I know that my coverage of biotech Dendreon (NASDAQ:DNDN) has been heavily slanted towards the negative side. Over the past couple of years, this stock has been one of my best short ideas. I initially detailed how the stock could collapse when it was in the mid-teens, and over time I've recommended short positions as the stock fell into the mid and low single digits. Shares closed Thursday at $2.29, after a mild rally has brought shares back from their 52-week low of $1.81.
For Dendreon, there is still hope, although the picture may not appear as bright as it used to be. While I'm still not sold on the company's future, I'd like to discuss today what the company needs to do to change my overall opinion. There are a couple of key items that could make this stock worth the risk, so today I'd like to detail the other side of the argument for Dendreon.
A new and hopefully more transparent leader:
It was about a month ago when we learned that Dendreon CEO John Johnson was stepping down. Johnson's time at the helm of Dendreon was not a great one for shareholders, with shares declining about 85% since he was announced as CEO. As my article linked above details, Johnson's departure started the big debate again: bankruptcy or a buyout? The answer to that question will play out over time.
Next month, Johnson will depart as CEO on August 15th. A new leader is obviously needed, so it will be interesting to see who will take charge at Dendreon during this critical time. Regardless of who becomes CEO, I would like to see a bit more transparency from this person. I've detailed in several past articles how management promised an update on the debt situation, but all we got on future conference calls was "we're making progress in our thinking." One of the reasons why shareholders have become so frustrated with this name is the lack of transparency. Reading through the conference call transcripts, trying to get select information out of the company is like pulling teeth. I'll have more on this in the next section.
More clarity on key issues:
We didn't exactly get a statement from management recently, but Dendreon did pay back its 2014 notes. The company had more than enough cash on its balance sheet to pay these back, so they were not really a problem. It is the 2016 notes, more than $600 million that's due, that are the key issue.
In regards to transparency, the company could provide more updates on its situation, and particularly be a little better in its wording. One of the key issues with the company's troubles is that it is burning heavily through cash. Dendreon recorded an inventory charge last year due to bad inventory, and the company is hoping to receive an insurance payout. Here's what the company said on the most recent 10-Q filing for Q1.
For the year ended December 31, 2013, we recorded a charge of $46.2 million related to antigen inventory, which no longer met quality specification and was not usable for commercial production, or which was determined to be likely to fail such quality specification. We have insurance coverage for up to $30.0 million for antigen losses of the type we believe we have sustained, although reimbursement cannot be assured with certainty at this time. We have filed an insurance claim to seek recovery for these losses. We are awaiting further information and, ultimately, reimbursement from our insurance carrier. As such, we are continuing to investigate the loss and are exploring all available options for recoverability.
That's what the company stated in the filing, but here's what was stated on the Q1 conference call at the same time.
In 2013, we've recorded a charge of approximately $46 million related to Antigen inventory which did not meet product specifications. We have insurance coverage for up to $30 million for Antigen losses at this site, and we expect to receive recovery up to this amount in two installments during 2014. In addition we're continuing to invest to get remaining loss and are exploring all our available options for additional recoverability.
So there may be a little bit of confusion here. In the 10-Q, the company says that "reimbursement cannot be assured with certainty," but on the call, management expects to get up to $30 million in two installments this year. I understand that Dendreon probably can't put the "expectation" into the 10-Q, but this is a big issue. $30 million right now is roughly equal to a quarter of cash burn. Any money the company gets back would be a tremendous help to the financial situation. Dendreon was around $170 million in cash and investments at the end of Q1, but the 2014 notes payment was around $28 million. Dendreon also expected to burn through cash in Q2. As I've stated in the past, if Dendreon does not get any insurance money this year, the cash/investments position is likely to go under $100 million in either Q3 or Q4 of this year. Hopefully we'll get a bit more clarity on this issue at the Q2 report. Some may see this as nit picking, but this is just one example of why investors are so frustrated with CEO John Johnson and this company. Shares don't just go from the $50s to less than $2 for no reason.
Revenue growth would be nice:
Dendreon's Provenge was expected to be a blockbuster drug, but revenues have continued to fall short of expectations. When the company reported Q1 results, management seemed to celebrate 1.75% revenue growth over the prior year period. Management noted that this was the first quarter since the introduction of competition that revenues grew on a year-over-year basis. Johnson & Johnson's (NYSE:JNJ) Zytiga and Medivation's (NASDAQ:MDVN) Xtandi (which is co-marketed and co-manufactured by Astellas), are providing a tough challenge to Dendreon's Provenge. While Dendreon seemed positive about this growth, the Q1 revenue number missed analyst estimates, and those estimates had been cut by a few million after the last quarterly report.
So Q2 will be an interesting quarter for Dendreon. The company expects a sequential rise in revenues from Q1, just like what happened in 2013. Right now, analyst estimates are for just under $73 million, which would actually be a 0.5% decline compared to Q2 in 2013. Even if Dendreon were to come in at say $75 million, you'd be looking at around 2.3% growth. That's miniscule, especially when analysts are looking for Medivation to see more than 70% revenue growth in its quarter. Medivation's total revenues are expected to be a lot more than Dendreon's total in 2014, and obviously, Johnson and Johnson's is an industry giant.
Dendreon needs revenues to pick up, and I'm not just talking about Provenge getting into Europe later this year. US revenues need to improve as well. Analysts are barely calling for any sequential rise in Q3 revenues, and just 3.3% growth for all of 2014. Competition is a huge issue for Dendreon, and Medivation and Johnson & Johnson continue to do well. In 2015, analysts are looking for 16.5% revenue growth for Dendreon. However, the current 2015 estimate doesn't show too much improvement from Dendreon's total reported revenues in 2011 or 2012. Europe might provide a boost, but Dendreon needs to get US revenues going as well.
Automation sooner rather than later:
The second part of Dendreon's expansion into Europe involves automation, which is expected to significantly reduce the company's cost of goods sold. The company believes that it can get the cost of goods sold down into the 30-40% (of revenues) range once automation is fully implemented. Dendreon did note on the call that these efforts could take several years. In the first quarter of 2014, the cost of goods sold was about 53.25% of revenues. That was, however, down from 64.17% in the prior year period.
Automation is key to helping Dendreon move towards profitability and positive cash flow. Obviously, the timing of automation is critical to Dendreon's success. If Dendreon gets automation in the US during 2014, for example, it would be a lot better than in 2015 or even 2016. As I detailed above, the second part of Dendreon's European expansion depends on automation. The first part includes Provenge being available through centers of excellence beginning with Germany and the UK.
A buyer or refinancing:
This is the biggest issue Dendreon has to deal with at the moment. The company has over $600 million coming due in January 2016. In about a week, the maturity date of those 2016 notes will be just 18 months away. Unless something changes in an extremely substantial way before then, the current business situation will not allow for Dendreon to simply pay back these notes with cash. With conversion prices being well above where shares are currently, it is unlikely that bond holders would convert to equity.
Most Dendreon longs are hoping for a buyout before then. I will not speculate on any takeover price because that price would depend on the buyer. There are too many factors in play, depending on the buyer, to determine what Dendreon is actually worth. Looking at the balance sheet, Dendreon's equity is worth a negative amount currently. If you read any comment boards or message boards on Dendreon, you'll hear people throw out values like $5, $10, $20, etc. A lot of times, these numbers are just thrown out there, and most of these "valuations" are not based on any actual facts. Dendreon is a highly debated name, and there are tons of people who like to speculate on things, both on the long side and short.
If a buyout does not occur, perhaps Dendreon could refinance its debt in 2016. To do this, the company needs to show revenue improvement, and not just a small bump from Provenge entering Europe. Costs also need to come down further, and the company needs to map out a trajectory to profitability, positive cash flow, or both. Given Dendreon's financial situation, if the debt is refinanced to purely interest rate debt, you can figure the rate will be a bit high. Dendreon isn't going to get the rates that many large firms can. Most likely, any new debt would probably be some sort of convertible debt, where bondholders could convert at a given price. Remember though, over $600 million is due in 2016, and Dendreon's market cap is just $355 million currently.
Dendreon still has a chance to survive, with the next year and a half determining this company's fate. The company will be getting a new CEO, and it would help if this person is a little more transparent, especially on key issues. Dendreon needs revenue growth to improve, and not just due to the European launch. Automation is also needed to cut the cost of goods sold, which will help move the company towards profitability and positive cash flow.
Today, I examined these key issues regarding Dendreon. The company needs to overcome these key issues to survive the major debt payment due in January 2016. Investors that believe Dendreon can solve these issues might want to take a risk on this highly speculative stock. Just realize that given the company's recent history, there are reasons to be extremely doubtful.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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