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'Este' means 'the latter' in this case. It refers back to the dragon, as you would expect. The dragon is the subject in the first clause. The direct object pronoun 'te' is someone familiar to the speaker. Rather than use the subject pronoun 'él', the author chose to place the subject after the verb and tie back to the last noun mentioned.
You cannot use 'lo' to refer to a subject (since it's a direct object pronoun).
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