Dendreon: Is It Going To Get Out Of This Mess?

May.11.14 | About: Dendreon Corporation (DNDN)

Summary

Dendreon equity is practically worthless due to convertible bond overhang.

Raising new capital to remain an ongoing concern past 2016 will be challenging.

Buyout would be ideal but with patents expiring between 2014 and 2018, an important box is unchecked for a potential acquirer.

Dendreon (DNDN) has pretty much been a nightmare for long-term investors. They deal with the risk and the stress of investing in a development stage biotechnology company, see their lead drug approved & reach a meaningful level of sales and yet their stock price is close to an all-time low and probably heading lower, much lower.

I'm not saying the company is worthless, far from it. It has two main assets that have value, Provenge and the ~$600 million in NOLs (worth about $210 million at a 35% corporate tax rate). Unfortunately, thanks to a massive convertible debt overhang, the stock has almost no value to current investors, it is caught in a death spiral of the management's (actually the ex-CEO's) creation.

Let's take a look at what is facing the company. In their most recent quarter, DNDN burned $30 million, leaving it with $169.7 million in cash plus investments. At that burn rate they have enough cash to last until the 3rd quarter of 2015. Cash-burning biotechnology companies raise money from investors all the time but the difference here is that right after the 3rd quarter of 2015, in January of 2016, equity investors will face a major dilution event (there will also be a smaller one in June of this year when $27.7 million in debt comes due but it is more manageable). At that time, $620 million worth of convertible notes will be due, payable either in cash or in stock (the management has already said that they intend to pay it in stock). Just to illustrate the dampening effect this has on any new potential investors, let's just look at what such an issuance will mean to current investors at different stock prices (and remember that we have 153.6 million in common stock outstanding today):

Stock Price Shares to be issued Dilution of current investors
$2 310 million 67%
$1.50 413.3 million 73%
$1 620 million 80%
$0.50 1.24 billion 89%
Click to enlarge

I don't see how DNDN is going to raise any money from new equity investors, especially at the scale that they would need to (~$120 million which equates to a year's worth of cash). Immediately after purchasing the shares, your percentage ownership of the company goes down by 67-90%! I haven't seen such immediate value destruction since my sister bought a Range Rover.

The other option for DNDN is to raise debt but it is not exactly the kind of company that debt investors love giving money to. It is far from a cash flow positive company and based on current sales and expense trends probably has no prospect of becoming anything better than break even. And debt investors can't feel comfortable with the prospect of depending on equity raises to get paid back given the scenario above and DNDN's general prospects. Think about, if DNDN raises $120 million in 5 year debt, that means that they would have to raise $600 million (assuming the burn remains steady) just to remain a going concern long enough to even have a chance to pay back the debt and then an additional $120 million to pay back the principal. That is just not feasible.

And sorry, Europe is not going to be the savior here. I don't see how losing money on two continents is better than losing it in just one. Europe is not a huge fan of paying for therapies that are extremely expensive and have so-so data (also, nobody can ever tell if it is actually working) so usage there should remain low and not be at all helpful to the company's financial situation.

The best way out of this mess for DNDN is to try to sell the company, but that is not anywhere near a done deal for two reasons:

  • Provenge patents expire between 2014 and 2018. I don't think anybody thinks a generic is going to be approved in this case and even a biosimilar is probably not going to happen, but that is an important check box for any potential acquirer. Why pay top dollar for something without patent protection?
  • Provenge is not a growing asset. Usually pharmaceutical companies like to buy assets that improve their growth profile and Provenge will certainly not do that.

That is not to say there is no reason for someone to acquire them. DNDN is worth something to an acquirer. I ran an NPV calculation to see what the minimum value of DNDN is. If you assume flat sales, no product past 2018 (when the patents run out, an unrealistic assumption but it does provide a floor) 30% cost of goods and all other expenses stripped out, and take into account cash, debt and NOLs, I get a value of $1.92 per share to an acquirer. However, with slightly more positive assumptions, 5% annual revenue growth and cash flows through 2024, I get a value of $5.50 a share to an acquirer. So there is a financial benefit to someone buying DNDN, the question is will business development folks want to put their necks out for a pretty unexciting asset?

The only other solution for DNDN is to restructure the debt right now through a massive equity issuance which will finally clean up the balance sheet, eliminate the debt overhang and allow for new equity investors to come in before the company runs out of cash. That will certainly be painful to current investors but at least there will still be a company on the other side.

Basically, owners of DNDN should realize they don't really own a share of the company, they own a call option with a payoff only if it is acquired. Otherwise their call option will expire practically worthless.

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.