I Was Wrong About Dendreon

Almost a year ago, I selected Dendreon (Nasdaq: DNDN  ) for our "Best Stocks for 2011" series.

My reasoning was simple: The biotech was fairly de-risked, having already gained FDA approval for its prostate-cancer treatment Provenge. All Dendreon needed to do was gain Food and Drug Administration approval for its two new manufacturing plants, and the company would be home free.

The FDA approved both plants, but that wasn't enough. "If you build it, they will come" works better for fictional baseball movies than for drug sales.

Dendreon is down 77% year to date after a rough launch that resulted in a pulling of its sales guidance for the year.

Getting paid is still risky
It's not enough to have an innovative product that's better than the current standard of care. Sure, it's helpful, as Vertex Pharmaceuticals' (Nasdaq: VRTX  ) launch of its hepatitis C drug Incivek has shown, but it isn't enough. You still have to get doctors to prescribe the drug.

In the case of Provenge, that means having doctors front the cash for the $93,000 treatment before being reimbursed by health insurers or Medicare. Other cancer drugs are just as expensive: Bristol-Myers Squibb's (NYSE: BMY  ) Yervoy and Seattle Genetics' (Nasdaq: SGEN  ) Adcetris are pushing or exceeding the $100,000 mark. But Dendreon is uniquely expensive; the treatment requires three infusions two weeks apart, so the entire cost is absorbed within a month. By contrast, Adcetris is dosed every three weeks, and it's spread out over 16 cycles. The extra time allows doctors to be reimbursed for the first dose well before the treatment is complete.

Learning from my mistake
Biotech is a risky sector to invest in, but fortunately most of the risks are fairly obvious and can be easily avoided if the potential rewards don't justify the risk. Aeterna Zentaris (Nasdaq: AEZS  ) and Keryx Biopharmaceuticals' (Nasdaq: KERX  ) phase 3 trial testing perifosine is more risky than most because the trial tests only a subset of the patients from the phase 2 trial. Cell Therapeutics (Nasdaq: CTIC  ) is trying to get the FDA to reverse course on its cancer drug pixantrone despite turning it down once already.

What I failed to notice was the unique risk that Dendreon posed. The launch looked good in the beginning because the early adopters were academic institutions that didn't have to worry about fronting large amounts of money. It wasn't until Dendreon started expanding to community doctors that the risk became apparent.

Still an opportunity?
Dendreon is more risky than it was a year ago. Until doctors are convinced that they'll be reimbursed quickly, they're not going to prescribe Provenge en masse. And predicting when that might happen is difficult. Dendreon isn't even willing to give anything but vague "modest quarter-over-quarter growth" sales guidance.

But there's also more potential upside for Dendreon than there was a year ago. Biotechs are ultimately valued on the peak sales of their drug, so assuming the payment problems eventually get worked out and no other issues crop up, Dendreon's terminal value hasn't changed much; it'll just take longer to get there.

I registered a Motley Fool CAPS call on Dendreon in March, predicting that the biotech would beat the market over five-plus years. I'm sticking with that prediction even though I'm currently trailing the market by 66 points. I have four years to catch up, after all.

Perhaps my biggest mistake was entering a long-term pick into a series with a short time frame.

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