Dendreon: Too Little, Too Late?

’s last two years of trading could be considered the stock market’s version of a slow motion train wreck. We could see some relief for the casualties as we head into Q4 2013, but Dendreon’s 1.4% drop yesterday (8/26/13) was very unsettling in the midst of a roaring biotech bull market. Dendreon’s CFO Gregory Schiffman also notified the company that he wanted to resign, which sent a troubling signal to shareholders.

Virtually all cancer-related assets have drastically increased their valuation this year. Dendreon’s Provenge, on the other hand, returned from the chopping block at roughly half its old worth.

Q1-Q3 2013 In Retrospect
In a previous note written on March 25th 2013, I mentioned the likelihood that DNDN would approach $2/share by 2016 because of its overvaluation. DNDN has dropped about 41% since. At the time the stock was just under $5/share and seemed unlikely to drop any further due to already-high short interest. The highly bearish call caused controversy, as one might expect.

Note: I also recommended a long position in Questcor Pharmaceuticals (QCOR) due to it undervaluation. QCOR is up 122% since the call

Why did it drop so much?
The declines make perfect sense in hindsight given Q1 and Q2 2013 earnings. The company is still not profitable, and doesn’t seem capable of reaching the $100 M per quarter needed to break even this year. The company may also struggle to reduce its COGS, which was still 59.7% in Q2 2013. Apparently, some of Dendreon’s expenses (like CEO Johnson’s $1.6 M salary) can’t be reduced.

Even worse are the trends in the company’s balance sheet, which imply that the company will have to dilute the stock heavily before the end of 2014 lest they run out of money. Analysts have also grown more bearish, and have probably contributed immensely to the investor panic.

Additional discussion of Dendreon’s financial data, for those interested, can be found in a recent Bill Maurer Seeking Alpha article (link)

Still, the financial distress of the company should be very obvious at this point. In recent quarters the company has addressed this with vague promises of deeper cost-cutting efforts and supposedly effective DTC (Direct-To-Consumer) advertising campaigns, although a shortage of details (and tangible results) has permanently damaged investor confidence in Dendreon’s plan.

Then there is the elephant in the room –$545.7 M of convertible 2016 notes, which were only mentioned just once in the call:

“As you know we have the majority of our convertible debt due in 2016. While we are more than two years out we have been looking at our options to address this and are putting a plan in place consistent with our objective to reach profitability…”

Note that these were sold when DNDN was trading at $36.60 per share, with a conversion rate equivalent to $51.24 per share. The company appears to have a plan to address this, and wording implies that they are going with the likely remedy – share dilution. Refinancing is an option if an appropriate party is found, but this may be quite difficult. The problem is that Dendreon’s market capitalization is no longer large enough to support a public offering of that size, which means that a proportionally huge loan would be needed.

Where’s the upside?
Countering this – to some extent – are promises of future revenue growth potential from Europe and sequencing trials using both Provenge and JNJ’s Zytiga (with plans to enroll into a Provenge/Xtandi trial soon). While these future catalysts are exciting, investors should note that they are already being used to justify Dendreon’s $829 M enterprise value. It is also debated whether or not Europe will be an option for Dendreon, since they would have to find a partner willing to bear the extraordinary startup costs for a Provenge facility and the high manufacturing expenses of the autologous cell therapy.

On the bright side, Dendreon could be an interesting acquisition target, although it seems unlikely that a bid would be made at least until the company is on the verge of bankruptcy. This theoretical bid should be a big deterrent for the bears once Dendreon drops below a certain level (perhaps the $2/share I suggested earlier this year), although their previous successes might make them hesitant to take their profits.

The Takeaway
It might be best to steer clear. Dendreon’s financials are truly abysmal, and seem unlikely to turn in the next few quarters. The company is very likely to dilute shares heavily to meet debt obligations, which could turn DNDN into a penny stock without a reverse split.

On the other hand, short interest is extremely high at ~54 M shares (about 1/3rd of shares). The short side of Dendreon is simply not as favorable as it was just a few months ago. There are also too many shares in the bear trade, which presents a dangerous short squeeze situation in the event that Dendreon has a few upticks.