When I was in high school I played the trombone in the marching band. I could never stay in step, but my mother always encouraged me when she said that everyone was out of step except me. I feel the same way now as I am positive on the outlook for Dendreon (NASDAQ:DNDN) at a time when the prevailing investment view is neutral or negative. I am not happy about being out of step with the Wall Street marching band, but my analysis suggests that I may be the one in step. Let me explain why.
Some Investment Perspective: The Last Year Has Been a Rough Ride
Over a long period of time, the value of a stock will be largely determined by its current sales in combination with projections for future growth. Biotechnology firms are so early in their development that the projection for sales and earnings drives most of their value. Unfortunately, sales projections are highly uncertain whether they come from management or analysts. Consensus projections can fluctuate wildly in short periods of time. I'll have more to say about this shortly.
No matter what anyone tells me, I think that the most important factor for stock price performance on a particular day is usually what happened on the previous day(s). Stock trends tend to build on themselves. Rising stock prices lead to optimism and optimism begets more optimism while pessimism begets pessimism Apple's (NASDAQ:AAPL) consistent day after day price gains in my mind are an example of optimism perpetuating itself. In contrast, the price fluctuations (primarily downward) of Dendreon over the past year have helped to create a dark cloud of pessimism around the stock. Let me illustrate how declining sales expectations and stock price volatility have created this dark cloud.
Dendreon had issued guidance at the beginning of 2011 that Provenge sales would reach $350 to $400 million in 2011 and based on that guidance, the stock traded in the $30 to $40 range up until August 4, when management withdrew this guidance. The stock closed at $35.84 on August 3 and plummeted 67% to a close of $11.69 on August 4. From there it drifted lower reaching $7.17 at the close on December 13. During this time most major Wall Street analysts sliced sales projections for Provenge and slashed ratings. I think that fully 90% of the major Street analysts following the stock switched to neutral or recommended sale.
On January 5, 2012 Dendreon pre-announced that full year net sales for 2011 had come in at $213.5 million versus $48.0 million in 2010 and that 4Q net sales had come in at $77.0 million versus $25.0 million. The 4Q results exceeded Street expectations of about $65 to $70 million. As a result of this upside surprise, the stock which closed at $7.60 on January 4, 2012 soared 40% to a close of $10.62 on January 5. It then marched upward to close at $16.53 on February 6. Most analysts remained either neutral or upgraded from sell to neutral. Almost none upgraded to a buy; once burned, twice shy.
The company released full and detailed fourth quarter results on February 27, 2012. The stock closed that day at $11.26, down 24% from the previous day's close of $14.86. The purpose of this report is to analyze the key statements made in the fourth quarter conference call that led to that price decline and place them in perspective to the events of the past year. However, before I do that I want to talk a little bit about how the investor psychology enveloping Dendreon arose.
If you were to sit in a darkened movie theater and yell fire, it would not be long before someone else yelled fire and then another and another until soon everyone in the theater thinks that it is on fire. Even though the movie goers may be wrong (no fire), one by one all the movie goers swing to the belief that there is a fire. The starting point for creating investor consensus expectations is management guidance. If the guidance is badly wrong, the first and loudest voice in the theater is likely to be someone yelling disappointment or opinion downgrade. This is how negative consensus views can be set.
It is not the actual level of sales that is important in the short term, but the level in relation to expectations. Dendreon's guidance for Provenge sales for 2011 was set at $350 to $400 million and even though sales came in at $214 million they were deemed to be disappointing. However, judged by sales this was one of the top ten biotechnology launches in history. If management had not provided such aggressive (and wrong) guidance on sales, it would almost certainly be the case that there would be a more positive consensus opinion. Instead there is profound skepticism and pessimism.
Analysts to some extent are capable of coming up with an independent view on prospects for Provenge, but they are mostly dependent on the guidance set by management. In essence, the expectations of analysts feed off of Dendreon's guidance. The whipsawing resulting from management sales (mis)guidance shattered confidence, created skepticism and played a major role in building a consensus negative view. Moreover, analysts are human beings who are susceptible to having their view importantly shaped by the consensus. Overall, it is easier and more gratifying to be with the consensus than to go against it. The poor and volatile stock performance only reinforces the negative consensus. Most analysts would rather recommend a stock like Apple that goes up almost every day than one like Dendreon which has had unbelievable volatility.
Guidance for the First Quarter of 2012 Was Taken as Disappointing
Management stated in its conference call that fourth quarter revenues had been helped at the expense of 1Q, 1012 revenues to the tune of $2 to $3 million This forward shifting of sales was caused in part by patients wanting to complete therapy before the holidays and by others who were concerned that the deductible on their health plan might go up in 2012 relative to 2011. Management also said that there were end of the year closings of medical offices that resulted in fewer patients being seen. They stated that these factors had resulted in a slowing of bookings so that the order book entering the quarter was softer than expected. The company then went on to say that it expected first quarter Provenge results would show only modest single digit sequential sales growth relative to the fourth quarter. Many or most analysts were looking for sequential sales growth of 10% relative to the fourth quarter so this was taken as a disappointing signal of a slowing in Provenge sales growth.
Management shot themselves in the foot by providing overly exuberant guidance for 2011 and then withdrawing it. One would have thought that they learned their lesson, but they drilled themselves in the same foot when they pre-announced Provenge sales. It was stupid to do this. Why not wait until the 4Q, 2011 sales and earnings announcement when they could be put in perspective?
The news of the strong Provenge sales would have encouraged and excited investors and management could have easily explained the seasonality of Provenge to a more receptive audience. This seasonality is very common to products lie Provenge. The pre-announcement of Provenge 4Q sales without any discussion about the potential for seasonality resulted in the disappointment with the 4Q conference call.
So just how bad will the first quarter be? The indication that Provenge sales will be up in modest single digits suggests a 2% to 5% increase in first quarter sequential sales from $77.0 million in 4Q to $78.5 to $80.9 million. If indeed $2 to $3 million was shifted from 1Q, 2012 into 4Q, 2011 then 4Q, 2011 sales would have been $74 to $75 million and 1Q, 2012 sales could be $80.5 to $83.9 million.
The range of sequential sales increase would be 7% to 13% and this is pretty much in line with what Street expectations were. However, I believe that it is incorrect on the part of management to say that there was a shift of $2 to $3 million. In my opinion, there was no shift; it is just a normal seasonal pattern that will be repeated through the life of the product.
Most analysts and investors took this discussion to mean that Provenge was slowing down and was meeting a demand barrier. This might be true. None of us can see the future and only time will tell. However, the interpretation that I have just gone through is much more encouraging and optimistic that this is not the case. Two bullet holes in the same foot can be painful.
Guidance for the Year
When guidance was dropped in August of 2011, management would only say that it expected modest sequential growth for quarterly sales going forward. The strong fourth quarter sequential sales gain thus came as an upside surprise. The company continues to suggest that quarterly sales gains for 2012 beyond the first quarter will be modest. They have never defined modest.
I would think that if I were the new CEO, John Johnson, coming into the company, I would want to issue guidance that is conservative and beatable. It doesn't take a rocket scientist to figure out what not meeting expectations can do to a stock. In my view, the projection for modest sequential sales increases is kind of meaningless. Also, there is a bias for a new CEO to set the expectation bar low so that it is easy to hurdle.
What about Same Store Sales Growth?
Even the bulls on Wall Street express concern about the need for a pickup in same store sales growth to be optimistic on the stock. I agree that this is critical, but I don't know how you can calculate it at the current time. Dendreon has added a large number of accounts over the last year, but taking the total number of accounts and dividing it into Provenge revenues can be misleading.
This gives equal weight to an account added lately that is not yet producing revenues to an established account that is. What we really need to know is what a select number of established accounts are doing and even this could be misleading because history is so short even on older accounts. While I think that same store sales growth is critical to the long term success of Provenge, I just think it is too early in the launch to have a meaningful estimate.
My View: Perhaps We Should Be More Optimistic
I think that there are a number of reasons that lead me to believe that confidence in the growth potential for Provenge could increase as the year unwinds. The issuance of the J code means that physicians can reasonably expect to receive payment in 30 days or so versus a much longer period of time, perhaps 90 days or more.
The three infusions of Provenge cost about $93,000 and carrying this amount of accounts receivable discourages the broad use of Provenge. Many physicians have been treating one patient and wait until they collect outstanding accounts receivable before treating the next. The J code accelerates the payment and also increases the likelihood of getting paid. Both of these issues suggest more financial risk acceptance on the part of physicians going forward.
Dendreon and Provenge have been battered from every angle about the perception that the price is too high at $93,000 per course of therapy. I have argued in prior reports that because there are few serious side effects with Provenge that require supportive care or hospitalization and because it only needs one course of treatment as opposed to a series, the cost is not out of line with other therapies. I think that this perception of excessive price will be of less importance in 2012 as patients and physicians incorporate these facts into their assessments.
There has also been a lot of negative publicity about the median survival of Provenge being only 4.4 months. However, as I have written before patients in the placebo groups in the clinical trials were allowed to cross over to Provenge once their cancer progressed. A recent statistical analysis of these trials that tried to account for this factor suggested that the median survival could have been 7.8 months, which is extremely good for any drug in a metastatic setting, Gleevec aside. Even 4.4 months is good. As physicians and patients become better informed on this, I think that the perception of efficacy for Provenge can improve.
Some analysts are concerned that there is a paradigm shift going on for the treatment of prostatic cancer. Patients in the past have been treated by urologists until their disease became metastatic and they were passed on to oncologists. Now with Provenge and the coming introduction of Johnson & Johnson's (NYSE:JNJ) Xytiga (abiraterone) and Medivation's (NASDAQ:MDVN) MDV 3100 in the pre-chemotherapy setting, the urologist will control the patient for perhaps one to three years longer before passing the patient on to the oncologist. This leads to the concern that training the urologist to do this will be a slow and frustrating process. I disagree. With all of the pressure on physicians' incomes, I think that most urologists will view this as a great opportunity.
The other concern is that Xytiga and MDV-3100 will quickly erode Provenge when they become available in the pre-chemotherapy market setting. This argument seems to be based on the fact that they are hormonal type agents that are better understood by physicians and that they are pills. I don't buy this argument. I think that based on the data, all three drugs will be used sequentially or in combination as is common in oncology.
In my view, Provenge should be the first therapy used and then followed by Xytiga. MDV-3100 could be used with Provenge or possibly before and used before or in combination with Xytiga. This is the logical way to use these drugs to provide the greatest extension of life for metastatic prostate cancer patients. The only argument that would persuade me that this is wrong would be that Provenge is not that effective. However, the clinical data so far available tells me that Provenge is effective and may be as good as or better than Xytiga and MDV-3100.
I think that investors and analysts have been so whipsawed by the management guidance fiascoes that they have become caught up with negative psychology that has impaired their ability to give more weight to the potential for upside surprise. This creates an opportunity for anyone who chooses to march in step with me and ignore the rest of the marching band.
I could be wrong on Dendreon. I make mistakes. However, I just see a lot more positives in this situation than negatives. I have also learned over the years to go where my analysis leads me and not necessarily go along with the consensus view. It will be an interesting year.