I recently put out a somewhat bearish note on Dendreon DNDN that glossed the company's history throughout the last few years, and described a bullish turnaround that brought DNDN a bit higher this year. Since I put out the note, DNDN has dropped about 8% although YTD gains are still positive at ~12%.
DNDN receives quite a bit of attention, although one of the key factors that work against Dendreon's $887 million valuation is often glossed over in the discussion of the company's financials. While the company's revenues and expenses have been covered quite thoroughly, why hasn't there been discussion on the company's balance sheet?
Dendreon is making progress on cost-cutting, and may be able to expand Provenge sales significantly following approval in Europe (anticipated in mid-2013). It's also true that Dendreon has a chance of reporting operating profits sometime this year, which would be a big psychological victory for the company and its stockholders after years of suffering.
But how is Dendreon going to deal with the $560 million of debt that it's accrued throughout years of negative earnings?
Looking at Dendreon's most recent 10-K filing, you can see that Dendreon sold $27.7 million in senior subordinated notes due in 2014 and a whopping $532.7 million in notes due in 2016. While the first batch of notes isn't very intimidating for a company holding $188 million in cash, they simply cannot afford the second batch.
Well, they can, but shareholders will have to take a hit. Either we'll see this debt converted into common stock, or we'll see Dendreon faced with a tsunami of debt that could possibly bankrupt the company. In either situation, we're seeing major pain for Dendreon's stockholders.
So, can Dendreon avoid share dilution?
Yes - there are two general ways this can happen:
1.) Dendreon sells more convertible notes
Covering debt with more debt is generally a bad business practice, although doing this could avoid share dilution between now and 2016 if done properly. The catch is that this move would only expand the already scary size of Dendreon's debtload.
2.) Provenge sales explode
I expect Provenge sales to reach Dendreon's estimated break-even point of $100 million/quarter at some point (probably after European approval). The problem is that $100 million isn't nearly enough to prevent share dilution. We'd need to see triple, or maybe quadruple the sales revenue. Since it's virtually impossible, I think we can rule out this scenario.
While I will agree that Provenge is a very good therapy that has growth potential, Dendreon's balance sheet just looks like a disaster waiting to happen.
Ultimately, I have a very hard time believing that the company will be able to gather enough money to pay off debt expirations in 2016 without the sale of common stock. Since this money won't come from Provenge, it's just going to have to come out of shareholder's pockets through dilution.