Not a Healthy Bet

 | Jan 09, 2013 | 1:00 PM EST  | Comments
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According to a filing with the Securities and Exchange Commission (SEC), Deerfield Management controls 7.9 million shares of Dendreon (DNDN), a biotechnology company. James Flynn manages Deerfield, which is a healthcare focused fund. According to our database of 13F filings, it had not owned any equity in the company at the end of September (see its top stock picks here). Dendreon's market capitalization is only about $870 million, but on average, more than 4 million shares have traded per day in the last three months. The current stock price is about $5.75. This suggests that investors have plenty of dollar volume to enter and exit any positions.

Dendreon's current products and products in development focus on treatments for a variety of cancers. The stock has declined 84% in the last two years, with a large collapse in the price coming in August 2011 when it became clear that Provenge, its lead product, would come in far short of sales expectations. Provenge is still Dendreon's primary source of revenue as sales of the drug did increase by 21% in the third quarter of 2012 compared to the same period in 2011. However, net losses have been more or less unchanged and the revenue increases have been offset by cost-of-product revenue as well as ongoing restructuring, contract and impairment charges. Some of these restructuring charges are a result of cost reduction initiatives. For example, Dendreon will be closing one of its three Provenge production facilities. In the first nine months of 2012, Dendreon lost $2.39 per share, compared to $2.58 per share at the same point a year earlier. The company has underperformed earnings expectations and so the stock is down 51% in the last year.

Dendreon currently has about $520 million in current assets, including nearly $400 million in cash, cash equivalents and short-term investments. It used about $150 million in cash in its operations in the first nine months of 2012, and has $100 million in current liabilities. So while the cash position looks fine for now, the company is in danger of having liquidity problems in another year or two if it cannot improve its cash flow situation. In addition, more than $500 million in convertible senior notes are due in 2016, so Dendreon would have to strain to pull cash out of the financial markets in order to cover its operating problems.

The stock is heavily shorted, as the most recent data show that 30% of the outstanding shares are held short. We would also note that the stock's beta is 2.9. Even though the company might not be expected to be dependent on the broader economy, its share price is very responsive to market indices.

The company expects sales growth to continue, and we can see that being the case. Our concern is that up until this point costs have generally risen. Even if this has been due to restructuring in recent quarters, it's not clear that losses will shrink much. Wall Street analysts don't anticipate that Dendreon will break into the black in 2013 (analyst expectations are for $1.34 in losses). Of course, there are the cash-flow related issues to consider as well.

It's interesting that a healthcare oriented fund is buying shares of Dendreon right now, but we would still not recommend buying the stock. The company has significant issues in terms of its profitability and cash flow. In addition, a number of investors and traders familiar with healthcare are likely taking a short position in the stock, so it might not be accurate to characterize "the smart money" as being net long. We think Dendreon is best avoided.

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