Lexicon Genetics Inc. formed its most notable drug discovery alliance to date, forming a partnership with Genentech Inc. to discover therapeutic proteins and antibody targets through a deal that could bring Lexicon more than $39 million.

Lexicon will focus on genes identified by South San Francisco-based Genentech to discover their physiological function and potential medical use. Genentech receives certain exclusive and nonexclusive rights for the research, development and commercialization of proteins and antibodies stemming from the alliance. Lexicon also granted Genentech an internal-use sublicense under a patent covering Lexicons' isogenic DNA gene targeting technology.

"Genentech has been very aware of our operation as the leader in determining the function of genes for some time," said Arthur Sands, CEO and president of The Woodlands, Texas-based Lexicon.

Sands said three things helped cement the deal between the companies. First, the sequencing of the mouse genome "has helped the world realize that drug discovery must be founded in physiology," and Lexicon can provide custom knockout mice. Second, Lexicon has a "genome-wide knockout library." Third, Genentech has its secreted proteins discovery initiative (SPDI) that would benefit from a healthy dose of Lexicon technology.

Genentech's SPDI program is based on the theory that secreted proteins are the proteins with the highest likelihood of becoming therapeutics. The program is dedicated to identifying the thousands of secreted proteins from the human genome. So far, Genentech has identified and sequenced nearly 2,000 genes that encode secreted proteins.

"Genentech is undertaking this as part of our ongoing activity to understand the biological function of many of these genes that we have identified through our SPDI program," Page Sargisson, manager of corporate affairs at Genentech, told BioWorld Today. "Lexicon is an attractive collaborator with their proven record in in vivo capabilities."

In a research note by Punk, Ziegel & Co., of New York, Sharon Seiler commented on the finances of the deal, saying: "The $39 million figure . . . reflects solely the real money' component of the alliance. The value in bio-dollars' is probably several-fold higher."

She estimates Lexicon will receive a $15 million up-front payment, a $4 million convertible loan at Lexicon's option and $20 million in payments for fulfilling research obligations. Beyond that, there are pre-commercialization milestones worked into the agreement, as well as an undisclosed royalty rate on product sales.

Seiler said Lexicon will "work to discover the physiological function and potential medical utility of up to 500 genes that Genentech has defined as high priority based on Genentech's research to date."

The companies are not sure where the work is heading - but that's to be expected when working to discover the gene function.

"The alliance is designed to be opportunistic," Sands said, adding that "no one can predict what a gene can do" or where its medical applications will lie.

In November, Lexicon filed a shelf registration statement with the SEC to sell up to 12 million shares. The company has not raised funds from the registration and Sands said there doesn't appear to be any plans to do so.

"We have modified our guidance for 2002, reducing our cash burn estimate so that we believe we will end the year with about $120 million in cash," he said.

The overall business model for Lexicon and its 575 employees "is to discover true breakthrough therapeutics," Sands said. It has 11 alliances for target validation and target discovery, including ones with Bristol-Myers Squibb Co., of New York, and Incyte Genomics Inc., of Palo Alto, Calif. But it also is working toward drug discovery through alliances, "the most significant of which is Genentech," Sands said.

Sands said that "a number" of mouse genes the company has already fully analyzed might be involved in the alliance, acknowledging that "we are in a race here" to take the mouse genome and pull medicinal uses from it.

"We've knocked out over 60 percent of the mouse genome already," Sands told BioWorld Today. "Over the next four years we hope to fully analyze 5,000 genes. This 5,000 encompasses what we call the druggable genome."

Lexicon has 14 preclinical research programs, including LG653, a small-molecule program aimed at diabetes and obesity. But, he said, Lexicon will "build our future in drug discovery alliances."

Lexicon's stock (NASDAQ:LEXG) rose 18 cents Wednesday to close at $4.03. Genentech's stock (NYSE:DNA) rose 52 cents to close at $35.02.