Investor Calls on XenoPort, Inc. (XNPT) to Change Focus, Oust CEO
10/15/2013 10:27:30 AM
XenoPort, Inc. : Clinton Group Calls on Xenoport to Hire a New CEO and Focus on Promising Drug in its Pipeline
NEW YORK, Oct. 15, 2013 /PRNewswire/ -- Clinton Group, Inc. ("Clinton Group"), one of the largest owners of Xenoport, Inc. (NASDAQ: XNPT) ("Xenoport"), sent a letter to the Chief Executive Officer of Xenoport, Dr. Ronald W. Barrett, calling for change in Xenoport's management and capital allocation.
As indicated in the letter, the full text of which is copied below, the Clinton Group believes Xenoport's assets are worth substantially more than the current stock price implies, but that changes are required for stockholders to realize that value. Clinton Group believes the fair value for the Company is $13 to $16 per share.
About Clinton Group, Inc.
Clinton Group, Inc. is a Registered Investment Advisor based in New York City. The firm has been investing in global markets since its inception in 1991 with expertise that spans a wide range of investment styles and asset classes.
[Clinton Group Letterhead]
October 15, 2013
Ronald W. Barrett, Ph.D
Chief Executive Officer
3410 Central Expressway
Santa Clara, CA 95051
Re: Capital Allocation and the Importance of Focusing on 829
Dear Dr. Barrett:
I write on behalf of the Clinton Group, Inc., the investment manager to various funds and partnerships ("Clinton Group") that collectively own more than 1.3 million shares of the common stock of Xenoport, Inc. ("Xenoport" or the "Company"). This ownership stake makes Clinton Group one of the Company's top ten owners, according to Bloomberg data.
We have been aggressively buying the Company's stock lately because we believe Xenoport's assets are worth substantially more than the stock price implies. We believe fair value for the Company is closer to $13 to $16 per share, but we are also convinced that some significant changes in capital allocation and management need to be made for stockholders to realize this value.
At the moment, we believe the Company is on the wrong course, with the wrong management team. Having spent $750 million since the inception of the Company, you have had no commercial success. The capital markets have assigned an enterprise value to Xenoport of just $195 million (despite the Company having spent multiples of that amount on research and development) and the stock is down more than 47% and 86% in the one- and five-year periods ended Friday. Over the same periods, the NASDAQ Biotechnology Index is up 42% and 185%, respectively. Investors in the Company's 2005 initial public offering have lost nearly half their investment over the last eight years.
For stockholders to expect a different outcome in the future, the Company must change leaders, capital allocation strategy and direction. We are bullish on the prospects for the stock, if the Board adopts these suggestions.
Fourteen years into the Company's history, Xenoport is left with three principal assets: gabapentin enacarbil, the Company's FDA-approved drug for the treatment of moderate-to-severe primary restless legs syndrome ("RLS"), known as "Horizant" in the United States; XP23829 ("829"), the Company's novel fumaric acid ester compound and pro-drug for monomethyl fumarate (or "MMF"); and cash, which we estimate to be $70 million. (FN. 1).
It appears to us that gabapentin enacarbil (which, for ease of reference, I will refer to as "Horizant") will not be successful commercially. We wish it were otherwise: as stockholders we would certainly benefit if Horizant had developed a strong clinical following or if it were on a predictable path to commercial success or lucrative sale. However, we see no objective reasons to be optimistic.
In the United States, the drug has been on the market for more than two years and has garnered aggregate sales of approximately $14 million, according to Morgan Stanley Research. You chose to partner the drug with Glaxo ("GSK"), which was certainly sensible at the time given GSK's experience in the RLS market with Requip and its large neurology sales force. Horizant did not sell, which you now blame on GSK's approach to the launch. But there is no evidence that the flaccid launch was solely or even primarily the result of GSK's approach.
Rather, an equally or more likely thesis is that Horizant (at $125 per month) is not differentiated enough from generic gabapentin (available for $11 per month) or the two other generic RLS treatments (ropinirole and pramipexole, both also available for $11 per month), other extended-release versions of gabapentin, such as Gralise (which admittedly is not labeled for RLS), or other branded RLS treatments, such as Neupro, Requip XL and Mirapex ER. In a crowded market for RLS drugs, dominated by three drugs that have gone generic, the Company chose not to do any head-to-head clinical studies, leaving doctors and payors without any evidence of superior efficacy or differentiation. We suspect this lack of objective, comparative studies is the real cause of Horizant's tepid reception; GSK's marketing approach likely would not have mattered.
Evidence from Asia bolsters our view. In Japan, Xenoport's Asian partner, Astellas Pharma Inc., has sold just $2 million of the drug in the first 12 months of availability there. (There is hope that Astellas will achieve a small increase in run rate as some of the year-one Japanese regulatory restrictions are lifted, but no one appears very enthusiastic.) In May, Astellas informed the Company that it does not want to launch the drug in the five other Asian markets to which it had rights.
It appears Horizant will never be the commercial success we all wish it were.
XP23829 ("829") is quite a different story. We are extremely enthusiastic about the prospects for 829. With a pharmacokinetic profile that nearly matches that of Biogen's Tecfidera (another MMF prodrug), so-called "formulation 1" of 829 appears very likely to be developed into an effective treatment for relapsing-remitting multiple sclerosis ("MS") or psoriasis, or both. The Company's early studies also suggest formulation 1 of 829 is likely to produce fewer side effects than Tecfidera. As promising, so-called "formulation 2" of 829 holds the prospect of superior efficacy compared with Tecfidera as its time-release formulation may allow more constant exposure to MMF and improve upon Tecfidera's daily, dual-peak MMF exposure.
It appears to us that 829 is poised to follow in the footsteps of other "second generation" biotechnology blockbusters that, even with just small improvements in efficacy, dosing or side effects, have proven to be substantial clinical and commercial successes. Like 829, these second-generation drugs - examples include Abraxane (which improved upon paclitaxel), Vyvanse (improving upon Adderall) and Eylea (improving upon Lucentis) - were built around the known efficacy of chemically related "first generation" drugs (or use the same mechanism as that parent). Building a product on established science in this way has proven to be relatively lower risk than the typical biotechnology endeavor and enormously profitable for investors as even small improvements can be clinically and commercially significant.
That is the opportunity - and it is not small - with 829. Citigroup Research projects that Tecfidera will garner sales of $5 billion globally in 2019, growing to more than $8 billion annually by 2027. After just six months on the market, Tecfidera already has captured 11% market share among MS drugs, according to Credit Suisse Research, and its commercial launch has been characterized as having "stellar performance" that makes it the "holy mother of launches." (FN. 2)
The capital markets have certainly taken note of the MMF opportunity. Since the time Biogen announced Phase III results of BG-12 (the compound that became Tecfidera) on April 12, 2011, Biogen's market capitalization has grown by more than $36 billion. Most of that growth, in our view, is attributable to Tecfidera's prospects as the only approved MMF prodrug on the market.
Yet Tecfidera, having proven that MMF is extremely effective in treating MS, is vulnerable to competition. Reported side effects, primarily gastrointestinal events and flushing, affect more than 40% of patients, and Tecfidera's dosing pattern and pharmacokinetics may not be ideal.
Xenoport's 829 - having received just $10 million of research and development support (FN. 3) from the Company - is positioned to be a second-generation MMF prodrug and presents the Company with a massive commercial opportunity. Given its overlapping pharmacokinetic profile with Tecfidera, we believe the Company's ability to demonstrate efficacy in MS and psoriasis is a low risk proposition. And the early signs suggest, as noted, that 829 may well have fewer side effects or, in formulation 2, may even be superior in efficacy.
Developed correctly and expeditiously, 829 thus has the opportunity to share in the MMF market with Tecfidera as an equivalent or superior compound for treating MS. We believe 829 could be approved, and in the market, for MS by 2019 and for psoriasis by 2017. With Tecfidera protected by patents through at least 2028 (and 829 protected by non-overlapping composition-of-matter patents even longer), the two compounds could split the commercial market for MMF for many years. Even modest market share for 829 would generate hundreds of millions in cash flow to Xenoport annually.
The Path Forward
The significant economic prospects for 829 are clearly not fully priced into the stock. Instead, the capital markets have seemingly attributed nearly all of the value of MMF as a treatment for MS (and psoriasis) to Biogen. We think we know why.
We believe the capital markets have largely ignored the prospects for 829 because Xenoport's operational, strategic and capital allocation history suggests that Xenoport will not execute well on this golden opportunity. The stock market is betting against our management team and strategy, not against our compound. (Consider, for example, the 2013 class of biotechnology IPO companies, many of which carry valuations that are multiples of Xenoport despite having less developed science, a riskier development path and uncertain end-market dynamics. Nevertheless, these "fresh" public companies have captured the stock market's attention because their management teams are well regarded, they appear focused and they have not yet disappointed investors.)
I am sorry to say that Xenoport, on the other hand, has given the market good reason to be skeptical. In its fourteen-year history, the Company has incurred cumulative losses of $500 million, chasing various markets and drug prospects, always with enthusiasm, but seemingly without discipline and never, so far, with commercial success. With the Company's cash hoard whittled to just $70 million at the hands of these various failed efforts, the Company again appears to be distracted from advancing its highest probability prospect (829) in what we believe will be an unprofitable, and likely fruitless, effort to salvage Horizant.
As you know, the Company has announced plans to spend as much as $35 to $40 million of its remaining cash in an attempt to demonstrate that Horizant is commercially viable. We are skeptical that it will work, but more importantly, we are flabbergasted that a small-cap biotech company would chose to spend some of its last dollars (which are not cheap) to hire a contract sales force, produce marketing collateral, hold science talks for doctors, develop sales operations and distribution capabilities and build other internal capabilities (such as FDA reporting) that are necessary to be a full commercial enterprise. This is not the prerogative of $250 million biotech companies. That is especially so when the Company has an exceptional compound in its lab, just waiting to be developed.
Indeed, we see these renewed and expensive efforts on Horizant as little more than a Hail Mary pass, without any objective evidence to suggest that the effort will be successful. (Query why, if there were such evidence, another party with more and cheaper capital has not rushed in to fund the effort in a structure that would be beneficial for both it and Xenoport.) We are mindful that you and the Company expended a lot of hard work (and capital and emotion) in the development of gabapentin enacarbil, in the hard-won FDA approval, in the initial licensing success and in the subsequent litigation and settlement with GSK. But sunk costs and emotion have no place in capital allocation decisions.
The reality is that the drug had a failed launch and it is nearly unprecedented for a drug re-launch to achieve significantly different commercial results. We fear the book on Horizant has been written.
Importantly, the Company also no longer has the luxury of "excess" capital. It is time for Xenoport to be ruthless about its portfolio of assets and disciplined in its capital allocation. The only proper question for the Board and management team now is: how does the Company maximize the value of its assets for the benefit of the current stockholders?
The Company is down to its last $70 million. With the stock severely undervalued, doing an equity capital raise should be off the table. (More on that math later.) The Board and management team should assume that the remaining cash is the only cash the Company can invest. Xenoport needs to put its $70 million to work in the highest probability-weighted investment projects available.
We are convinced that the capital can all be put to work, with extremely high probability adjusted returns, on the further development of 829. The capital could be used for a Phase 2 study in MS, or a Phase 2 and Phase 3 study in psoriasis, or some combination of these. Spending on drug development - the core mission of the Company - has a much higher expected return than hiring sales people to pitch doctors. Indeed, our models, which we are happy to share with you, suggest that spending the $70 million on 829 would advance the science far enough along to garner a significantly improved partnering deal on 829 or a sale of the entire Company at a significant premium to today's stock price.
We estimate the net present value of 829 to the existing stockholders (in the scenario in which the Company moves the science along further by using substantially all of its cash on this effort) at approximately $600 to $700 million, or $12.50 to $14.50 per share. The major assumptions used in our model, which we believe are very conservative, are described in the appendix to this letter.
By contrast, spending less on 829's development (e.g. so the Company can hire a contract sales force to market Horizant, as the current plan calls for) is likely to result in a less advantageous licensing deal on 829 and a lower premium on the sale of the Company. Simply put, the science will not be as far along and the risks and costs will be higher for a partner. When we model those assumptions, based on as much market data as we can gather, we conclude that 829 has a net present value to stockholders in this scenario of $450 to $550 million.
Thus, we believe that were the Company to spend the $30 to $40 million of cash currently earmarked for Horizant commercialization instead on 829 science, the increase in value to stockholders would be approximately $150 million (the difference between $650 million and $500 million), or about $3 per share. We also believe that the signaling effect of allocating capital properly - and demonstrating management's confidence in its 829 program - would in any event lead to a higher stock price, as more of the $650 million in 829 value that we estimate becomes priced into the stock.
Dr. Barrett, we have heard you say that you believe you can have it both ways. That essentially you can spend the $30 to $40 million on Horizant and then raise additional capital to advance the 829 program. We are supportive, of course, of raising non-dilutive capital, if you can do so before you spend on Horizant and if doing so will augment the value of the Company's assets without distracting management. But, given where the stock trades today, it would be a huge mistake to dilute the current stockholders' ownership of 829 (which is worth, in our view, more than three times the total enterprise value of Xenoport) to raise capital for Horizant commercialization. That is especially true given that Xenoport has absolutely no experience commercializing a drug and the returns on spending $30 to $40 million on Horizant are completely speculative.
The math is relatively simple. Assume that Horizant is worth $50 to $100 million today ($1 to $2 per share), consistent with what several sell-side analysts have written. Even if spending an additional $35 million on Horizant could be expected to increase Horizant's value by $50 million (color us skeptical), stockholders would be worse off if that $35 million is taken away from 829 development or raised by selling equity. And, of course, the math is even worse for existing stockholders if, as we suspect is likely, Horizant's value is left unaffected by the $35 million in spending. See below.
The Company, in our view, has sub-optimally deployed stockholder capital for too long. It is time, in our view, for some focused efforts and belt tightening. With just 88 employees, we are befuddled by the cost structure of the Company, which has incurred "selling, general and administrative" expenses (not including R&D) of nearly $30 million per year over the last five years, including more than $2.6 million per year for your services. (We also note that less than 10% of your bonus last year was dependent on progress with 829.) And while annual SG&A costs have grown over those five years, the Company cut its R&D budget nearly in half during the period. Now the Company spends more on SG&A than it does on R&D.
Stockholders are much worse off. From 2008 to 2012, while you collected more than $16 million in pay, grew SG&A expenses, cut the R&D budget in half and spent less than $10 million on 829, the stock dropped 86%. We recognize as well that your interests and ours as stockholders are not very well aligned. Despite serving as a co-founder of the Company and its Chief Executive Officer for the past twelve years, we calculate that your equity stake in Xenoport is currently worth less than $1.4 million.
Dr. Barrett, we believe the Company needs a new Chief Executive Officer who will think like an owner, with a mandate to urgently execute on the Company's best prospects and grow the value of its most promising asset, 829. We encourage you to step aside and to ask the Board to search for a new Chief Executive. More importantly, we urge you to stop your spending on Horizant immediately and to pursue with exigency the development of 829.
Please know that we believe these changes are critical for stockholders to realize the full and fair value of the Company's assets. Accordingly, if you and the Board choose not to move along this path, we will have no choice but to exercise our various rights as stockholders to ensure the value of the Company is preserved and grown.
We are available at any time to discuss these matters with you or members of the Board of Directors.
Gregory P. Taxin
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