Volatile biotech Dendreon (DNDN) has been a painful lesson for some investors that there's a big difference between good technology and a good stock. The company deserves, and gets, plenty of credit for developing the first-ever cancer vaccine, but serious questions about efficacy, cost-benefit, competition and intrinsic profitability have lingered from the moment of approval Now that repeated sales disappoints have knocked the stock down significantly over the past year, the stock may at last be priced with more rational expectations in mind.
On Target, But The Trend Is Not Friendly
Dendreon did meet expectations with first quarter sales of $82 million - more than 6% sequential growth from the fourth quarter. The company also added a significant number of infusion sites and new accounts to the mix, growing the latter metric by about 17% and bringing the total to 572.
Unfortunately these numbers point to some pretty unfavorable trends in same-account sales. The company has gone a long way towards resolving reimbursement worries, but per-account sales have dropped about one-third from the second quarter of 2011 and 15% from the fourth quarter. Some of this can certainly be tied to the fact that new accounts are not going to go from "zero to 60" right away, but there does not seem to be much of a usage surge in more experienced accounts either.
Making matters worse, Dendreon management's guidance for the second quarter seems to be leading most analysts to lower their numbers yet again. This is increasingly establishing Dendreon as a quarter-to-quarter story, and that brings a miserable level of volatility for investors who want to be long-term holders.
New Drugs Are The Known Unknown
The bear argument on Dendreon hasn't changed all that much over the past few quarters. The skeptics hold that the drug is too expensive ($93,000), not efficacious enough, too different from what oncologists are used to, and too expensive for the company to produce. Last, and by no means least, a lot of the bears expect rival drugs from Johnson & Johnson (JNJ) and Medivation (MDVN) to take away whatever momentum Provenge has by virtue of better economics and a more familiar administration profile.
There has definitely been some concerning progress with J&J's Zytiga. A trial of Zytiga in chemo-naive patients was stopped early for positive efficacy, and this is a clear threat to Provenge (which is presently labeled for asymptomatic or mildly symptomatic patients). Moreover, Zytiga is an oral pill with a relatively clean safety profile (by the standards of chemo drugs) and it costs about $5,000 a month. With a median treatment time of 8 months, the economics don't favor Provenge, though the survival data numbers on the Zytiga chemo-naive study have not been presented yet.
Making matters worse from a perception standpoint, some analysts have come out recently expressing skepticism that Exelixis (EXEL) will be able to easily enroll its pivotal study of cabozantinib (cabo). The idea here is that doctors will not want to randomize patients into a study when there are promising new drugs (Zytiga and MDV3100) available instead - suggesting that the challenge of marketing Provenge is only going to get harder.
The Post-Reality Check Dendreon
I don't subscribe to all of the bearish worst-case scenarios. I think Provenge is efficacious enough to be a significant and successful drug, and I do think there will be patient types that are better candidates for Provenge than Zytiga or MDV3100. All in all, I believe Provenge can gain and hold about 25% to 30% of its target market over the next five years.
What I'm not so sure about is the company's ability to drive a highly profitable business from these sales. The company's relatively new CEO John Johnson has the relevant qualifications (leading ImClone and Lilly's (LLY) oncology unit before joining Savient (SVNT) for a year), but I worry about the margins of Provenge production and question whether the competitive impact of Zytiga and MDV3100 (and perhaps Exelixis' cabo or other drugs at some point) is going to stretch out the cash flow breakeven point to an extent where dilution starts chewing up the benefits.
The Bottom Line
I don't want to completely ignore Dendreon's pipeline, but the reality is that the stock trades as though the company has nothing beyond or behind Provenge. As I said before, this has turned into a quarter-to-quarter sales momentum story.
If Dendreon can get a quarter of the market by 2017, that translates into over $1 billion in revenue (which is well below the $2 billion-plus estimates that were common just a year ago). I expect the company to produce a free cash flow margin below typical biopharmas, but still in the high teens by 2017 and moving higher thereafter.
Factoring in the dilution and a relatively generous discount rate of 10%, Dendreon would appear to be worth about $10 today - not a huge bargain at today's price, but quite a change from the price-value equation of a few quarters ago. For those bulls who believe 2017 sales could reach $2 billion with a free cash flow margin of 25%, the fair value would triple, but that strikes me as an exceptionally aggressive assumption today.