The Unmitigated Gall of This Week (UBS, CHS, EXEL, PDS)

I expect very bad results from my portfolio companies to come along every once in a while. That's part of why I maintain a very broadly diversified portfolio, and why I focus on a very long time horizon for most of my holdings.

But this week has been abysmal for the short term prospects of several of my investments.

As I wrote yesterday, Precision Drilling (PDS) -- my most recent purchase -- got caught up in the new Canadian tax proposals for trusts, bringing an immediate haircut of 15% or so. Still thinking about the long term prospects on that one, and whether it's worth holding on for what I think will be a good business, and for four more years of low-tax, high-yield dividends before the new law goes into effect.

Earlier in the week, UBS (UBS) disappointed -- their trading results were weak and brought down the earnings for this most recent quarter, and it is starting to look like their investments in expansion are going to put the kibosh on the full exercise of their buyback and on any significant increases in the dividend in the near term. Although the same trading problems impacted most of the major foreign banks and that kind of thing is certainly to be expected from time to time, I may need to look for an alternative investment in this space -- UBS has shown some nice gains over the past year, but the future is looking a little murkier for me in this name.

Then today, both Chico's and Exelixis get pantsed ...

Chico's (CHS) is wearing a bit on my patience -- I fully expect even a company with a history of excellent merchandising to make some marketing or merchandising mistakes on occasion, and with a company as excellent as I've thought Chico's is, I'd consider most of these mistakes to be buying opportunities. But the tought times have really piled up for this retailer -- same store sales growth disappointed through the Spring, and again at the end of the Summer and for the last several months the same store sales have declined, which is unheard of for this company prior to this year. That's led to reduced third quarter guidance today from the company, and another decline by more than 8% in the share price.

Call me crazy, but I'm planning to hold through at least the next earnings call and see exactly what management is doing to fix their problems in same store sales growth. The fact that they are still successfully opening stores, as evidenced by their overall sales growth of about 10%, is encouraging, and I continue to believe that there is ample room for significant expansion for at least their Soma and White House/Black Market concepts (and I really wish they would buy out Lucy, the activewear company that has venture backing from Chico's, Maveron and others, before it gets too expensive).

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Just as an aside, Maveron has got to be the most interesting venture firm out there -- using Howard Shultz's money, among others, they've backed not only Lucy, but the Motley Fool, Potbelly Sandwich Works, iFloor, Drugstore.com, and Eos airlines. I don't know what their record is, but they definitely are funding some fun companies.

And back to the bad news, today also brought about a 15% decline in Exelixis (EXEL), one of my larger speculative biotech holdings. EXEL doesn't have any drugs in production yet, and an investment in this company is a bet that their excellent scientific reputation and well-stocked pipeline of cancer drugs is going to bring at least one significant drug to the market.

The odds dipped a little bit today, as EXEL announced a very dramatic safety concern with XL999, one of their drugs in Phase II clinical studies, and from the initial announcement it's not at all far-fetched to assume that this drug will be dropped (nor is it a guarantee, since they are still continuing the study with existing participants even as they pause new enrollments).

They basically found that close to a third of newly enrolled patients in this study had "serious cardiovascular adverse events", and that about 10% of all enrolled patients had similar "events". That sounds awful to me, though I'm not a doctor and I suppose it's possible that the drug may still have some future.

But although this is certainly negative news, it's far from catastrophic for the company -- XL999 was among the more advanced EXEL drugs, one of four in early Phase II studies (there's one in Phase III, though it carries pretty limited financial expectations), so this cuts the chances that one of those drugs will make it through -- but the company also aims to file IND applications to enter the clinic with three new drugs each year, and they have three Phase I drugs and one IND lined up just behind the lead group already.

So if you bought EXEL because you thought XL999 would be a blockbuster, which is unlikely given that none of these cancer drugs have really progressed far enough to wow investors with their efficacy, you are very disappointed today.

If, on the other hand, you bought EXEL because the pipeline is strong and deep, this isn't much of a reason to sell even if the 10-15% haircut is fair -- after all, you'd have had to predict that at least half of their Phase II drugs were unlikely to gain approval.

If you do the math, there is a certain logic to today's decline -- they have eight drugs in the clinic, so -- all else being equal -- one failed drug could conceivably make it fair to downgrade the value of the pipeline by 12.5%, roughly where we are today. Given that it might take 15 years to develop a drug, and that somewhere between 10-20% of all drugs that make it as far as Phase I eventually get approved, you could really get carried away with valuing these companies based solely on probability ... but EXEL, with their strong history in target identification and drug discovery, and their deep pipeline, remains in my portfolio and I hope they'll have better results with some of their other Phase II drugs.

So ... one cruddy week on the back of a women's retailer, an oil and natural gas driller, a biotech company, and a megacap international bank -- if anyone had predicted for me that all of these would get pounded at about the same time, and for different reasons, I'd have thought it very unlikely. Shows what I know.

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Buy note -- EXEL

I took advantage of the broad downturn today to pick up some more shares in one of my favorite small biotechs, Exelixis (Nasdaq: EXEL). I wrote yesterday about how much I like the company, and particularly what I find impressive about their use of SPEs to help finance their clinical trials, so I won't go into much more detail here.

Though I haven't acted on it yet, I've also been very tempted by Amgen (AMGN) lately -- AMGN and Genentech (DNA) really seem to be this generation's Pfizer and Merck, and AMGN appears remarkably low priced given their solid pipeline and very strong earnings. I don't generally spend a lot of time looking at larger companies like these, but AMGN at a forward PE of less than 17 seems absurd. I'll be watching closely to see what happens around their earnings next week.

For the record, I bought additional shares this afternoon of EXEL at $10.75, which is about 15% down from the peak EXEL hit a couple weeks ago in the mid-12s. I don't see any reason for the decline, other than perhaps some profit taking after a nice year, and given EXEL's potential with such a broad and deep pipeline and array of partnership agreements I really like the risk/reward ratio here.

I've written a bunch about EXEL and their lead compounds in the past -- they've got two Phase II drugs and two just about to enter Phase II, all of which look pretty compelling, to go with several Phase I compounds and one nearing approval in Phase III. In total, they now have an active pipeline of eight drugs going through the clinic, and a commitment to keep moving about three drugs per year into the clinic from their deep bench of preclinical compounds. That provides a much greater opportunity for success compared to many companies, even if you don't look at EXEL's great reputation and strong partners and just assume that the overall odds apply, which would put the chances of any one drug that enters the clinic being approved at a bit less than 10% (the odds go up dramatically with each phase, so once you've got a Phase III drug it has odds of about 75%, by my understanding).

If you'd like to see a lot more detail about the specifics of the drug programs and financials, you can also access the recent buy recommendation and full analysis from WR Hambrecht here (PDF file).

Suffice to say, having a deep pipeline of drugs is great for companies that have to live with such an uncertain approval process, and I'd be surprised if at least a couple of EXEL's lead compounds didn't gain approval.

Though of course, I could be wrong -- and it will be years before most of them are actually ready for the marketplace, so patience is definitely called for. With so many compounds in active trials, we should receive fairly regular updates over the coming year on preliminary results and final results of any of these trials, which could easily move the stock dramatically if they are strongly positive or negative. I'm particularly interested in seeing preliminary Phase II results from XL999 (various cancers) and XL784 (diabetic kidney disease), both of which began Phase II trials within the last few months, and in news on XL647 and XL880, both of which target tumors, which should finish up Phase I shortly (880) and begin Phase II soon (647) if all continues to go well. (The pipeline is detailed here if you're interested.)

I've now bought EXEL on three occasions in the past year, at $7.66, $8.66, and today at $10.75. I've been buying larger portions on the way up, so my current cost per share now stands at about $9.75.

Other recent Exelixis comments:
Exel's no ENE
Exelixis upgraded with good reason
Annual Checkup -- EXEL

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EXEL's no ENE

Interesting article in Forbes recently talking about the special-purpose entities used by some small biotech companies to raise money. Exelixis (Nasdaq: EXEL) has been in partnership with Symphony Capital for almost a year, and I've written before about the fact that I like EXEL's innovative financing -- special purpose entities get everyone's arm hairs tingling these days, but this is very different from the infamous SPEs of Enron.

Exelixis is in an interesting position now, but it's also a somewhat perilous one financially. They do have plenty of cash on hand at the moment, but they also have a huge number of drugs in the pipeline that will require very expensive clinical trials. As each phase of FDA approval progresses, the next trials become dramatically more expensive -- early safety and efficicacy trials might be relatively inexpensive and include dozens or a few hundred patients, but a late phase III trial for final approval might have thousands of patients and take several years to complete.

That costs a huge amount of money, which is part of the reason that many small biotech companies partner their drugs with large pharmaceutical companies to help with costs, or end up themselves being bought out because a larger partner can do a better job of pushing their pipeline forward.

There are several ways to raise this money, of course -- you can borrow from the bank, or issue bonds if investors are at all interested, or you can offer more shares and dilute current shareholders. All of these are used with some frequency in biotech, but there are negatives associated with them -- for small companies that are not near profitability, it's hard to get favorable terms.

So EXEL, and some other companies recently, have gone to special purpose entities to raise money. Unlike Enron's special purpose entities which seem to have been intended simply to defraud and to hide debt, these SPEs are intended to raise money for targeted programs, in exchange for the rights to that drug, a piece of that drug's income, or other considerations.

In the case of Exelixis, they have partnered with Symphony Capital, a big private equity firm, to fund several of their ongoing drug programs. That means Symphony puts up a sum of money in a separate investment fund -- up to $80 million under their current agreement -- to pay for clinical trials on specific drugs. Symphony has effectively purchased the rights to these drugs (XL647, XL999 and XL784), but EXEL maintains the right to buy them back at attractive prices if they choose, and has agreements with Glaxo SmithKline to provide larger milestone payments to cover that repurchase of rights in the event of a successful trial.

The big think that EXEL has done with these special purpose entities is reduce risk. Even for a company with such a large and deep pipeline, the failure of a drug in development is costly -- if the drugs that Symphony has purchased fail in trials, EXEL is not obligated to buy the rights back and will not have to repay that part of their financing.

Dr. Scangos, CEO of Exelixis, had a few quotes in a press release last summer that seem to sum up their thinking:

"We have retained exclusive rights to the compounds, obtained attractive funding to enable aggressive, thoughtful clinical development, and have off-loaded the financial risk of compound failure ...

"We have been remarkably productive over the past few years, and are on track to have eight compounds in clinical trials by the end of the year. We believe that conducting extensive Phase II trials is an important aspect of avoiding late-stage product failures. Obviously more extensive programs require significant financial investment, and this transaction is one example of how we intend to finance these programs while minimizing dilution to our investors."

With the massive warchests being built by private equity firms, I think we'll see more of this -- private equity and venture companies with good biomedical analysts will start looking at investing not in biotech companies themselves, but in specific drug programs to underwrite clinical trials. It seems a good deal for everyone involved, but it's an especially effective one for a company like Exelixis that has a market cap of less than a billion dollars but is trying to manage a deep pipeline of cancer drugs that's as large as or larger than many of those of larger biotechs and pharmas.

EXEL's stock has been performing pretty well recently, breaking out of an $8-10 range that it had traded in for several years. Since the pipeline is so large we're likely to hear relevant news about specific compounds with some frequency, any of which could move the stock if they're dramatically good or bad. I would like to add more to my EXEL position, and I'm not sure whether it makes sense to make a buy soon or to wait for a possible dip if one of their trials hits a snag, I'll let you know if I make up my mind.

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Exelixis upgraded with good reason

Exelixis (NASDAQ: EXEL), one of my favorite small biotech companies, was upgraded today by WR Hambrecht and has seen a nice bump in share price. I think WR and other analysts who are starting to look at this company are on the right track.

I bought EXEL after reading a Motley Fool article on them back in June, and I added a bit to my position in November, so I'm now holding what is still a smallish position at an average cost of $8.13. I'm now regretting not adding more to my holdings, as this little guy seems to be finally getting some big attention for their early stage cancer drugs and their many collaborative research programs.

EXEL is also going to be presenting at an investor conference on Thursday this week, and if the past is prologue it should be worth tuning in -- the last time I listened to a round of their presentations I came away very optimistic and impressed with the quality of their pipeline and the strength of their ambition to grow into a leadership position in the biotech industry.

The pipeline looks pretty incredible at this point -- nothing has jumped out as a potential blockbuster yet, but the sheer number of promising compounds that are moving through into Phase II this year is extraordinary for a company of this size. In no way does EXEL depend on a single drug or even on two drugs, though of course their path is still quite risky since their key drugs are all still quite early in the FDA approval process and it will likely be years before they bear fruit (if they succeed at all).

EXEL's lead drug, XL119, is in Phase III trials for Bile Duct Cancer, but that's not likely to be the prime mover of the stock whether it's approved or not. The next batch will make a much bigger difference, and they're all moving almost in lockstep through the approval process, without a hitch so far. XL784, their first non-cancer drug for renal disease, is moving into Phase II now, XL 999 initaited Phase II in December, and three more cancer compounds -- XL647, XL880, and XL820 -- will be starting phase II by the end of 2006.

That will mean six drugs in or through Phase II or III by this time next year, most of them in oncology -- that's simply remarkable for a company that has just barely crested the $1 billion mark in market capitalization.

Risks remain, of course, as do significant expenses. EXEL has a lot of cash, good income from collaborative research work with Sankyo, Bristol-Myers and Wyeth, among others, and some innovative financing agreements with Symphony to cover some of the costs from the expensive trials that are now underway and that should be expected to mushroom in cost for the next couple of years.

But the risks don't seem to be bothering investors right now, and I don't blame them -- this will be a critical couple years as their Phase II trials run the gamut, but with the depth of their pipeline I'll be thinking about any dips as buying opportunities as funds allow.

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Annual Checkup -- EXEL

As I just wrote about Exelixis (EXEL) a few days ago, I don't have a lot new to add. I'm showing a small gain with my holdings right now, as my average purchase price is $8.13, but that won't necessarily last through the year. I expect a lot of volatility in the next couple of years from EXEL as their three current lead compounds of interest move into and through pivotal phase II trials beginning this first quarter of 2006. Hopefully their continuing efforts to build licensing income streams will help to offset the volatility and high costs that accompany the FDA approval process, but the returns might be spectacular if one or two of their cancer compounds actually makes it as a widely accepted drug in the next four or five years. This continues to be a long-term hold, wait and see what happens kind of stock for me.

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Exelixis diversifies

It's starting to appear that Exelixis (EXEL) is going to be the most capable and diversified small biotech company in the country.

News today -- EXEL is now in a pact with Wyeth to develop new drugs for liver and metabolic diseases.

And last week, EXEL entered an agreement with Bristol-Myers, also focused on metabolic disorders -- but this time, with a focus on developing a new class of anti-cholesterol drugs.

All this comes as Exelixis' own drug programs are starting to move through the clinic. EXEL made it's mark years ago as a contract researcher for pharma companies, and everything I've read reassures me that their science is top-notch (I'm not smart enough to evaluate their science myself, but I first learned of EXEL from reading a piece by Charly Travers at the Motley Fool, who I greatly respect, and have read many other pieces on them in the financial press, as well as listening carefully to their conference calls and presentations). I filled out my EXEL position about two months ago, and I'm very pleased with their recent progress.

So not only does EXEL have two new potentially lucrative licensing deals in place, in addition to the several licensing deals they already had and the innovative financing they've done with outside investors, but they're finally going to get to the important stages of determining which of their own compounds might make it through to the market.

I wrote a while back that early November was a key time for EXEL since that was when they released preliminary phase one results on three of their drugs, and indeed it was a significant time. It didn't move the stock all that much because none of the results where shockingly good or bad (as almost no phase one results ever are -- the exception lately has been Vertex's VX-950).

But what we do now know is that their three lead cancer compounds are moving out of phase I and into phase II by the first quarter of next year. As results from those come in over the coming years we'll really start to find out what EXEL's stock might do. In the meantime, the licensing deals they've signed recently will help them to further build up their research capabilities and to increase cash flow to fund these expensive clinical trials.

So no single big announcement from EXEL of late, but the news continues to build and is nicely positive even as Exelixis remains largely under the radar.

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Still EXEL-lent

Well, as I had been mentioning I might do for a week or two, I bought some more EXEL today. I had been assuming the earnings release would be a non-event, as it was, and that I would be able to buy at roughly the same price anytime prior to their release of data next week on a few of their phase 1 compounds ... oops.

That turned out not to be the case, as the company strongly implied in their conference call that there would be good news in the preliminary trial results we'll see next week. That, I imagine, is the reason why I had to pay almost 10% more than I could have paid last week for my shares. Still, I'm happy with a long-term hold of EXEL at this price.

Bought more EXEL today, November 7, at $8.66. That brings my average cost for my EXEL holdings to roughly $8.11, and I now own what I consider a full position for a risky biotech play like this one.

I last wrote at length about Exelisis back when they did a round of conference calls, including one at the Banc of America conference (my writeup of that call is linked here). There really isn't any news out since that writeup, but there is clearly a feeling in the air that something is coming. That feeling was fed by the earnings call in which the upcoming data release was mentioned several times -- one has to imagine that they wouldn't emphasize that preliminary data release so much unless the data was going to be in some way pretty significant.

And since these are all cancer drugs, significant performance in phase 1 trials might well move the market. I can't say whether or not we've already had that move, or whether the news will be enough to even support this recent post-earnings share price performance. But I do think that this company's deep pipeline and excellent (and creative) financing will move them into the big leagues of biotech eventually. It may be with the three drugs we'll hear something about next week, or it may be one of the other eight compounds in trials or some of the other projects that are still in the clinic. But the odds favor something successful for a company with this scientific track record and reputation, and something successful against cancer would be big news, as we have seen with all the recent biggies from Genentech, Imclone, and others.

So I'll be waiting along with the rest of you to see what the news is, and hoping that the CEO didn't lead the market to expect too much (these are, after all, still phase 1 drugs -- Vertex excepting (and VRTX is, by the way, now up 100% for me -- joining Google as the only ones with that distinction in my current portfolio), we shouldn't see those causing dramatic stock advances very often). I've grown to really like this company's management, and everyone loves their pipeline -- soon we'll have a better idea of whether or not those feelings are misplaced.

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Recapping how they EXEL

Just got a comment from a reader, " Did you hear the EXEL CC call by Bank of America? quite an impressive presentation" -- I did hear the call, and I agree. Thought I would call it to all of your attention.

Exelixis is still quite early in the process of becoming a big company, and I've written about them before, but anyone who's interested would do well to check out the webcast from the BOA conference (link here) . It's reassuring the hear a confident, mature CEO talk when you're invested in a company that is still quite a ways from becoming profitable.

The key takeaway? In my opinion, it's this [shortened] quote from CEO George Scangas, "Our goal is really to become a top-five biotech company ... we don't make this statement lightly ... I believe we have a legitimate chance to meet that goal" And they've designed the company for that long term goal, this is not a pie-in-the-sky hope.

And the other key takeaway, no kidding, is "this is a bit of a small group, so I'll take questions during the presentation" -- translation: No one loves EXEL yet, so we do not yet have to pay for the hype if we want in. Looks like the next potential chance for EXEL to get a lot of attention from the market will be when they release data from three early stage trials in early November.

EXEL is doing it the right way, conservative management of a very large (especially for such a small company) pipeline of drugs that is organically growing at a steady clip.

This mature but still small company is not betting the farm on a blockbuster drug, though they may come up with one someday -- they're also going after known targets with novel approaches or techniques in their compounds, and they're going after big diseases, with a primary focus on cancer. You can hear about some of them in the conference call, but, for example, one of their promising cancer drugs, XL999 , targets the same basic mechanism as Genentech and Protein Design Labs' Avastin (which, recent news notwithstanding, has proven itself as a spectacular drug for at least some cancers) even as it tries to improve upon that drug. Potential blockbusters that break new ground with higher risk make up part of the pipeline, and compounds that follow established targets or strategies and have lower risk of failure make up the rest -- that's a smart way to manage a pipeline, in my wholly uninformed opinion.

Exelixis is also not taking the other popular path of the small biotech company, betting on becoming a lucrative takeover target so the big boys will bail them out. Instead they're partnering compounds and coming up with smart and innovative financing to lessen their risk, and they're trying to develop and bring to market themselves and in coordination with their partners a large number of effective drugs. This is a company that believes it has a good future on their own, and I agree.

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Exelixis (EXEL)



Bought June 17, 2005 at $7.66


Since this stock had a big pop on Friday, it seemed like a good one to write up now. It looks like the reason for the 12% rise on Friday was a brokerage upgrade as Banc of America started coverage at "buy." (Incidentally, they also just started coverage of Vertex Pharmaceuticals, one of my other holdings, at "neutral" ... i suppose they must have just hired a new biotech analyst.)

Exelexis is a pretty small biotech with a promising pipeline of cancer drugs that appear to have better than average chances of eventual FDA approval (nothing revolutionary in terms of targets or in terms of the technology applied -- sometimes "revolutionary" is a bad word if it means trying to get the FDA to approve a whole new way of treating a disease instead of an improved drug that does something similar to existing treatments, only better).

Some of my other biotech holdings, including both Vertex and CV Therapeutics, have had much more coverage in the press and seem to be more fully hyped. That isn't necessarily a bad thing, but I think that these smaller companies with somewhat less attention might be priced at discounted levels in comparison to their more widley understood compatriots.

Biotech has certainly been in the news a lot over the past six months or so, with Genentech blasting off thanks to lots of good drug news -- including lots of coverage of Avastin, which looks like it might be the most important cancer drug in the world (and on which one of my other holdings, Protein Design Labs, makes a nice royalty for use of their proprietary antibodies). That has led to some good price climbs for a number of stocks, but I don't really have much interest in the huge biotechs like Genentech and Amgen -- I think those ships have sailed, for the most part, and that the explosive growth and exciting potential lie with the smaller biotechs with promising but mostly early-stage drug programs. Biotech is a relatively small proportion of my portfolio, and I treat these investments as very long term holds. Ideally, I like to pick companies that I think have the potential for long term growth into powerhouse companies -- the Genentechs and Amgens of a decade from now.

That kind of growth and future generally is built first on one or a few very successful drugs, but also on very deep pipelines and strong science going forward -- I'm not interested in investing in the one trick ponies of the biotech world, the companies that have one booming drug to make money for a few years, but nothing in the pipeline behind that the help them grow into a significant company.

Biotech is also an area I don't personally understand very well, so I rely on reading the advice and analysis of people who do understand the science and who can explain it in terms that a non-scientist can understand. The first person I found like that is Charly Travers over at the Motley Fool, though there are certainly others. Charly and his colleague, Karl Thiel, have both done some nice writeups of biotech companies and Charly writes a monthly biotech column in the Rule Breakers newsletter that I find provides a great education. This coverage alone is largely the reason I subscribe to Rule Breakers -- while the other recommendations they make and the analysis they do in general is compelling, it's the biotech stuff that I couldn't do on my own.

This article on the Motley Fool site is very useful in summing up reasons for investing in Exelixis.

Exelixis has a very promising mid-stage pipeline of primarily cancer drugs, including one currently involved in stage 3 trials for bile duct cancer (and which has orphan drug status, which provides extended exclusivity rights and some tax credits). Their full pipeline of drugs is explained on their website, and they have had a busy year -- aside from the ongoing stage three trials they have several drugs in or just beginning phase 1 trials, and three applications pending with the FDA as of this summer to begin additional clinical trials.

Exelixis is unlikely to be one of the biotech takeovers, in my opinion, because they have followed a strategy of partnering and licensing their drug programs in order to offset the cost of research and development and, indeed, the high costs of the clinical trials themselves. I see them as a separate company going forward, and I trust the analysis of Travers and others that the drug programs themselves seem very promising and are aimed at known cancer targets. This strategy is both good and bad, in that it helps to keep the company from going boom or bust with each FDA approval or denial, but also moderates the impact of a blockbuster. I'm pleased to see with their XL119, the drug closest to market, that they have partnered with Helsinn for a good amount of upfront money and ongoing milestone and royalty payments, but that they have retained the rights to repurchase the North American rights from Helsinn if the drugs performance warrants.

This one is going to be a wild ride, as it has been already from its IPO at nearly twice this price until now, but I think the solid science, low profile and good pipeline that includes several promising programs but also one drug that's in the final stages of approval make for a worthy bet.

This, like most of my biotech investments that have very long time horizons, is a "set it and forget it" stock that I'm not going to sell for the next ten years unless they receive a huge buyout offer, which I do not expect, or unless their proprietary science is discredited (in which case, I wouldn't likely sell anyway, since the stock would then be all but worthless). And for those interested in investing in biotech who aren't doctors or pharmacologists, I strongly recommend finding advisors who you trust who understand the science and the investing theses for these companies -- in my opinion, Motley Fool's Rule Breakers is a great and affordable resource, but there are certainly others as well.


Technorati tags: Exelixis, exel, biotech, Motley Fool

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