Biotech Values

[DewDiligence]

Here’s a provocative DNDN write-up in Seeking Alpha:

http://seekingalpha.com/article/185947-dendreon-to-short-or-not-to-short

›Dendreon: To Short or Not to Short?

by: Michael Shulman
February 02, 2010

I "made my bones" with a bullish and complicated call on Dendreon (DNDN) several years ago, predicting it would get a thumbs up from an FDA panel for its advanced prostate cancer treatment Provenge. Only one other biotech analyst with a public audience agreed with me - and the panel, sure enough, voted yes. The panel meeting itself was a mess and it was clear the FDA staff was going to fight like hell to make sure Provenge did not get an approval. I told my subscribers to get out - the stock had run from $4 and change to as high as $27 - and a few weeks later the FDA said no, we need more data.

Since that time, Dendreon has released data from a subsequent trial that shows it met its primary end point for the trial, giving bulls their way and driving the stock to $30 and change; it is now around $28. The company is expecting an FDA decision - and approval - on or near May 1. Analysts peg Provenge sales at around one billion by 2018. The current market cap is $3.25 billion.

Shorts would love to cream this stock. Bulls would love to see a great big spike if and when the FDA grants an approval. What is more likely? Some thoughts.

• My original bullishness was based on the need for the FDA to approve some form of cancer immunotherapy in order to launch a new technology into the marketplace, the composition and biographies of members of the panel and the location of the regulatory process - inside the biologics group at the FDA, not CDER, the hard core cancer people who are more concerned, at times, with statistics than human life. The CDER people won the first round - but there is a new and respected FDA administrator and new trial results to consider.

• The problem with the trial data submitted for the initial panel meeting was size (very small trial and structure). The company blended results to get their final data in a way not valid for FDA statisticians.

• The new trial results, from a different trial, published by Dendreon last year hit the endpoint by a seemingly healthy amount to some, and a spit to others. The question will be is this good enough and how did they construct the data to reach this endpoint? The trial was not well constructed, but it was not poorly constructed either. I am more concerned about how the company constructed the results. The FDA is very unforgiving, and they should be, with companies that obfuscate or overly manipulate data.

• Why the skepticism? Because DNDN management is outrageously aggressive and insensitive to the FDA and I am openly skeptical of how they constructed the data. And given what I know of the FDA, that agency will be even more skeptical given management's approach to the approval process. The dunderheads (that is a nicer word than moron) at DNDN are already putting out Provenge sales projections - not a smart move and something the FDA frowns on for drugs not yet approved. Roche/Genentech can get away with something similar when discussing Curis' (CRIS) new Hedgehog pathway drug because they are an understated company and they are providing dates for hitting the marketplace if approved, not sales numbers. Dendreon is not Roche and this can only serve to anger the FDA.

• Why any bullishness? The FDA really does need to approve a cancer immunotherapy, a treatment that uses the patient's immune system to attack the cancer cells and Dendreon is the best bet right now. It is clear that the treatment works very well on a subset of patients and the challenge in the future is to determine how to identify the characteristics of this subset before treatment. If I were an FDA commissioner I would send my statisticians to the back of the classroom and do everything I could to get the drug passed this spring.

• There is a political component to this approval; there were serious protests and legal action by prostate cancer victims when the FDA overturned the panel decision. This will have an impact on FDA actions.

Bottom line: 65/35 for approval.

Some other things to consider about valuation:

• Provenge is not a lifesaver - it extends life a bit more than 4 months longer in patients receiving the current standard of care. And it is going to be horribly expensive given comments by DNDN management and the cost of preparing the treatment. Provenge is not a drug; a patient has blood drawn, it is sent to a factory, the blood is treated with Provenge and the treatment is sent back to the physician and injected into the patient. It is very capital-intensive and expensive to produce. It will be a while before reimbursement is set in the US and it is very possible it will not be approved for reimbursement in most European countries.

• Unlike many new cancer drugs on the market or in trial, such as Curis' Hedgehog pathway treatments, Provenge is not easily extensible to other tumor types. Moving Provenge to another patient set - such as breast cancer - requires new research and development work and wholly new trials and those will take many years.

•Based on history, DNDN management will over-sell the potential of the drug and disappoint investors.

Does that make the stock or the options a buy?

• For a day or two or maybe a month, but longer-term the approval of Provenge and aggressive sales success are already priced into the stock. If Provenge gets approved and the stock moves like OSI (OSIP) did on the approval of Tarceva, it will settle in at five times sales. I focus on Tarceva because it is a very promising cancer treatment, is expensive and the core technology is not easily extensible. OSI now sells for five times sales - in part because of an ill-fated acquisition - but five times sales is a fair valuation for a cancer treatment company. That gives DNDN a five billion dollar market cap in 2018, a long time from now, and that translates into a $45 stock price. In 2018.

So, is DNDN a short or a buy?

• For a trader, and if the 65/35 potential for approval is correct, it is a potential winning trade for a few days - and options traders know this; premiums are high.

• For the investor, the current valuation has future success baked in, and assumes the stock migrates to five times sales and those sales are a billion in 2018. You are looking at less than 6% appreciation per year. That number speaks for itself given the risk of the FDA saying no.

• For the short seller, you can get killed - or make a killing. Take a look at puts; despite their potential of expiring worthless, they do not generate margin calls the way a traditional short position does when things go wrong.‹