pharmaceuticals: Upcoming Phase Two Major Depressive Disorder Data Readout Represents An Opportunity