Is Dendreon a $360 Stock - Or Is That Too Low?

| About: Dendreon Corporation (DNDN)

Since Dendreon's (NASDAQ:DNDN) conference call on April 13 to announce that the Provenge Phase III IMPACT clinical trial easily met its primary endpoint of a 22% reduction in deaths versus the placebo group, there have been numerous posts, articles and message board flames on both sides about what happens next. Not one of the seven analysts who published a rating on Dendreon's stock recommended buying it ahead of the release of the positive results, and not one has raised their rating to buy since the conference call.

That's remarkable, not just because this is the first cancer vaccine that will be approved by the FDA, but because Provenge works the way an effective cancer drug should work with no significant side effects. Just in the small group for which it was approved, it is likely to be a $1.5 billion drug in the U.S. alone, as I will show in the model below.

My valuation model explained below shows $1.5 billion dollars in Provenge revenue should equate to about $30 a share for DNDN stock today. Considering the potential for immediate off-label use in earlier stages of prostate cancer, I think there is another $1.5 billion in revenues in the U.S. alone. If the day comes that a doctor says: “Well, would you rather be castrated or try Provenge,” which would you choose? And for all those men currently dealing with prostate cancer by “watchful waiting,” how many might be interested in boosting their immune system to fight the illness? It's not hard to see how the U.S. market for Provenge in prostate cancer, on- and off-label, will hit $3 billion. That gets DNDN's current value up to $60.

In the next several months, probably sooner than later, Dendreon will sign a marketing agreement for European and possibly Japanese sales of Provenge. The rest-of-world market for most drugs is roughly equal to the U.S. market, so that adds another $3 billion in Provenge sales. One can argue that Dendreon will have to share the benefit of these sales, which is true, but one also can argue that they will avoid all the costs, which also is true. Until we know for sure what the royalty rate is, or whether this will be a joint venture with Dendreon providing amplified cells to a marketing partner, it is not possible to be more precise. On balance, until we get more information I am going to assume that a dollar of overseas Provenge sales is, one way or another, as good as a dollar of domestic sales, so this additional $3 billion in Provenge sales gets DNDN up to $120 in a couple of years if the U.S. data are acceptable for approval overseas.

Two years ago, when the FDA overruled the Biologics Advisory Committee and declined to approve Provenge, the company stopped early stage trials of the exact same technology platform in breast cancer and head & neck cancer. With the cash coming in from the forthcoming marketing partnership, those trials can be restarted. On the recent conference call, management said:

As you know, Provenge employs our novel proprietary Antigen Delivery Cassette technology that may be leveraged to develop similar products to treat breast, colon, bladder, kidney, and multiple other types of cancer. The IMPACT results renew and validate our confidence in this platform technology and our ability to extend its benefits across other cancer types. We will be evaluating a more comprehensive development plan to expand our cancer immunotherapy product pipeline.

Breast cancer can be a label expansion study, which may require a Phase II study with several dosage arms and a two-year Phase III survival study in the sickest patients, plus another year for FDA approval. The breast cancer market alone is at least as large as prostate cancer, so counting eventual approval and use on- and off-label in the U.S. and the rest of the world, that's another $6 billion in revenues. That gets DNDN up to $240 a share in about five years.

At the same time, given the financial resources likely to be available to the company without any shareholder dilution, other label expansion studies for “colon, bladder, kidney, and multiple other types of cancer” can be underway during the same five years. The markets for all of these put together are at least as large as for breast cancer or prostate cancer, so that's another $6 billion in revenues worldwide and another $120 a share on DNDN stock, getting it up to $360 a share in seven or eight years.

But that's not all. Dendreon had to do their Provenge trials in the sickest patients for ethical reasons. They can now move back the disease progression chain, creating earlier-stage prostate cancer trials for men who might not want to be castrated, or undergo procedures that will leave them impotent and incontinent for the rest of their lives. The main reason to expect these trials to succeed is this:

Provenge is the right way to treat cancer.

Cancer is an indication of underlying immune system weakness, just as a fever is an indication of an underlying infection. Treating only the tumor is like treating only the fever; it does not resolve the underlying problem. No less an authority than the American Cancer Society said as far back as 1975 that people with strong immune systems do not get cancer. That is because everyone has cancerous cells circulating in their body at all times, and one function of the immune system is to find them, kill them, and escort the dead cell out of the body. Our primary current methods of treating cancer are surgery, which always releases some escaping cells into the body, and chemotherapy and radiation, both of which substantially depress the immune system. Chemotherapy may kill 99% of a tumor, but the 1% it does not kill are the cancer cells that were drug-resistant. So if the cancer returns, it will be in the form of drug-resistant cells. That is why current cancer protocols have an abysmal record of curing recurrent cancer.

Provenge, on the other hand, takes a patient's specific prostate cancer cells, attached an antigen to “teach” the immune system what a bad cell looks like, and reinfuses the altered cells. The resulting very strong immune response triggered by the antigen naturally causes flu-like symptoms – headache, fever, chills – that are typical of the immune system at work. Those are the limited side effects of Provenge, a remarkably safe profile.

Remaining Issues

Why have the seven analysts on the sidelines not made Dendreon an aggressive buy? Some investors think at least some of the analysts are in bed with the shortsellers, but I think by their comments they simply don't understand the approval process from here.

At least one analyst said he wants to wait for the April 28 data presentation at the annual meeting of the American Urological Association before he believes it. Recall that there is only one data point under the Special Protocol Assessment for the IMPACT trial: Did Provenge reduce the number of deaths by 22% compared to the placebo? In the press release announcing the results, management said:

The magnitude of the survival difference observed in the intent to treat population resulted in the study successfully achieving the pre-specified level of statistical significance defined by the study's design.

On the conference call they said: “The results are unambiguous in nature. It was a clear hit on a pre-specified primary endpoint of overall survival.”

It seems unlikely to me that the data presentation on April 28 will show Provenge did not meet the 22% goal – their next call would be from the SEC. In light of words like”unambiguous” and “clear hit,” one wonders exactly what additional data this analyst needs to see. I believe the results could be stunning, on the order of a 25% to 28% reduction in deaths. Remember that in the trials presented to the FDA in 2007, 34% of the men who received Provenge were still alive after three years. That compared with only 11% of those in the placebo arm – the highest survival benefit ever seen in a trial for hormone-refractory prostate cancer patients. Doctor Paul Schellhammer, Program Director of the Virginia Prostate Center and Professor of Urology at Eastern Virginia Medical School, will give us the number during the Late-Breaking Science Forum at the April 28 AUA meeting, around 2:20 PM CDT.

I have also seen comments that the current valuation of Dendreon is ridiculous, because who knows if the FDA is going to approve the drug? Wrong. This trial was done under a Special Protocol Assessment – you hit your numbers, you get approval. There will not be another Advisory Committee meeting. There will be no interference, lobbying or letter-writing campaigns this time from the Oncology Division of the FDA.

It is true that in 1996 Dendreon management decided to advance Provenge through the Biologics Division of the FDA, so they went to the Biologics Advisory Committee for approval and got it. The Oncology Division is run by a long-time, rigid bureaucrat who believes Dendreon is going around him, and if he lets Provenge be approved, other cancer-treating biologics will go through the Biologics Division instead of the Oncology Division. It is all about bureaucratic turf wars. He was the one who sabotaged FDA approval in May, 2007, even after the Advisory Committee recommended approval. Even the last head of the FDA, himself a prostate cancer survivor, could not overpower this guy. Provenge has very minor side effects, but because the FDA turned the drug down, many men died needlessly in the last two years. Someone will write a book someday about this shameful blot on the FDA's reputation. It's disgusting, but many years ago the head of Genentech (Private:DNA) told me: “This business is not about developing effective drugs, it is about getting drugs through the FDA.”

One of the key factors in Dendreon's favor that the negative and neutral analysts have not understood is that the company is organized to get their drug through the FDA. For the 1997 filing, they contracted with several ex-FDA reviewers to hammer on the data, the presentation, and anything else they could find that might bother the FDA. This time, they are taking until the fourth quarter to get the data polished up for their Type 2 resubmission. (Not a new BLA or Biologics License application – another error I've seen recently by the negative commentators. Dendreon filed their BLA in late 1996.)

In response to one analyst's disappointment on the conference call that they would not file sooner, management said:

This is a study that enrolled 500 men with metastatic advanced prostate cancer. It’s been going on now for almost six years. So there’s a tremendous amount of data for us to compile and include in this application. One of important things to remember about IMPACT, this is a landmark study, not just because it’s the first cancer immunotherapy to show a survival benefit. This is probably the longest follow-up that we’ve ever seen in a randomized Phase 3 clinical trial of men with advanced prostate cancer. So it’s very meaningful in terms of how this disease population behaves. It’s very important that we put together a high-quality amendment to the FDA, and we’re committed to doing that by the fourth quarter of this year.

Modeling Dendreon

A tip of the hat to Adam Feuerstein of, who first published his Dendreon model over two years ago. I have modified it here, updating the underlying numbers on prostate cancer and raising the likely price for Provenge based on Dendreon management's comments on the conference call.

The first row shows the new cases of prostate cancer each year, starting with American Cancer Society current statistics and increasing that by 1.5% per year to account for the aging baby boomers. I also could have modeled this using annual deaths from prostate cancer and assuming a much higher penetration rate and faster ramp for Provenge, but the numbers come out only a little lower.

So the first row shows the incidence of prostate cancer. But prostate cancer is a multiyear illness, and the prevalence of a disease is the total number of patients at any one time. Obviously, the prevalence numbers for prostate cancer are much higher than these incidence numbers, so this is a very conservative estimate of the potential market for Provenge.

The second row shows the percentage of patients that have hormone-refractory, metastatic cancer, which is what Provenge will be approved for. “Hormone-refractory” means hormone treatments are no longer controlling it, and “metastatic” means it has spread beyond the prostate. About 35% of prostate cancer patients have hormone-refractory, metastatic cancer, so that is row two. Row three is simply row two times 35%.

Row four is an estimate the percentage of patients willing to try Provenge. About 65% of all these patients today are willing to try chemotherapy, the dreaded Taxotere that has numerous nasty side effects. The other 35% chose not to move on. I estimate that most of those will gladly try Provenge, and around half of those who go on to Taxotere today will be willing to give Provenge a try first. Again, I think those are very conservative estimates, considering the relatively small benefit and miserable side effects of Taxotere. But I have assumed that at least 65% of these patents would try Provenge rather than do nothing or take Taxotere.

So row five is row three times 65%. Row six is the percentage of Provenge penetration. About 50% of the patients were treated by urologists and about 50% by oncologists. Dendreon management says a sales force of 100 will cover the market, but it takes time to build and train a sales force, have them make calls, get the doctors' attention and make sales. Of course, the whole prostate cancer community has been watching this drama, and my initial penetration estimates could be low. I have assumed Provenge gets FDA approval in mid-2010, although I actually think Dendreon will file the Type 2 resubmittal in October and get approval in April 2010. So the penetration rate in 2010 is only 5%, rising to 10% in 2011. I maxed it out at 60% in the fifth year, although many mature drugs are closer to 80%. Again, I am trying to make a conservative estimate for this patient population.

Row seven is the penetration rate times the possible number who would choose Provenge. Row eight is my estimate of the cost of Provenge treatment, three infusions over six weeks. Leading cancer treatments today cost around $50,000 and are fully reimbursed by Medicare and the HMOs and other payers. Management said they would price Provenge in line with other cancer treatments. I gave that a 10% or $5,000 haircut to come up with $45,000.

Row nine is my year-by-year forecast for Provenge sales in the U.S. only, on-label only. As you can see, the drug soars past $1.0 billion in 2014 and hits $1.5 billion the next year, five years after introduction.

So what's the stock worth?

A simple discounted revenue valuation model starts with Provenge sales of $1.5 billion in 2015. Apply an 80% risk adjustment and discount back five years to a net present value of $500 million today. Apply a typical revenue multiple of 6X and the enterprise value of Provenge today is about $3.0 billion. There are 98 million shares outstanding today, so $3.0 billion divided by 98 million shares is a little over $30 per share for every $1.5 billion in Provenge (or other) revenue in 2015.

When to Sell?

Certainly not before the April 28 meeting, which is likely to bump the stock to my $30 present value. After that will come the European marketing deal, a possible Japan/Asia deal, the filing of the Type 2 resubmission, and then approval next year. At, we are looking at a strategy of swapping DNDN in May for a stock that will get approval for a revolutionary medical device this summer, then swap that for another biotech company with a Dendreon-like clinical win coming this fall in one of the biggest drug markets ever, and the swapping that back into Dendreon before the Type 2 resubmission. Seeking Alpha readers are welcome to look at my April 16 Radar Report by using the user name SEEKING and the password ALPHA, both all caps and good through April 29.

Considering the recession-impacted alternatives, biotech looks like a great sector to be in the right stocks for the rest of the year. One DNDN bear said that it's very inexpensive to bet against the long-term success of Provenge right now by buying out of the money puts. He's right - betting against the long-term success of Provenge is very inexpensive, because it is very stupid.

Disclosure: Long DNDN and DNDN call options

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