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Dendreon Hits The Big Time

Posted: Apr 15, 2009 02:47 AM by Eric Fox

Tickers in this Article: ILMN, LJPC, BMRN, DNDN

Most biotech companies focus their resources on the research and development of one or two wonder drugs, which leads to a binary investment outcomes on the stocks. If the new drug works, it is approved. But if it does not work, funding dries up and the company slips into obscurity.

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Dendreon (Nasdaq:DNDN) proved this theorem correct in a huge way when its stock tripled in price after disclosing positive news on a new drug to treat prostate cancer. Dendreon reported that patients who took Provenge had a significantly higher statistical rate of survival than those who took a placebo during recently ended Phase 3 trials. The company put 512 patients through the study.

FDA Approval
The company's revenues in 2008 totaled $111,000, down from $743,000 in sales in 2007. The drug is not yet licensed for sale in the U.S., but the company stated that it would amend an agreement with the Food and Drug Administration (FDA) and asked for a license to sell Provenge in the fourth quarter of 2009. Once the request is submitted, it could take months for the company to gain approval. (Learn how to find a healthy pharmaceutical investment in a market full of weak drugs in Measuring The Medicine Makers.)

Bitter Valuation Pill
The market now values the company at $1.7 billion as of intra-day April 14. Prostate cancer affects millions of men and the market is discounting the eventual approval of Provenge and future sales of the drug. However, this valuation is ridiculously excessive.

Senior analyst for Zacks Equity Research, Grant Zeng, estimates that U.S. sales of the drug will reach $120 million and earnings per share will total 36 cents in 2010. Now that Dendreon is trading near $20 per share, its price-to-earnings ratio (P/E ratio) now approaches 56. Even with a $15 share price, the forward P/E would come in near 42.

This type of valuation is business as usual in the biotech industry, as established companies with approved drugs and profits trade at high valuations. According to Thomson Financial Networks, Illumina's (Nasdaq:ILMN) sales totaled $573 million for the last 12 months and its stock trades at 29x expected earnings for 2010, or $1.17 per share. The industry as a whole has an average P/E of 16.

Trials And Tribulations
Drug trials don't always go the way investors want, however. La Jolla Pharmaceutical (Nasdaq:LJPC) and BioMarin Pharmaceutical (Nasdaq:BMRN) were jointly developing a drug to treat lupus, before they announced in February 2009 that development would cease. Both stocks dropped after the news became public. But because La Jolla was essentially a single drug company, its stock fell by 90%. (Learn more about the stocks of this sector in The Ups And Downs Of Biotechnology.)

Bottom Line
Investors are excited about the prospects of Dendreon's new prostate cancer drug. But enthusiasm must be tempered by recognition that the company's valuation may not be justified by the sales prospects for a drug that has not been approved yet and won't experience initial sales for at least a year.

By Eric Fox

Eric J. Fox, is the founder of Brittain Capital Management, LLC., which manages the Alesia Fund, LP., a Value oriented long/short investment partnership. You can read more of his views on investments at his blog - Stock Market Prognosticator.

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