No-Moat Exelixis Struggles to Find Footing in First-Line Setting but Well Positioned in Second Line

by Anna Baran
Equity Analyst
Authors can be reached at Analyst Feedback
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Business Strategy and Outlook 05/16/2019

Exelixis is best known for its discovery of cabozantinib, a tyrosine kinase inhibitor (TKI) that was first approved in 2012 for medullary thyroid cancer (MTC). The small molecule was later approved in renal cell carcinoma (RCC), as well as hepatocellular carcinoma (HCC). The cabo opportunity has room to grow further, with late-stage trials in differentiated thyroid cancer (DTC) and in immuno-oncology combinations. Although we anticipate robust returns from cabozantinib, we believe the long-term outlook is uncertain given the company's pipeline outside of cabo, which is early-stage and relatively sparse. This is exacerbated by cabozantinib's eventual patent expiration; we believe generics could enter as early as 2026 (when the composition of matter patent expires) or later, depending on whether secondary patents are upheld in court.

Cabozantinib experienced a rocky path through clinical development. Despite promising early trial results, GlaxoSmithKline turned down a partnership opportunity in 2008, and then Bristol-Myers Squibb returned the rights to then-phase-3 candidate cabo in 2010, leaving Exelixis to ultimately develop cabo on its own. This proved to be a fortuitous strategy, with Exelixis retaining all of the economic benefit from the successful franchise in the U.S. The company receives royalties on sales outside the U.S. from partners Ipsen and Takeda.

Cabo--marketed as Cometriq in MTC and Cabometyx in RCC--has shown remarkable efficacy, despite competing with several other TKIs. Cometriq initially contributed only a small stream of revenue due to the small patient population associated with MTC, but DTC presents a much larger opportunity. Then, Cabometyx garnered approvals in both second- and first-line kidney cancer as well as second-line liver cancer in 2016, 2017, and 2019, respectively. Given cabo's success in these indications, we understand the company's focus on label expansions, namely into DTC, second-line HCC, and RCC with the combination with Opdivo. However, we're also watching how the company builds out its pipeline outside of cabozantinib, which we expect could be hit with generic entry near the end of our 10-year explicit forecast period.

Economic Moat 05/16/2019

Despite strong returns from its lead molecule, cabozantinib, we are reluctant to award Exelixis an economic moat due to its concentration in crowded oncology indications and the impending patent expiration of cabozantinib. All of Exelixis' marketed products (Cotellic for melanoma, Cometric for medullary thyroid cancer, and Cobometyx for kidney cancer and second-line liver cancer) were discovered in-house, but we do not believe its intangible assets or research and development strategy are strong enough to award the company a narrow moat. With that said, we see strong potential for cabozantinib to become a choice TKI in kidney, liver, and thyroid cancers.

Since its launch in 2013, cabozantinib (or cabo) remains the key driver for Exelixis. Cabo is a tyrosine kinase inhibitor (TKI), meaning it blocks the action of certain proteins involved in regulation of cell signaling and growth. There are several competing TKIs approved and on the market, including sorafenib (Bayer's Nexavar), sunitinib (Pfizer's Sutent), pazopanib (Novartis' Votrient), axitinib (Pfizer's Inlyta), and lenvatinib (Merck's Lenvima). Cabozantinib has been steadily gaining share, thanks to its strong efficacy, label expansions, and the company's focused marketing strategy. According to the company, cabo has surpassed several of its competitors in TKI market share, and we believe most of this volume has been in kidney cancer. However, combinations with immune checkpoint inhibitors can propel a TKI's success, as evidenced by various Inlyta combinations that pose a threat to cabo's uptake.

The company's selling agreements with Ipsen and Takeda, which sell cabozantinib in Europe and Japan, respectively, expose the company most to U.S. sales of cabo. Exelixis sells in the U.S. and books those profits but gets royalty payments for cabozantinib sales outside the U.S. The strongest U.S. patent, on composition of matter, expires in 2026, while the European and Japanese equivalents extend to 2029. Exelixis also has secondary U.S. patents covering formulation and method of treatment that extend to 2030 and beyond. It is possible that the secondary patents are upheld in court, extending Exelixis' profits, but given the high uncertainty associated with that outcome, we believe it is appropriate to model generic entry near the end of our 10-year explicit forecast period.

It is also worth noting that other TKIs will be going off patent sooner than cabo. These include Nexavar (2020), Sutent (2021), Votrient (2023), and Inlyta (2025). Even if cabo presents compelling efficacy, the generic TKIs will be priced at a heavy discount, meaning that a cheaper TKI will be available and competing for the same share.

Exelixis' solid footing in the TKI market is several years in the making, with its first approval in advanced medullary thyroid cancer (MTC) as Cometriq in late 2012. Only about 1%-2% of thyroid cancers are medullary, and about one third of these are diagnosed in the advanced stage, making this first approval a relatively small opportunity with about 3,000 to 6,000 eligible patients in the U.S. The MTC opportunity is further diminished by Cometriq's black-box warnings for gastrointestinal perforations, fistulas, and hemorrhage, but there is only one other TKI approved in this setting, vandetanib, which comes with its own black-box warning for serious side effects, including sudden death. Both cabo and vandetanib are considered preferred TKIs in MTC. Although the indication contributes incremental revenue, we don't think the MTC opportunity significantly weighs on the company's moat.

Cabozantinib was subsequently approved in previously treated kidney cancer as Cabometyx, opening the door to a much wider opportunity. Cabometyx proved very efficacious, and there was no black-box warning for life-threatening risks on the label. Further, the eligible population is much larger than that of MTC. We estimate there are about 15,000-16,000 kidney cancer patients eligible for second-line treatment with cabozantinib in the U.S., and this addressable market doubled when cabo was approved in first line kidney cancer in late 2017. However, with greater opportunity comes heightened competition, including several TKIs, Bristol's immuno-oncology checkpoint inhibitor Opdivo, and several pipeline candidates and combinations vying for first-line share.

We think there is strong potential for cabozantinib in combination with Bristol's Opdivo, which is in a phase 3 trial (called Checkmate 9ER). In our base case, we assume a high likelihood of approval for the combination, given that each drug is approved as a monotherapy and previous studies have indicated that checkpoint inhibitors combined with a TKI result in strong efficacy in kidney and liver cancers.

Cabometyx was most recently approved in second-line liver cancer, a deadly disease with few approved treatments. We estimate about 6,000 patients eligible for second-line cabo treatment in the U.S., and this addressable population would double with approval in first-line liver cancer, which we model in 2021. However, the patient population is relatively small with a high mortality rate.

One of the company's main future opportunities is in differentiated thyroid cancer (DTC), where cabozantinib is in a phase 3 study. Unlike MTC, DTC represents a significant market opportunity, with 90% of thyroid cancers being differentiated. Both Lenvima and Nexavar are already approved in first-line DTC.

The company has been focusing development efforts on cabozantinib, so its pipeline outside of cabo looks fairly sparse. Most of its pipeline candidates are partnered with Big Pharma, meaning Exelixis will just get royalties, if approved. This means that most of its pipeline is based on cabozantinib, namely the potential combination with Opdivo in kidney cancer and the opportunity in differentiated thyroid cancer. The company's heavily reliance on one drug precludes a moat, in our opinion. Although we model cabo as a potential blockbuster therapy, the company's pipeline doesn't give us confidence in excess returns outside of cabo if generics enter the market.

Fair Value and Profit Drivers 11/01/2019

We are lowering our fair value estimate to $23.50 per share from $24 after adjusting for near-term headwinds in first-line kidney cancer. We think immuno-oncology combinations will continue to have strong penetration in both kidney and liver cancer, prolonging the time it takes for patients to get to cabozantinib for second-line treatment. Our valuation is driven by cabozantinib's potential in kidney, liver, and thyroid cancer. With its larger patient population, kidney cancer is Exelixis' largest opportunity, closely followed by a probability-weighted opportunity in differentiated thyroid cancer and then the opportunity in liver cancer. We expect cabo to be a widely used tyrosine kinase inhibitor in both kidney and liver cancer, but there is heavy competition between other TKIs and immuno-oncology combinations, especially for first-line share. We weight the differentiated thyroid cancer opportunity with a 65% probability of approval. Overall, this results in peak U.S. sales of cabozantinib of over $1.8 billion, in addition to royalty revenue from sales outside the U.S. Sales in medullary thyroid cancer, a rare subset of thyroid cancers, contribute only marginally to this figure. We model generic declines beginning in 2027, after cabo's composition of matter patent expires. Generics could enter earlier or later depending on possible litigation outcomes and competitive dynamics, which are highly uncertain and difficult to predict. The firm's other marketed product, Cotellic, in melanoma also contributes incremental revenue, and we expect over $35 million per year from the profit share in the out-years of our explicit forecast, in addition to probability-weighted royalties in breast cancer. Exelixis' pipeline outside of cabozantinib, which is in relatively early stages and weighted with 10%-20% probability of approval, accounts for less than 5% of total revenue for most of our explicit forecast, until generic declines hit cabozantinib. While Exelixis can rely on partners to shoulder development, we expect R&D expenses will remain significant as cabozantinib is evaluated in other indications and the company bolsters its pipeline. We use a 9% cost of equity, in line with its biotech peers.

Risk and Uncertainty 05/16/2019

Exelixis' reliance on its cabozantinib franchise in competitive cancer indications warrants a high uncertainty rating for the company. Cabo will likely face similar competition in each indication, including competitive threats from already-approved tyrosine kinase inhibitors and immuno-oncology combinations, as well as pipeline candidates. Since nearly all of Exelixis’ product revenue comes from the United States, the firm is exposed to pressure on drug prices, such as potential policy changes regarding rebates.

Exelixis has focused on expanding cabozantinib's therapeutic reach, but its pipeline outside of cabozantinib remains in relatively early stages. There is no guarantee that these other partnered pipeline drugs will be viable, as the development of several formerly attractive early-stage candidates has been discontinued in the past. Exelixis’ development of cabozantinib in other indications, namely differentiated thyroid cancer or first-line liver cancer, could also fail to gain approval.

Additionally, the length of cabozantinib's patent protection remains in question. We model generic entry shortly after the composition of matter patent expires in August 2026. However, the company has received notice that MSN Pharmaceuticals has filed an Abbreviated New Drug Application with the U.S. Food and Drug Administration for a generic version of cabozantinib. Exelixis responded with a lawsuit, arguing the validity of patents that extend to 2030. The timing and outcome of this litigation is highly uncertain, although we think our modeled generic entry in 2027 is a reasonable base-case assumption at this point.

Stewardship 05/16/2019

We award Exelixis a Standard stewardship rating. In 2010, Michael Morrissey, formerly the president of R&D at Exelixis, replaced longtime CEO George Scangos, who left the company to lead Biogen. The CEO transition coincided with the return of cabozantinib rights to Exelixis from its partner, Bristol, due to competing priorities. Without the support of a developmental partner, Morrissey restructured the company away from its discovery platform model to focus primarily on progressing cabozantinib. We think this decision was reasonable, given the unsustainably high cost of R&D that this approach entailed and the challenging financing environment that the company faced at that time.

We approve of the board's decision to lower Morrissey's total compensation in 2018 to $8 million from $9.4 million, given the lackluster stock performance. He owns about 1% of the company's outstanding shares. We also like the company’s experienced board of directors, whose ranks include industry veterans such as former biotech executives and several prominent healthcare academics. All the directors aside from Morrissey are independent, and we like that the chairman and CEO roles are separate. Scangos remains on the board, as well as cofounder Stelios Papadopoulos, who is chairman of the board.



Exelixis is a biopharmaceutical firm that discovers, develops, and commercializes treatments for cancer. Its lead molecule cabozantinib is indicated for the treatment of patients with metastatic medullary thyroid cancer (as Cometriq) and advanced renal cell carcinoma, or kidney cancer, and hepatocellular carcinoma, or liver cancer (as Cabometyx). Exelixis and partner Roche have also brought Cotellic to market for the treatment of melanoma.