Dendreon (DNDN)
Thesis
DNDN is an unprofitable, cash burning, over-levered biotech company whose only product, Provenge, has had stagnant sales in the face of stiff competition. DNDN will face a liquidity and solvency crisis in the next 20 months which will likely force it to declare bankruptcy or a massive debt restructuring. With $170M in cash outstanding at the end of the 1Q 2014, and $28M due on June 15th from the 2014 convertible notes, the continued cash burn in the underlying business will further stress DNDN’s financial position. DNDN’s biggest issue is the looming January 15, 2016 maturity of its $620MM of convertible notes. Management keeps moving the target on when it will start to address the 2016 notes. For example, Management stated in their 3Q13 earning call that they would outline steps to address the convertible notes in their 4Q13 earnings call. However, on their year-end call they punted and said that they had made significant progress in their thinking but would not be providing details in their thinking. At the 1Q14 earnings call they once again noted that their thinking had progressed, but refused to provide specifics. It is highly unlikely that any measure management takes to deal with the 2016 notes will be positive for the equity. Between now and January 2016, DNDN is likely to burn $154M, meaning that their current $170M in cash is more like $16M of cash. With the 2016 converts trading at 73 cents on the dollar they imply an enterprise value of $310M whereas the equity holders value the company at $806M. We believe that this disconnect will be resolved over the next few quarters as shareholders recognize that there is no solution to the 2016 convertible notes except a massive debt-for-equity swap or Chapter 11 bankruptcy filing.

Capital Structure

Debt
4.75% convertible sr. subordinated notes due 2014 ($28)
2.875% convertible sr. notes due 2016 ($620)
Total debt ($648)

Cash
Cash and cash equivalents $90
Short-term investments $65
Long-term investments $15
Total cash & investments $170

Net cash (net debt) ($478)

Equity
Shares 160
Current stock price $2.05
Market Cap $328

EV $806

On their 1Q14 earnings call, DNDN management noted that due to changes in the working capital, their cash burn was less than expected in the 1Q and that 2Q cash burn would be approximately the same as 1Q’s $30M.

Catalyst
Continued cash burn and realization from the street that management has no solution to pay off the 2016 convertible debt. The company restructures the 2016 converts in or out of court resulting in massive to complete dilution of the existing equity.

Company Overview
DNDN is a biotechnology company with one approved therapy on the market, Provenge, an immunotherapy for prostate cancer. Though initially approved with great promise, given the difficulty in finding patients appropriate for the label, the high upfront cost of the treatment, and the availability of much easier to administer oral agents (Xtandi, Zytiga) have limited the use of this therapy to a niche patient population.

Provenge Background
Provenge is an individualized treatment vaccine for asymptomatic or minimally symptomatic metastatic castrate resistant prostate cancer that was approved by the FDA on April 29th, 2010. Unlike other vaccines that are preventative, Provenge is effective in patients after they have prostate cancer.
The chart below demonstrates the progression of prostate cancer. The green oval area highlights the appropriate window to use Provenge. The natural course of prostate cancer makes it hard to find minimally symptomatic or asymptomatic metastatic prostate cancer patients.

Source: JNJ Presentation June 2012

The Provenge treatment involves 3 treatments, 2 weeks apart, over a month’s span. The treatment involves harvesting a patients’ own cells, sending them to a DNDN manufacturing plant where the cells are primed to attack the tumor cells, and then reinfusion into the patient.
The pricing of Provenge is $31,000 per infusion or $93,000 initially (there has been a price increase of 9% since the initial approval). Though $93,000 for a cancer treatment is actually not unheard of, there was concern over the price tag, given the need to use the drug upfront, unlike most other therapies where continued use of the drug was based on the patients responding according to some biological marker.
In clinical studies, Provenge was shown to extend the survival of patients as compared to a control (placebo) arm. In the main Provenge study for FDA approval, the median overall survival was 25.8 months vs. 21.7 months in the control arm. The Kaplan-Meier overall survival curve shown below demonstrates the % of patients alive in either arm over time. The separation between the curves demonstrates the survival benefit of Provenge over the control arm.

Source: Provenge Prescribing Information

Source: Provenge Prescribing Information
Despite the efficacy of Provenge, the high initial price tag, the uncertainty over who would benefit, and the hassle of having to schedule infusions with patients made many physicians wary of using the agents. The introduction of competitive agents such as Zytiga and Xtandi which are able to be taken orally, easier for physicians to prescribe and have very clear biological rationale has greatly restricted the uptake of Provenge. Though the agents are not necessarily directly competitive physicians have been reaching for Zytiga and Xtandi prior to Provenge, and by the time the patients have progressed they are no longer eligible for Provenge. On their 1Q14 earnings call, DNDN management noted that less than 5% of patients who receive Provenge have received Zytiga first.
Sales data shown below clearly demonstrates that Provenge has been unable to grow in the face of competition, and has actually had a drop in sales since the introduction of Xtandi.

Provenge COGS
Despite the high price of Provenge (nearly $100,000 per treatment), the COGS are very high for this product. This is due to a number of factors. The need to draw blood and to infuse the cells adds to the cost, as does the need for manufacturing plants and the personnel needed to manufacture the individualized treatments. COGS as a percentage of sales were 53% for Provenge in the 1Q14, and are expected to remain at this level for the rest of the year according to management. Though DNDN hopes to bring this down to 30% over time through automation of the manufacturing process and increases in revenues (due to the high fixed costs of the manufacturing plant), this will be many years in the future. In comparison, for a small molecule drug such as Zytiga or Xtandi, the COGS would only be 5-10%.

Cash Flow
In the 3Q13 DNDN announced their 3rd restructuring in 3 years. They announced that they expected to reduce R&D costs by 14% on an annualized basis from the current run rate in 2013. They expected a 23% reduction in SG&A from the 2013 run rate as well. This would translate into $15.5M and $47.6M in R&D and SG&A spend per quarter once the restructuring is in place. They also guided to 820 employees once the restructuring had taken full effect. At the 1Q 2014, the SG&A and R&D expenses were lower than projected from the 3Q13 restructuring comments, and their employee count was 730. Therefore we believe that expenses may actually increase quarter over quarter as they may have cut too deep, or alternatively operational performance may be compromised. However to be conservative we have kept expenses going forward similar to what they were in the 1Q14.

Under such a scenario they are able to extend their cash runway to 1Q16 when the 2016 convertible note becomes due.
Worth
We struggle to find value in the equity shares, even assuming they are able to roll over the 2016 convertible debt. Even with an acceleration in sales growth and holding costs relatively constant, it will be difficult for DNDN to generate significant cash flow. The assumption of steady growth going forward may be a stretch as well, as Xtandi has FDA decision date of September 18th, 2014 for the pre-chemotherapy setting. As this is the setting where most of the Provenge eligible patients reside, this approval may negatively affect Provenge sales.

2014 2015 2016 2017 2018 2019 2020 2021
EBITDA (60.7) (55.3) (8.4) 29.9 32.9 36.2 39.8 43.8
% growth 10% 10% 10% 10%
Tax rate 0% 0% 0% 0% 0% 0% 0% 0%
Net income (60.7) (55.3) (8.4) 29.9 32.9 36.2 39.8 43.8
Discount rate 10% 10% 10% 10% 10% 10% 10% 10%
Years 0.64 1.64 2.64 3.64 4.64 5.64 6.64 7.64
NPV ($57) ($47) ($7) $21 $21 $21 $21 $21
Terminal multiple 6x
Total NPV $100
Net Debt ($478)
Equity Value ($378)
Shares 153.62
Price/Share ($2.46)

Management and Board Changes
DNDN has had significant turnover in senior management and the board recently. Below are some of the resignations.
Director Peter Granadillo resigned on March 4, 2014. He had been on the board of directors since 2009, and was a member of the compensation committee.
On February 3rd, 2014 Christine Mikail, EVP, Corporate Development, General Counsel and Secretary gave her notice to resign from the company.
On January 20, 2014, Joseph DePinto, Executive Vice President, Commercial Operations, notified Dendreon Corporation (the “Company”) that he will be leaving the Company effective February 7, 2014.
On January 13, 2014, Mark Frohlich, Executive Vice President of Research and Development and Chief Medical Officer, notified Dendreon Corporation (the “Company”) that he will be leaving the Company effective February 1, 2014.
On August 5, 2013, Gregory T. Schiffman, Executive Vice President, Chief Financial Officer and Treasurer, notified Dendreon Corporation (the “Company”) that he would be leaving the Company effective as of December 31, 2013. In connection with his departure, the Company will provide severance benefits to Mr. Schiffman pursuant to the terms of his employment agreement.

Risks
DNDN has substantial net operating loss carry forwards remaining. At the end of 2013 DNDN had $1.76B federal NOL and $541 state NOLs remaining. Would an acquirer be willing to purchase DNDN just to utilize these? While we are not tax experts, we note that DNDN has already been shopped, see the Bloomberg article from last fall in the appendix, without interest from buyers. We believe that the value of these NOLs is likely to be limited by Section 382 which limits the value of the NOL that can be used in any year by an acquirer to the current long-term tax-exempt rate multiplied by the stock value of the acquisition. Thus even at a $4 per share acquisition or $614M in equity value, only $614 * 3.36% = $20.6M could be utilized per year, substantially limiting the amount of benefit of the NOLs to an acquirer.
We also believe that takeover risk is relatively low due to the impending competition from the approval of Xtandi in the pre-chemotherapy setting. This will move up Xtandi earlier in the prostate cancer treatment regimen and likely make it more difficult for patients to be put on Provenge. Even though Zytiga is already approved in this setting, those patients failing Zytiga will be more likely to try Xtandi once the FDA approves the pre-chemo indication. Another competitive consideration is that JNJ purchased Aragon in June of 2013 for $650M in cash and $350M in milestones in order to gain access to a drug with the same mechanism of action as Xtandi. This drug is still in testing, but if approved, this will further limit the market for Provenge. This is also a signal that JNJ which is very active in this space, and viewed by some as a natural acquirer of DNDN, is likely not interested in such a transaction.
Furthermore, DNDN’s high debt burden and complicated manufacturing process make the company a relatively unattractive acquisition candidate.

Appendix
http://www.bloomberg.com/news/2013-10-25/provenge-drug-maker-dendreon-said-to-be-seeking-takeover-offers.html

Continued cash burn and realization from the street that management has no solution to pay off the 2016 convertible debt. The company restructures the 2016 converts in or out of court resulting in massive to complete dilution of the existing equity.