Exelixis: With Patent Litigation Decision Due Soon. There Are Options (NASDAQ:EXEL) (2024)

For years, Exelixis (NASDAQ:EXEL) has been growing Cabometyx’s (cabozantinib or cabo) revenues, but the company’s burn rate has been accelerating as well until recently (see more below) causing angst among its shareholders. Worse, cabo’s main patent has been under fire with a judgement due soon that could dramatically impact the drug’s future revenues to the tune of $10B or more.

Farallon, an investor turned activist, stepped in publicly last May to help force the company to pivot. Over the past year, EXEL has now largely implemented Farallon’s suggestions and as a result, been able to increase its focus on cabo’s performance and profitability through R&D cost cuts as well as a stock repurchase program. In addition, the renewed R&D focus looks to have positioned EXEL’s strongest potential assets to the front and their pathways in the clinic are now much clearer. However, the patent resolution for cabo is currently the most important pivotal moment in the company’s history, with significant implications to the positive or negative.

Win, and EXEL gets to keep generating a couple of billion dollars a year for cabo possibly over the next 6-7 years. Lose and that window shrinks to ~2+ years before generic competition starts to aggressively erode sales. Thus, there is a double-digit, billions of dollars gap in potential valuation impact in play that we should have a verdict on within the next 4-8 weeks. I estimate the short-term upside could be worth ~50 to 100% compared to today’s ~$23.50/s and $7B valuation versus the downside of -30 to 50%. That much of a potential swing makes me too uncomfortable to hold physical shares until after the judge’s decision.

Yet, some of the prices and duration of options opportunities I actually find pretty compelling. Full warning: options are not suitable for most investors. And using them in even the most basic examples I am going to present below will subject my investment to significant loss if I am wrong. Therefore, I will spend a brief amount of time reviewing the background of the company, its development/pipeline and improving financials to justify why I put ~1% of my portfolio at risk to “play” the patent event.

Company Overview

In November of 2012, Cometetriq (cabo capsules) was approved by the FDA for medullary thyroid cancer. In April of 2016, Cabometyx (cabo in tablet form) was approved for second line (2L) renal cell carcinoma (RCC) in the US. Since then, the company has further studied the drug and gained approval in 1L RCC and additional indications. Ipsen (OTCPK:IPSEY) picked up ex-US rights to cabo for all territories except Japan where Takeda (TAK) purchased those rights.

Cabo is an oral, multiple Tyrosine Kinase Inhibitor (TKI) that is currently the standard of care (SOC) in 1L RCC when combined with an immune-oncology agent and as monotherapy for 2L RCC. Because of this, cabo has grown net product revenues for EXEL in 4Q’24 to $429.3M and $1.629M for 2023 (see Financials below).

Pipeline

Label extensions: EXEL is pursuing cabo for neuroendocrine tumors and metastatic castration-resistant prostate cancer. The data have been fine for both to date. However, some clinicians have not been as impressed with the findings as EXEL has been. Although there is potential for additional incremental revenues down the road due to cabo’s current patent question(s), I am going to ascribe zero valuation to these extensions for the purpose of this article and subsequent valuation.

Zanzalintinib (zanza): EXEL is positioning zanza as a next generation multi-targeted TKI that might be used as monotherapy and/or combination therapy in several different cancer types. While I think the drug has promise, the TKI space is very crowded and zanza will need to be better and/or safer than cabo to have a shot at one day replacing it. EXEL’s XBOO2 and XL309 are still early in development, and XB0101, XB628 and XL495 have yet to file for Investigational New Drug Applications. Therefore, similar to above, I am going to zero out the value of zanza and these additional 5 for now. I do want to note that EXEL has made some nice early progress in another area, the antibody-drug conjugate (ADC) space which is very hot right now. I agree with Farallon that once the patent and litigation issues are behind them EXEL should get some recognition/increased valuation on these assets.

Each of the above continues to require significant resources from EXEL to develop which is why the projected R&D spend for 2024 is just under $1B (see below). But this spend is necessary based on the current situation EXEL is in. Should the company win the cabo patent challenge, additional cabo label extensions could be more lucrative and then additional funding would be there particularly for the above top 5 to continue to progress to later stages. If the patent challenge goes against EXEL, then I would expect another review and restructuring for the pipeline.

Discussion on Financials

I like what we have seen to date with the EXEL restructuring story. As I shared above, if the patent situation were not present, I would be an acquirer of the stock in this range ($22.5-$23.5/s and ~$7B valuation). Why? Revenues continue to grow, cost-cuts are increasing profitability and stock repurchases are shrinking the # of shares outstanding. Here is a brief snapshot of some of these trends from the company’s 4Q'23 and Fiscal Year 2023 Results presentation.

Revenues: Cabo’s 2023 US revenue was $1.629B with net income (NI) of $208M (about 12.77%). To put that in context, 2022 revenue was ~$1.04B with NI of ~$182M (about 13%) and 2021 revenue was ~$1.08B with NI of ~$231M (about 21.45%).

• Total global cabo franchise revenue was ~$2.3B.

Further, of the $208M NI in 2023, 4Q’24 GAAP NI was ~$85.5M. This is a very positive trend.

GAAP R&D: 4Q’23 was $244.7M vs. $336.8M in 4Q’22. That is a decline of -$92M YOY on a quarterly basis. The company is estimating a range for 2024 between $925-$975M which indicates that that this segment should continue to decline and moderate to less than $1B/yr whereas it had been heading to ~$1.35-$1.4B or higher just 1 year prior. Most of the workforce reductions EXEL announced in its 01/07/24 Corporate update were targeted at this group.

GAAP SG&A: 4Q’23 was $131.4M vs. $119.3M in 4Q’22. That is just over a 10% increase YOY, which is in line with other biopharma companies.

Stock repurchases: The Board of Directors authorized an additional $450M for purchase of common stock in 2024, on top of the $550M it repurchased in 2023. That is up to $1B in repurchases over this two-year period potentially shrinking the share base by 12-14% (depending on how many new shares are given out through award and ESPP, etc.) Further, the average purchase price per-share was $20.97 (~10% lower than today’s price). This should help improve earnings per share as well in 2024.

GAAP Cash: EXEL had ~$1.724B of cash and investments at YE’23 vs. $2.067B at YE’22. This is strong, especially considering that the company repurchased $550M in stock last year.

My takeaway from the year end results: sales growth in a mature product is great to see, and the impact of Farallon’s fiscal “suggestions” are just starting to be seen in the financials, with R&D spend the most relevant to date.

The company announced 1Q'24 Financial Results yesterday and here are three financial metrics that I am tracking closest for my investment thesis;

1) Total revenues were down from the previous three quarters. The company attributed this drop to two factors. The first: typical 1Q seasonality for products like this due to the donut hole in Medicare coverage (patients may have switched providers/needed new forms, but they also have to spend a certain amount-the donut hole before insurance kicks back in). And the second: that there were implications from the IRA legislation that they were still working through. I am comfortable with these, but will be watching the next quarter or two closely to make sure revenues restart their growth.

2) R&D Expenses dropped for the 2nd month in a row (down over $100M/qtr from 3Q23). This is what the company said would happen as part of the restructuring and it is. This is good.

and 3) SG&A expenses declined for the 3rd month in a row (down ~$27.7M/qtr from 2Q'23). Similar to above, further results of the restructuring can be seen here and it is positive.

Patent Question(s)

As stated above, the outcome of the current patent litigation (referred to as “MSN II”) is the most impactful event in the company’s history outside of cabo’s approval. Three companies have filed Abbreviated New Drug Applications (ANDAs) for cabo’s 473 patent. EXEL settled with the second two, Teva (TEVA) on 07/23/23 and Cipla at some point after, allowing an FDA approved generic to enter the market on 01/01/31.

The litigation with first-filer, MSN Pharmaceuticals, has been more complicated. EXEL announced on 01/19/24 that the first round of litigation, known as MSN had been resolved with EXEL winning on the composition of matter patent ‘473 for cabo, but MSN was found not to be infringing on a different patent, ‘776. EXEL was pleased with this ‘476 result, whose patent expires on 08/14/26, but disappointed on the ‘776 outcome because its expiration went out to 10/08/30.

The second round of litigation MSN II is still ongoing. EXEL is suing MSN for violating 4 different patents: ‘439, ‘440 and ‘015 which expire on 01/15/30; and ‘349 which expires 02/10/32. The bench trial completed October, 2022 and the judge’s closing remarks indicated he would like to have things wrapped up by “spring.” This has left many wondering exactly when his decision will come done, but EXEL has listed 1H’24 as its marker.

Cabo is protected through mid-August 2026 and EXEL has allowed filer #2 and #3 to enter on 01/01/31. Although I am not a biotech patent expert, it would appear that the company may have had less confidence in the ‘349 patent out to 2032 which is why it settled with Teva sooner. Further, if the company wins on even 1 of the 3 patents that expire on 01/15/30, that would secure at least 3.5 years of additional patent protection for cabo (and potentially ~$6-$7B more in US sales) beyond the August ’26 deadline for ‘473. Additionally, the company does have 2 other patents (‘873 and ‘757) that expire 07/18/31. I have not seen them being challenged or mentioned yet publicly, but that doesn’t mean there won’t be additional litigation around them.

Which brings me to the original thesis of my wager. My gut (after 20+ years in the industry and observing similar challenges) says there is a good chance that cabo will receive additional patent life beyond the expected 08/14/26 ‘473 patent termination. Depending on the judge’s ruling, one side may file an appeal, but ~90% of these types of cases end up settling before the final patent in question (a point that CEO Mike Morrisey made during the company's presentation at the TD Cowen meeting on 03/05/24). I am therefore betting on that gap of ~4.5 years between 08/26 and 01/31 for a negotiated settlement, and the several billions of dollars of potential revenue that come with it.

Separately for the EU, cabo tablet Patent #EP2593090 was successfully defended against 3 filers (STADA AG, Teva and Generics Ltd.) whose panel “rejected all grounds of opposition” from the challenge. This particular patent expires on 07/18/31. This would appear to extend cabo’s life in the EU by 2 years, which is worth potentially hundreds of millions of dollars in additional revenue to EXEL if validated.

The “Wager”

I like the restructuring that has taken place at EXEL over the past year, but I am not comfortable owning shares in the company until it has received a decision on its current patent litigation. While I do believe the company will win this latest round, truly handicapping the myriad of specific outcomes and their potential valuations is too complex at this point in time to be worth the exercise for me. On a clean win, I want exposure to the upside. And on a clear loss, to minimize the downside. There are a ton of ways to play options and fancy names for strategies. Most are not appropriate even for experienced investors (and many professionals as well!)

So, why have I put ~1% of my portfolio into buying EXEL calls, and what does that look like? To simplify my thought process for this article, let me break down the 2 main reasons why and how they were applied to the bet:

Because we should have a decision in 6-8 weeks, I looked for an expiration date that would safely put me after the Spring and 1H24. At the time I started acquiring my calls, July was not open yet for EXEL, but August 16^th was. So, that is where I landed.

For valuation ranges, I elected to start with Farallon’s short term valuation of $33/s from last May which excluded the value of the entire pipeline and potential product extensions. I then added another 9% on top of that to get to my peak of $36/s now that the $550M stock repurchase in 2023 completed and $450M more in share repurchases is slated for 2024. Max drawdown could be to ~$12-$14/s, which is lower than many analysts’ current projections are. But in this market, the punishment for a litigation loss will most likely be magnified.

The goal then was to find a strike price not too far from the $23 range EXEL has been hovering around since March while not paying too much of a premium for it.

I settled mostly on 08/16/24 $25 calls a while back at an average of ~$1.70/contract (for those unfamiliar with options, a contract is for 100 shares.) That means I am in at ~$26.70/s and will have until August, 16^th to either sell the contract (hopefully for more) or purchase the shares for $25/s on that date. If the stock pops to say $33/s on a positive decision, I would make $6.30/contract (the difference between $26.70 and $33/s). However, if the stock stays below $25/s on negative news, my $1.70/contract premium would expire worthless. My cumulative premiums add up to ~1% of my portfolio, the amount I was willing to risk on a 2% position in shares of EXEL if the stock were to decline by 50%.

There really are many ways to play this, but this particular example is simple and gives me the flexibility to both participate in the potential upside as well as buy the shares later if I want. Should the stock drop say 30-50% on a negative decision, I can wait to reenter and purchase a new 1% position, once I think the proverbial knife has fallen far enough. Or not.

Also, for what it is worth, if I did own physical shares of EXEL heading into this event, I would have purchased some put coverage (most likely up to 100%). Why do this? Because I have had my face ripped-off plenty of times over the past couple of decades when I held naked positions into such a pivotal event.

Risks

There are multiple ways my option strategy mentioned above could fail and I could lose my entire wager. Here are the three most on my mind.

First, the greatest risk to EXEL and my option play is the obvious one: EXEL flat-out loses the patent decision. As mentioned above, in my opinion the stock would lose ~30-50% or more of its value in this current environment taking it down to close to the $12-$15/s range and a $3.5-$4.2B valuation. Had I owned a 2% position in physical shares, I could lose up to half of that (the ~1% in value I have put at risk).

Second, EXEL wins the challenge, but for whatever reason(s) the value of the stock does not increase to the level I need to make money (per above). Or, with a win, the increase does not happen in the timeframe I need it to (by August’s expiration). In both situations my long options could expire worthless.

Third, while the judge in the case stated he wanted to wrap things up by the spring, it is always possible that he decides to extend the time on his decision. If he pushed it to after August 16^th, my options could expire worthless as well.

All of these reasons (and more) are why I have kept the total value of my wager to just ~1% of my portfolio.

Conclusion

EXEL is taking the right steps to improve its current operating situation and profitability, regardless of the patent litigation outcome. Its 1Q’24 earnings call on April 30^th confirmed for me that the cost-cutting measures are starting to be impactful as is the pipeline focus. While I might have accumulated up to a 2% position in my portfolio if there were no patent overhang, owning shares prior to the judge’s upcoming decision on the company’s patents is too risky for me. However, a small, simple, long option play involving short/medium duration calls is appealing due to my reasoning above.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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