3 Investing Lessons From Dendreon

The fall of Dendreon (NASDAQ: DNDN) is a grim cautionary tale for biotech investors. The stock has fallen more than 40% year to date, and is down more than 90% since its peak in 2010.

Wall Street had believed that Dendreon's only marketed product, the advanced prostate cancer drug Provenge, would be the next biotech blockbuster. Unfortunately, the high cost of the drug initially spooked insurers, and the drug was eventually overshadowed by more cost-effective treatments, such as Johnson & Johnson's (JNJ -0.93%) Zytiga, and Astellas Pharma (ALPMY 1.20%) and Medivation's (MDVN) Xtandi.

Source: Ycharts.

As we approach the end of 2013, let's take a look back at three important investing lessons we can learn from the dire fate of Dendreon.

Lesson No. 1: Wall Street's peak sales estimates often miss the mark
First and foremost, Dendreon's collapse highlights just how wrong Wall Street analysts can be.

Back in 2010, analysts originally believed that Provenge could hit annual peak sales of $3 billion to $4 billion. Unfortunately, Provenge only generated $213.5 million in revenue in 2011, and $325.3 million in 2012. Sales in 2013, seen in the following chart, clearly indicate that demand for Provenge peaked last year.

Source: Dendreon quarterly reports.

At this rate, Dendreon will need to report $116 million in Provenge sales for the fourth quarter to top last year's numbers -- a highly unlikely target considering rising competition, and a steep decline in demand. By comparison, Johnson & Johnson's Zytiga generated $464 million in third-quarter sales alone -- a 75% jump over the prior-year quarter.

During the past three years, analysts have lowered their estimates for Provenge as it became obvious that the drug was not destined to be a blockbuster. However, quarterbacking after the fact was cold comfort for Dendreon's initial investors, who thought that Provenge actually had a chance of hitting $4 billion in annual sales.

Lesson No. 2: Cost effectiveness is a key factor
A combination of three other factors sunk Provenge -- its pricing, its efficacy, and its dosage.

Although Provenge arrived first, Johnson & Johnson and Astellas/Medivation were able to quickly steal away market share by showing comparative data to patients, doctors, and insurers.

Sources: Forbes.com, NYTimes.com, Xtandihcp.com, and company websites.

Provenge was less effective at extending a patient's life span than Zytiga and Xtandi, but was still the second most-expensive treatment. In addition, both Zytiga and Xtandi were pills, whereas Dendreon was administered intravenously in three hour-long sessions. Like Provenge, Zytiga was also approved as a first-line treatment for patients who had not gone through chemotherapy yet -- an indication that Xtandi had not yet been approved for.

In other words, Provenge had no discernible advantages over either Zytiga or Xtandi.

Lesson No. 3: Little biotechs usually need big partners
Last but not least, Dendreon's lack of a major pharmaceutical partner means that it simply doesn't have the marketing muscle to compete against medical giant J&J, which has $25.2 billion in cash, or Medivation, which is partnered with the larger Japanese pharmaceutical company Astellas Pharma.

By comparison, Dendreon has $167 million in cash, $598 million in debt, negative year-over-year revenue growth of 12.8%, and a negative operating cash flow of $239 million.

Let's also take a look at the approval timeline of these three drugs.

Sources: FDA, company websites.

Although the EU approval of Provenge in September should have been good news for shareholders, it highlighted two major problems -- that Dendreon did not have the marketing muscle to expand across the 27 countries of the EU, and that Zytiga and Xtandi were already approved and making headway across Europe.

If Dendreon can attract a big European partner to help it market Provenge, it could be a positive catalyst for the stock. I doubt that will happen, however, considering the aforementioned problems that the drug faces.

The support of a major partner usually means big things are ahead for a company -- simply take a look at how much Pharmacyclics has been boosted by Johnson & Johnson's vote of confidence for its blood cancer drug, Imbruvica, or how much Regeneron has been helped by its partnership with Sanofi.

The Foolish takeaway
In closing, the best hope for Dendreon shareholders these days is a buyout offer, or a really big marketing partnership -- both of which must happen soon before another year of declining Provenge sales starts.

For the rest of us, the fall of Dendreon yields three valuable biotech investing lessons -- realize that peak sales estimates are merely educated guesses, fully understand the cost effectiveness of a company's drug and its upcoming competitors, and see if the company has attracted the interest of larger companies. In other words, do your own due diligence rather than relying on simple buy and sell recommendations.