3 Paths For Dendreon As Provenge Plods Toward Profits

| About: Dendreon Corporation (DNDN)

Dendreon Corporation (NASDAQ:DNDN) recently reported fourth quarter revenue of $82 million, a sequential increase of 25%, and full-year revenue of $228 million. This compares extremely favorably to 2010 revenues of $48 million. However, $228 million is a huge disappointment to earlier (mid 2011) company estimates of $350-400 million for the year, which included as much as $200 million for the fourth quarter alone.

Provenge, Dendreon's prostate cancer therapy, could propel the company's stock to new heights. Then again, disappointing sales could sink the company altogether. By considering the extreme scenarios of what could befall Dendreon, we can define the borders of Dendreon's more likely, middle ground fate as attractive only to investors with a strong stomach for risk.

Scenario 1: Bankruptcy

This may sound extreme - how could a company with such a fantastic product and quickly growing sales go bankrupt? Dendreon, priced for perfection last summer, fell more than two-thirds in August after the company failed to meet sales figures and withdrew from issuing guidance. Although sales are growing, Dendreon still loses money every quarter. In the 3rd quarter of 2011 (the most recent quarter for which results are available), Dendreon's net loss was $147 million. This loss was larger than Q3 2010's $79 million, due to higher expenses in research & development, selling, general and administrative, interest expense, and well as "restructuring and contract termination" costs of $38.5 million due to its layoff of 500 employees in September 2011.

However, even considering Dendreon's larger sales force and other expansions, the higher net loss is disconcerting. For the first 9 months of 2011, the net loss was $376 million, 8% larger than 2010's $348 million. And don't look for a high-margin Provenge to come to the rescue - Provenge had just 14.5% gross margins in the most recent quarter, down sequentially from 42%, down from 38.5% a year ago, and down 26.8% for the first three quarters of 2011.

Dendreon can't continue indefinitely with quarterly losses in excess of $100 million. Dendreon has $523 million in cash and short-term investments, with total assets of $949 million. Total current liabilities are $582 million, but $503 million of that is in convertible notes not due until 2016. And Dendreon sold its royalty interest in Victrelis, a hepatitis C treatment, to Merck (NYSE:MRK) in December for $125 million. So Dendreon has current assets of ~$638 million before any 4th quarter losses. Neglecting non-recurring items, Dendreon's cash losses over the last 3 quarters have been $98 million, $105 million, and $98 million (information from Dendreon quarterly reports under "net cash used in operating activities"). Without any increases in revenue or raising cash in debt or equity markets, Dendreon would run out of cash in less than 2 years.

But of course Dendreon is increasing revenue, and we know that 4th quarter revenue was $82 million, a 25% increase over the previous quarter. Assuming Dendreon maintains ~15% gross margins and 25% quarterly revenue growth, Dendreon would run out of cash in the fourth quarter of 2013. If we assume that last quarter's margins were abnormal, as I suspect they are, and instead use the 9-month average gross margin figure of 27%, then Dendreon will turn profitable as long as its growth rate exceeds 15% quarterly. But 15% quarterly growth is equivalent to 75% annual growth: a growth rate achieved by very few companies. Assuming average margins and a growth rate less than 75% annually, Dendreon will run out of cash and be forced to go to debt or equity markets to raise more.

Scenario 2: The Sky's the Limit

Now for a sunnier outlook: Dendreon's best conceivable case. Assume the recent growth rate of 25% quarterly continues until we hit a revenue maximum of, say, $4 billion annually in 2014. Assume gross margins will match that of Dendreon's best quarter to date, and in fact actually exceeds it - we'll use 45% for this. At peak revenues, profits will be perhaps $1.3 billion annually, and it's entirely possible that investors will place an oddly high multiple on peak earnings. Twenty times earnings of $1.3 billion suggests a peak valuation of $26 billion.

With a current market capitalization of about $2 billion, this would increase the value of your investment 13-fold in a mere 2-3 years. Further growth opportunities exist in expanding the indications for which Provenge is approved to earlier stages of prostate cancer. In fact, there is an excellent argument to be made that Provenge is likely to be more effective the earlier treatment is started, while the immune system is stronger and the cancer weaker. And in the several years before peak sales and the beginning of patent expiration, Dendreon has time to develop other products, such as DN24-02, another active cellular immunotherapy candidate designed to treat bladder, breast, and ovarian tumors.

Scenario 3: Prudent Forecasting

Both scenarios above are possible, and are useful for investors to consider the extreme outcomes of an investment. But neither is particularly likely. In the first case, Provenge is simply too good a treatment for prostate cancer for Dendreon to fail so spectacularly. Dendreon may be forced to sell itself in order to survive, or issue dilutive equity, or take out additional debt. But when Provenge was approved it had the best survival benefit of any treatment ever approved for prostate cancer.

Other Seeking Alpha contributors argue strongly that the published survival benefits are understated because of the design of the clinical trial: Two-thirds of the control group received a frozen version of Provenge after the study was unblinded. Then again, the original goal of the study was to measure the time to disease progression, and on that measure Provenge showed no effect. Provenge also showed no statistically significant effect on prostate-specific antigen levels, which is one of the main measures of the efficacy of other prostate cancer treatments.

In the second case, 25% quarterly revenue increases is almost ridiculously optimistic and certainly unsustainable. A maximum of $4 billion on annual revenue implies either complete dominance - as in 100% of the patients for whom the treatment is indicated - or wild success overseas, and Dendreon has shown neither the ability to dominate the market nor the experience to roll out products abroad. Even the multiple of 20 times peak earnings - for a company that is not growing earnings - seems overstated by a factor of 2.

To come up with a fair, prudent, middle of the road scenario, let's suppose sales double from 2011 to 2012 then increase 50% annually for the next 4 years. That means fiscal 2016 would have $2.2 billion in sales, which seems to me a reasonable peak sales figure. Assuming 40% gross margins and similar SG&A and R&D expenses, earnings in fiscal 2016 would likely be around $400 million.

A price to sales ratio of 3 would give a market cap of $6.6 billion, and a P/E of 15 would give a market cap of $6 billion. Unfortunately, Dendreon's own 10-K says that the patents on Provenge expire between 2014 and 2018 domestically, and between 2015 and 2019 in some foreign countries. So Dendreon is likely to enjoy peak sales and earnings for only a few years before Provenge opens for generic competition. Now, Provenge is such an innovative treatment that generic version may take longer than usual to be released, but I don't think investors can count on that outcome.

A prudent market cap for Dendreon in 2016 that still allows for some upside is therefore $6-7 billion or $40-48 per share. That's a tripling of the stock price from here, and a return to the highs the stock saw last year. At that point, future positives for an increase in the stock value include foreign expansion, FDA approval for new indications for Provenge, and new products currently in Dendreon's pipeline. Potential investment hazards include competition due to other recently approved treatments for prostate cancer, continued rollout problems with Provenge, and generic competition.


If you're an investor now, you certainly don't think the first scenario of bankruptcy is reasonable, and you likely think Dendreon's future is somewhere between scenarios 2 and 3. In that case, you're anticipating somewhere between a tripling and 13-fold return on your investment, and you merely have to wait and endure volatility and potential management missteps on your way to profits. If you're a short-seller now, you think scenario 1 is the most likely, but you're exposing yourself to huge risk that Dendreon takes off.

If you're not currently long or short Dendreon, then I applaud your patience reading to this point. Dendreon stock has the potential for outsize gains, and the slip by management last year now has the stock trading at sale prices compared to last year. You must consider the likelihood of Dendreon overcoming the challenges it faces. Only you can determine whether your risk tolerance is sufficient for this investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.