Dendreon: Looking For Spare Change In The Cushions

Sep.28.13 | About: Dendreon Corporation (DNDN)

Earlier this month biotech Dendreon (NASDAQ:DNDN) announced the approval in the European Union of its only commercial product Provenge. Aimed at prostate cancer, Provenge is a novel therapeutic based on Dendreon's proprietary cellular immunotherapy technology. The good news could not have come at a better time. Dendreon has had Provenge on the market in the U.S. since spring 2010. While sales have ramped impressively to $304.3 million in the most recently reported twelve months, the top-line has failed to cover costs and expenses.

Indeed, for every dollar of sales generated in the last twelve months Dendreon has used $0.82 in cash. Perhaps even more troubling, the flames of cash burn have been leaping higher in recent months. In the six months ending June 2013, it took $0.99 in cash for every dollar of revenue. Investors should be questioning the sustainability of THAT business model.

Where is all the cash going?

In the most recently reported twelve months, direct costs associated with getting Provenge out the door represented 63.5% of revenue, leaving gross profit of $111 million. Dendreon spends about $75 million per year on research on development, most of which is targeted at testing and perfecting Provenge. That left $36 million to cover the rest of operating expenses. Alas, selling, general and administrative expenses totaled a whopping $270.9 million in that stretch of twelve months. Management claims the spend is necessary to position Provenge against a growing list of competitors and to snare new customers.

Smart investors reading this article are probably already thinking about non-cash expenses. It is a valid consideration. Stock compensation, depreciation and amortization account for $63.7 million of costs and operating expenses. There are other non-cash charges in Dendreon's recent history. Restructuring charges and others related to the company's debt financing were $46.4 million and $29.7 million, respectively.

Snipping out these non-cash expenses leaves an estimated $476.2 million in costs and expenses that require payment in hard cash. Cash interest expense totaled another $28.4 million. Thus in the twelve months ending June 2012, Dendreon used $252.1 million in cash to support operations.

After paying all its bills, Dendreon's cash resources dwindled to $92.0 million at the end of June 2013. Financial investments of various maturities that can be converted to cash provides another $118.6 million.

Can Europe save Dendreon?

The consensus estimate for Dendreon in the years 2013 and 2014, are currently $301.8 million and $352.7 million in total sales, respectively. Those numbers do not evoke the image of enthusiasm, especially after management provided dismal guidance during the last earnings conference call in August. However, it is important to consider that analysts have probably not had the opportunity to update their estimates in the two weeks since Dendreon announced its breakthrough in Europe. While it might be farfetched to expect a material contribution to the top-line in the year 2013, it would be entirely reasonable to expect a nice gift of revenue from Europe in 2014.

Provenge delivered $76.1 million in total sales in the first twelve months after it was approved for sale in the U.S. The European market is perhaps smaller than the U.S. market, but it seems reasonable to expect two years of experience to result in faster and more effective market penetration. Adding, $75 million to the 2014 sales consensus yields a revised estimate of $428.0 million. (This assumes none of the contributors to the consensus estimate had previously included sales from the European market.)

There is probably a dozen arguments for higher or even lower sales estimate for 2014, but I am just going to move on to what is even a more contestable topic - how much cash will be needed to support operations in 2014. Let's first assume that Dendreon is able to continue its track record of realizing improved profit margins on higher volumes. Profit margin was 36.5% in the last twelve months, so let's peg the 2014 margin at 40% just for the sake of argument.

With a 40% profit margin our revenue estimate will provide $171.2 million to cover operating expenses and charges. Dendreon management has made some tough decisions over the last couple of years, shedding excess product capacity and reducing headcount. So while we expect research and development to remain near $75 million, it is possible the company could keep SG&A near $300 million.

This line of reasoning implies that cash usage could be around $125 million in the second half of 2013, but only another $110 million in full year 2014. As encouraging these figures might be against recent cash burn, Dendreon will still not be in the clear. Without additional cost cutting, the company is not likely to begin generating positive cash flow until well into 2015 or beyond. (One place to start might be the C Suite where salaries for the top five executives remain near $2.4 million per year excluding benefits.) Nonetheless, bank and brokerage balances near $280 million will not carry the company much beyond the end of 2014.

Perhaps the more important question for any investor considering a long position in Dendreon is whether management has the resources to strategic goals.

The exercise above demonstrates that no matter how investors rationalize Provenge's market potential and Dendreon's cash requirements it is more likely than no the company will need to raise capital within the next twelve months. Besides the heavy burden to support SG&A, $28 million in convertible notes are coming due in early 2014. A second group of $620 million convertible notes comes due in 2016. On the bright side of things, the new shares outstanding will dilute the net loss on a per share basis.

As management looks through the cushions for spare change, investors have been aggressively selling Dendreon shares. Even the news from Europe failed to bring about more than a tepid recovery in sentiment. A review of recent trading patterns suggests DNDN is a broken stock with no meaningful support at any price level below the current price. That means there is 100% downside from the current price. With the European market announcement already old news, there are no significant catalysts in Dendreon's future.

Only profits and cash flow can save Dendreon now.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.