When a new drug backed by impressive clinical data hits the market, investors quickly size up its market potential. And when this drug receives a thumbs-up from Medicare and other insurance-reimbursement firms, projections of billion-dollar sales start to percolate. But in many instances, the new wonder drug can barely stand up to such high expectations, so those lofty sales targets slowly vanish from analysts' models. And investors, some of whom end up losing lots of money as a result, hope to never hear about the stock again.
This sums up the sudden rise and fall of Dendreon (Nasdaq: DNDN), which has developed an effective treatment for prostate cancer. Aggressive spending on new manufacturing facilities have begun to pummel the company's financial statements and, to make matters worse, doctors have been slow to prescribe the once-and-future promising drug, Provenge. Needless to say, the stock was badly hit, as you can see in the chart below:
Judging by second-quarter sales data, Provenge looked like it would be an absolute dud. Dendreon reported just $50 million in sales of the drug, noting that doctors were slow to prescribe it. For many physicians, the need to lay out money in advance and then wait reimbursement for this expensive drug was simply too much hassle (Total cost for a full course of treatment with Provenge, (three doses) is roughly $93,000). Things improved only slightly in the third quarter, when sales reached $64 million. Earlier in the year, analysts had been assuming quarterly sales would exceed $100 million by now.
Shares hit an all-time low of $6.46 on Nov. 4 and have barely budged since. That's a far cry from the $55 high hit back in May 2010, and further below the lofty $100 price targets many once anticipated for Dendreon. Well, those days are gone. Dendreon may never even revisit the more recent high of $40 seen this past summer. But with much lowered expectations in place, shares -- now under $8 -- may find fresh appeal, so a move up to $15 or $20 isn't out of the question.
As it turns out, Provenge still has tangible growth prospects. Despite a lousy launch, sales will likely exceed $200 million this year and could hit $300 to $400 million in 2012. Analysts' forecasts are all over the map, highlighting the hard-to-read ramp for this new drug. Here's why...
Even at $400 million in revenue, Dendreon would still lose money. This is the downside of a strategy that has yielded way too much manufacturing capacity. The key to reaching break-even -- and eventually profitability -- is international sales that augment the rising U.S. sales base. But this is not likely to happen before 2013, when Provenge completes the European regulatory approval process. From there, sales are expected to rise quickly. Think Equity's Marko Kozul sees U.S. sales of $440 million and European sales of $250 million for 2013. Layer in 20% more growth in 2014 and 2015, and he thinks total sales could hit $1 billion. At these sales levels, Kozul expects operating income to hit $250 million.
If Kozul is right, then Dendreon's current $1.3 billion market value starts to look like a bargain. That's why he sees shares rebounding to $21, placing him at the high end of Wall Street's forecasted price targets (and 180% above the stock's current price).
Will Dendreon's balance sheet hold out until then? To rebuild cash levels, the company announced plans in early December to sell royalty interests in another drug, Victrelis, for $125 million. This leaves Dendreon with a projected $600 million cash balance for the quarter that ends in a few weeks.
Yet it's the income statement that will be in focus. An ample amount of manufacturing capacity has left Dendreon with too much unamortized overhead, which translated to paltry 14.5% gross margins in the most recent quarter. When annual sales reach $500 million, a run rate that may be met by the end of next year, gross margins should reach 50%, according to analysts. So at some point in 2013, assuming European regulatory approval, Dendreon should finally have the quarterly sales volume to finally start generating cash. It may go down to the wire, but Dendreon should have enough money to last until profits arrive.
Even if Dendreon is able to post real sales traction for Provenge and generate the eventual cash flow that the most bullish analysts expect, we may still be a few quarters away from a change in sentiment. Many doctors are planning on using Provenge with just a few patients so they can see the drug's efficacy for themselves before exposing it to more patients. "While we continue to see Provenge as having the potential to be a $1 billion plus drug, we do not see an inflection point for sales acceleration until mid-2012 at the earliest," Goldman Sachs' analysts say.
Here's the tricky part: if investors wait until then to see more positive sales trends, then they may miss a quick early move in the stock. Goldman Sachs suggests that shares only have upside to $11 until this potential inflection point. Still, that's nearly 50% upside (with perhaps another 100% upside after that if Think Equity's Kozul is correct).
Risks to Consider: Weak fourth-quarter sales results would lead shares down to fresh lows as projected cash burn rates accelerate. Yet sales should at least meet forecasts as management guidance implied a sequential flattening in fourth-quarter sales, even though prior data show a steady ramp as more physicians get up to speed. Other prostate-cancer treatments, including Johnson & Johnson's (NYSE: JNJ) Zytiga, are also being studied by doctors and could win "mindshare" over Provenge.
Action to Take --> In the biotech community, this is a well-known and well-understood stock. So the company doesn't need to spend an extended period getting on investors' radars, unlike many other anonymous biotechs. This is a stock for further research, as fourth-quarter results are unlikely to deliver stunning upside. But if results show a continuation of improving sales trends, then it may pay to get into this name before the broader investment community warms up to the stock again in 2012.