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Dendreon (NASDAQ:DNDN) On March 10, 2011 a Federal Judge in the Southern District of New York issued a ruling in a case involving Medicare coverage for “off label” drugs that may come to have tremendous importance for cancer treatments, and specifically for Dendreon and its recently FDA-approved, revolutionary treatment for prostate cancer, Provenge. The Judge ruled that Medicare may not deny coverage for FDA-approved drugs which are used “off label” and are considered “medically necessary” by the prescribling doctors, just because the treatments have not been recommended by the treatment Compendia upon which Medicare routinely relies to make “off label” coverage decisions. The judge found it sufficient that the disputed treatments had been reported to be effective in peer-reviewed medical journals–finding that it was not the intent of Congress that Medicare coverage for “off label” drugs be limited to Compendia-listed treatments.

Provenge, the company’s breakthrough immunotherapy for late stage prostate cancer, that indicated the treatment would in fact be covered by Medicare. This was and is a huge big deal for the company. Provenge is Dendreon’s (DNDN) first FDA-approved product. The company and the investment world are expecting it to be a blockbuster.

The headline news from Medicare was that Provenge will be covered “on label”, meaning for the type of prostate cancer for which it was specifically approved–namely late stage prostate cancer that has already come back after intial treatment, and that has spread to other parts of the patient’s body. This is by no means a tiny market: In the U.S. alone there are 100,000 men who have this stage of the disease and there are 30,000 new cases each year. Based upon the strict “on label” market, many analysts are projecting multiple billions in revenue for Dendreon in the next year or two.

What I would like to draw attention to here is an aspect of the Medicare decision which received but scant notice in the media and which only received passing comment from the few analysts who noted it. It has the potential to be absolutely gigantic for the company and Provenge. In particular, if the recent Federal District Court ruling is upheld.

In its draft coverage decision, Medicare dealt not only with “on label” coverage, but touched on “off label” as well. The distinction between the two is this: The FDA approves a treatment for the precise sickness in which the treatment was studied in order to gain FDA approval. Thus a treatment for migraine headaches that is approved by the FDA for use in migraine headaches, and is prescribed by a doctor to treat a patient’s migraine headache, is being prescribed “on label”. Not everyone is aware of it, but the law specifically allows a doctor to prescribe any approved FDA treatment for any reason which the doctor, in the reasonable exercise of his medical judgment, feels is appropriate for the patient. Thus, if a doctor feels that, for example, migraine headache treatment will help a patient who suffers from tension headaches, it is legal and proper for the doc to prescribe it. This would be an example of “off label” use of an FDA-approved treatment.

Doctors, of course, do not regularly prescribe treatments “off label” willy nilly or on a whim. There must usually be a lot of science supporting the decision to do so–as well as real life experience. And the medical world has, of course, adopted procedures to facilitate the orderly handling of “off label” decisions. Publications called Compendia give docs advice and facts and statistics on the efficacy of FDA treatments used “off label”.

Here is where we get to an important, little appreciated connection for Provenge and Dendreon: Medicare has set up standards for allowing Compendia to stand in for FDA approval in making coverage decisions for “off label” use of FDA approved drugs. And the recent Medicare decision to cover Provenge did not, as many had expected it would, forbid “off label” coverage for Provenge. Instead, while specifically noting the need to leave the door open for further medical advances to benefit Medicare beneficiaries, they left “off label” coverage decisions to be made by local regional Medicare contractrors on a case-by-case basis.

Why is this important and potentially so big for Dendreon? Because Provenge works by boosting the patient’s immune system and giving it the ability to kill cancer cells. Virtually everyone in the medical and cancer research world hopes and expects that when given to men in earlier stage disease, (men with healthier immune sysytems to start with) that its life-extending effects will be even more dramatic. Earlier stage patients are going to be absolutely clamoring to get Provenge from their doctors once the Provenge story has spread wide. And doctors are going to be hard pressed to deny them, because there is so little to lose by doing so. Provenge has almost no side effects–a day or two of flu-like symptoms, while at the same time there is the prospect of dramatic life extension for the patient. Most importantly for investors in Dendreon, over 200,000 men are diagnosed each year with early stage disease in the U.S.–and thus the potential market for early stage Provenge is huge.

And it just so happens that Dendreon already has a Phase three study going on in men with earlier stage disease. While it is not a pivotal registration study designed to obtain FDA approval, there is still the prospect that if it produces good results in delaying the spread of cancer it could lead to a Compendia listing for Provenge for earlier stage disease. This could lead to widespread “off label” prescription–which could lead to a decision by Medicare to cover “off label”. Further, should positive results be reported in a peer reviewed journal–as they almost surely would, that alone would require Medicare coverage for “off label” prescriptions of Provenge under the New York Court’s recent ruling.

This could speed the movement of Provenge into the treatment of earlier stage disease by YEARS. The earlier stage market is many multiples of that for late stage prostate cancer. Dendreon could be looking at a $10 Billion annual market for Provenge.

The company is not entirely out of the woods yet.  A final CMS decision is due on or about June 30, 2011.Sales estimates for Provenge of $367 million in 2011 and about $1.2 billion in 2012 being ‘reasonably achievable.’  What Farmer believes is that doctors are likely to be more apt to recommend and prescribe Dendreon’s Provenge with a lower worry about reimbursement risk.

As a reminder, Provenge numbers for the next two quarters are not as critical as what is expected ahead.  The company’s increased production is on facilities being constructed as we speak and that means that the bulk of the 2011 guidance is very back-end loaded.  It will not be until 2012 that you start to see a normalized revenue growth rate from Dendreon.

Analysts noted a potential $4 billion or more in annual sales in the U.S. alone as being possible.  He also expects successful supply expansion and “on-label payor reimbursement” coming up. So why are we more bullish, assuming he is correct?  Simple… That $4 billion figure is massive. Dendreon’s market cap is about $5.4 billion and Thomson Reuters still has sales estimates of $370 million in 2011 revenues and $867.2 million in 2012.  Farmer is already calling for $1.2 billion in 2012 for now.  Another consideration is that Provenge is currently only approved for specific instances of prostate cancer.  Dendreon is evaluating Provenge and other possible drug candidates as possible renal cell carcinoma treatments as well as in colon, cervical, breast, and ovarian cancers.  We are not yet willing to model a single penny on these yet into future revenues, but these offer significant upside to the company with its other products and its other indications if the news flow on those is positive.

If Dendreon gets anywhere close to a $4 billion per year sales figure for Provenge, then Dendreon is likely to have a far higher share value based on that alone.  That would represent a mere multiple of about two-times eventual revenues at the forward price target.  We are currently seeing Dendreon trade at five-times to six-times 2012 revenue expectations with higher growth targets in the years thereafter.  Throw in other trials and other potential trial candidates and you have a new large biotech with even more implied upside ahead and it would still be considered cheap to established players even at the forward share price targets.

As always with any calls like this, the situation described is all an “if-then” model.  What CMS ultimately decides is often as unpredictable as FDA approval decisions.  There is a lot of potential upside here, but this one cannot be considered to be without risk by any measures.