The two ways to go bankrupt, as Ernest Hemmingway famously wrote, are gradually and then suddenly. The “gradually” phase of the process can take a good long while, sometimes years, but once a business starts to exhibit the two biggest symptoms of impending disaster–falling revenues and mounting debt–the “suddenly” part is all but inevitable. It came for the troubled biotech company Dendreon (ticker: DNDN) on Monday when it filed for Chapter 11 bankruptcy.
The move should have surprised exactly no one, and not just because I predicted it well over a year ago now on Seeking Alpha. Back in September, the company’s own management warned that it was probably going to wipe out its shareholders. But that didn’t stop credulous investors from buying Dendreon’s stock–incredibly, it didn’t dip below a dollar until earlier this month–or dubious stock boosters from feeding their hopes for a miraculous turnaround. Take a look at the headline on a Zack’s.com posting: “Why Earnings Season Could be Great for Dendreon.” The article, which gives DNDN a buy rating, is dated November 10, 2014–the exact same day the company announced that it had filed for bankruptcy.
Dodgy internet sites aren’t the only sources that hype failing companies. I’ve still got analyst reports from prestigious brokerages recommending Enron’s stock right up until the day it went bust. Enron was hugely successful for many years and it collapsed because of a massive accounting fraud. Its bankruptcy was a shocking and historic event. That wasn’t the case with Dendreon.
One of the main messages of my book (available for pre-order now!) is that failure in the corporate world rarely stems from Enron-style malfeasance or fraud. I’ve met thousands of top executives in my career, many of whom oversaw businesses that wound up in Chapter 11. The vast majority of these managers were bright, competent people acting in good faith. Things just go wrong in business and in life. The story of Dendreon’s rise and fall is a perfect example.
A little over four years ago, Dendreon’s stock was trading for over $50. Its prostate cancer treatment had gained approval by the FDA. Analysts were predicting massive windfalls. The company’s management, as so often happens, issued a large bond offering to fund expansion. That wasn’t necessarily a bad idea. Things just didn’t work out the way they had planned. Dendreon’s treatment cost a ton, for one thing. A lot of pharmaceutical products are expensive, of course, but cheaper alternatives came onto the market and crushed Dendreon’s sales. Its revenues started trending down, putting the repayment of its bond issue into jeopardy.
By the time I initiated my short position in DNDN, the “gradually” phase of the bankruptcy process was already well under way. Its stock was below $10. I regret making my short public, though, because doing so probably alerted other investors to the opportunity. After my article was published, the “negative rebate” my broker charges me to short stocks shot up on DNDN past 50 percent. Faced with this huge cost, I was forced to cover my 300,000 shares with the stock still hovering just under $3. It’s now trading for pennies, meaning I left almost a million dollars on the table when I had to cover.
Ironically, many people think short sellers seek to tank stocks by publicizing their positions. Thanks to negative rebates, which only came on the scene after the financial crisis as brokerages looked for new revenue sources, talking about short positions actually hurts rather than helps returns. That’s why I’m not going to do it anymore. I will say this, though: spotting a dead company walking like Dendreon is not rocket science. There are plenty of them out there at any given time. The best place to hunt for them is on the list of stocks consistently making 52 week lows. As fundamentals unravel a company’s stock price will inevitably sink and sink some more. But given the excessively optimistic (or promotional) mindset of investors who love low priced stocks, there is always some “meat left on the bone” before a company files bankruptcy and its stock goes all the way to zero.