This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the best...
On a generally "green" day for the markets, shareholders of cancer-drug maker Dendreon (NAS: DNDN) are smiling wider than most this morning. The reason: Six months after crushing their stock with a 180-degree downgrade from buy to underperform, the bankers at Bank of America just reversed course once again, and upgraded the shares.

Dendreon's enjoying a 2% bounce on the news -- as well it should. Consider the differences between these B of A ratings. Six months ago, the banker blasted Dendreon for missing sales estimates, even though those estimates called for only (as B of A described it) "minimal monthly growth." Growth expectations going forward were similarly muted, and B of A complained that it lacked "visibility into true demand" for Dendreon's Provenge anti-cancer treatment.

But today we're hearing the opposite. B of A cites a "75 physician survey" as supporting "a more constructive near term view on growth." Provenge sales are increasing. (Indeed, last quarter's revenues more than tripled year over year.) Costs are falling, and Bank of America now sees an "increased probability of success" for the company.

Are the bankers right?
Maybe. Earlier this week, my Foolish colleague David Williamson examined the theory that Dendreon has become buyout bait. The company just swiped a CEO from Savient Pharma, and its new boss, the innocuously named John Johnson, is the same guy who successfully guided ImClone to a buyout by Eli Lilly (NYS: LLY) a few years back. While Lilly's not exactly flush with cash today (it actually has slightly more debt than cash), it does have enough in its bank account to fund another buyout if it was of a mind to. And in Johnson, they already have a guy they know they can work with.

Other potential suitors (as I've suggested before) might include similar large-cap victims of the patent cliff such as Pfizer (NYS: PFE) (also debt-heavy, but with a substantial bank account in its own right), Merck (NYS: MRK) (same story, albeit to a lesser degree), or even Johnson & Johnson (NYS: JNJ) , which in addition to being a real free cash flow star, also boasts a balance sheet with significantly more cash than debt -- money burning a hole in the corporate pocket, and easily deployable for a cash-starved but product-rich prospect like Dendreon. Each of them could use a boost to their respective pipelines, and takeover targets that already have approved drugs aren't easy to come by for these giants.

Honey, who shrunk the cash?
In a nutshell, though, cash is Dendreon's problem. With $435 million in negative free cash flow showing up on its own cash flow statement, Dendreon is a company living on borrowed time.

Literally. With $565 million in debt, versus $523 million cash at last report, Dendreon is net-cash-negative right now. And at its current burn-rate, Dendreon will be out of cash in just a few quarters. Unless it manages to sell itself to someone a bit more flush, management's going to have to float more debt, or issue more shares (diluting current shareholders) pretty soon, if it intends to remain in business.

Foolish takeaway
Longtime readers of the Fool will know that I'm partial to cash-generating businesses, and often skeptical of companies like Dendreon that seem to be in the "business" of burning money. I trust you'll understand, then, if I don't rush to embrace B of A's upgrade as a reason to buy Dendreon shares in bulk.

That said, you can't argue with the company's mission (to cure cancer). The valuation, at seven times book value, doesn't look crazy-unreasonable for a fast-growing sales machine like Provenge. (The P/B on this one is only a little more than twice the price-to-book value at Johnson & Johnson, for example.) Most important of all, both hypothetical seller and hypothetical multiple buyers have good reasons to want to get together and do a deal here.

A buyout could happen.

Not interested in gambling on a takeover scenario in the topsy-turvy biotech market? Can't say I blame you. Perhaps we could interest you in a fewrock-solid dividend stocksinstead. Read our free Fool report today --but act quickly. It won't be available at this price forever.

At the time thisarticle was published Fool contributorRich Smithdoes not own (or short) shares of any company named above.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 355 out of more than 180,000 members. The Motley Foolhas adisclosure policy.The Motley Fool owns shares of Dendreon, Bank of America, and Johnson & Johnson.Motley Fool newsletter serviceshave recommended buying shares of Pfizer and Johnson & Johnson, as well as creating a diagonal call position in Johnson & Johnson.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.

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