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Is Solazyme in for a Crash?

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The draw of an investment's potential is always huge for investors. An untapped market with billions of dollars of potential could produce the next 10-bagger we've all been waiting for. This seems to be the investing thesis behind Solazyme (Nasdaq: SZYM  ) the alternative fuel, premium oil, algae growing company.

Amid all of the excitement about deals with Bunge (NYSE: BG  ) and Archer Daniels Midland (NYSE: ADM  ) investors seem to be glossing over the fact that the company's revenue declined in the third quarter and net loss nearly doubled. This isn't exactly a company that's currently operationally knocking it out of the park.

Don't buy potential
I've been covering renewable energy for over two years for The Motley Fool, and if there's one lesson I've learned it's: Don't buy the hype. Solazyme is looking eerily similar to A123 Systems, a situation where investors bought into potential and the clout of its high-profile auto partners. It happened again when investors bought into the hype of new solar technology like CIGS, an amorphous silicon that never generated much revenue but had cool and promising technology. Now we're buying into an alternative fuel and other random oil products company despite failures in these markets in the past. Let's not forget that ethanol has been an alternative we have talked about for decades that has never been truly economically viable.

The big challenge in the biofuels and oils markets is that once you have a product that becomes successful your feedstock price goes up. Take corn-based ethanol as an example. When ethanol production reaches a critical mass it also increases the demand for corn, which raises the price and reduces margins for ethanol producers. On the flip side, a market with attractive prices will see prices decline once you introduce an alternative product that increases supply. Market forces work against you on both sides.

Big potential, but still just potential
What Solazyme wants investors to buy into is the potential of increase in capacity, which it says is on a path for 400,000 metric tons in 2016. But there are a number of challenges to overcome before that capacity translates into big-time profits, whatever those profits may be.

  • The agreement with AMD includes producing tailored oils in Clinton, Iowa, but not until 2014. A lot of the other capacity won't be online until at least 2016.
  • One of Solazyme's target markets is a replacement for cocoa butter, which sells for $3,600 per metric ton. If 100,000 metric tons are dedicated to this market it could be a $360 million business. However, as we've seen in other markets, if supply is added the price will likely drop.
  • Most of Solazyme's capacity is in joint ventures, of which the company only shares in 50% of the economic interest. This means most of the capacity additions the company talks about can be cut in half when we look at bottom-line potential.

The challenge is the same as it was for A123 Systems, which had analysts buzzing about adding capacity to unproven markets with exciting and unproven partnerships. The reality of both situations is that companies that make biofuels, and a variety of other product alternatives, are unproven in the market on the scale that would be necessary for survival. All we do know is that Solazyme and competitor Amyris (Nasdaq: AMRS  ) are posting losses. Only Rentech (NYSEMKT: RTK  ) , which is the best performing stock of the group, has swung a small profit.

AMRS Net Income Quarterly Chart

AMRS Net Income Quarterly data by YCharts

High risk, high reward
Maybe we'll revisit this stock in five years and talk about what a smashing success it was. But investors should be aware that the risk is incredibly high and the list of winners in this kind of market is short. The list of losers who failed to live up to potential is long and painful.

I am keeping an eye on Solazyme's growth in interesting new markets, but until it generates a significant amount of revenue and makes major progress toward profitability, I see no reason to buy. I've seen too many business failures due to stocks built on hope and potential to be duped into buying this one right now. I'd rather miss out on the early pop than risk buying another dying company just before realizing that the potential upside wasn't as big was thought.

I'd prefer to stick with established oils, like oil.

Speaking of oil, if you're on the lookout for other currently intriguing energy plays, check out The Motley Fool's "3 Stocks for $100 Oil." You can get free access to this special report by clicking here.

Read/Post Comments (6) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 20, 2012, at 3:57 PM, Cake123xyz wrote:

    If investors are glossing over revenues, the writer is glossing over his ignorance concerning how those revenues are derived.

  • Report this Comment On November 20, 2012, at 6:08 PM, Gromitbuy wrote:

    I believe that the author has underestimated the variety of applications that the biofuel provides. Did A123 have a sellable product that was being applied in a half dozen or more different industries successfully? This biofuel also can be tailored for specific applications, which is not only groundbreaking, but also increased the potential for various types of buyers. I agree that success could breed higher demand for the underlying raw materials, and hence the cost of production, but isn't that true for any industry? There is certainly risk to Solazyme, as with any new technology, but the room for reward is there, particularly at the present low price of the stock.

  • Report this Comment On November 20, 2012, at 11:31 PM, BillStacker wrote:

    The author make a good point, right up until the last sentence. "I'd prefer to stick with established oils, like oil." is just asinine.

    Which oil are you going to stick with? Olive oil, linseed oil, or LSC?

    Oh. One more thing. The headline is silly. Solazyme has already crashed. I'm embarrassed to say what I paid for my shares. :P

  • Report this Comment On November 21, 2012, at 9:17 AM, Cake123xyz wrote:

    Wait, he made a good point? HAHA Well this isn't my writing but here's one person's response on the yahoo msg boards:

    "He does the usual incompetent job I've come to expect from their contributing writers.

    He portrays Solazyme as mainly a fuels company and uses ethanol as his main comparison. Yes, corn was not the answer for gasoline (duh). Thanks for the insight. But edible oils is a totally different product with different dynamics on the input side. Solazyme isn't trying to replace gasoline, and 500K MT globally isn't going shift ANY prices for sugar or dextrose. Those markets are far bigger than that. Might commodity prices move against them? Yes, that's why they negotiated parameters with Dow. But heck, don't let the facts get in your way. : )

    He compares them to A123 Systems. i.e. A123 had partnerships but things didn't turn out to well. Hmmmm....... A123 is a battery company........yeah, batteries. Where's exactly is the comparison? Is he trying to say that things may not go as planned for small tech companies? Well, gee, Mr. Author, thanks for letting us know. As Banya would say, "That's gold, Jerry, gold!"

    He talks about how far off capacity is, but doesn't mention that Bunge starts coming on line next year. He also makes no mention of Roquette or the fact that they are putting up all the capital. Well, let's not be too hard on him. After all, Bunge and Roquette are only their biggest and most mature partnerships.

    He slams the joint ventures because it means Solazyme only gets half the profit. Uhhh....ya know, there's a flip side to that. It also means that big players want in and are willing to pay to do it. Do you think it will be easier or harder for Solazyme to do well in oils with Bunge on their side of the table? Do you think it will be easier or harder for them to break into foods with Roquette distributing? Heck no! They should go it alone. Like Moses in the desert I tells ya!

    He does raise one important, though terribly obvious. Until they do start showing revenues, the stock may indeed languish. The sector is cold and tarnishes anyone close to it. Shorts can indeed set the price until they are forced to go away. So there may indeed be no rush to buy now. But for him to say "five years" is when he'll revisit the story is again more silly Motley hyperbole. By this time next year, with Roquett Phase II and Moema both on-line, you could see quite a higher price.

    If he wants less risk, that's fine. But at least give a decent article instead of misleading tripe."

  • Report this Comment On November 26, 2012, at 4:20 PM, TMFBlacknGold wrote:

    Check out the trend I discovered for sustainable chemical companies:

    See the charts in my post. Tough to argue...

  • Report this Comment On December 04, 2012, at 12:30 PM, waterskipper wrote:

    The author is correct....this is a high risk stock. He is correct, sales are down and losses are up. However, if he wanted to write a really good article he might consider delving into the income statement a little more than a cursory glance, which is what the average investor also seems guilty of. But, we don't want average here. So, looking a little closer we find that product revenue is up nicely. This indicates that the product does seem to be gaining traction in the market. So, this is what we want to see according to his article - increasing product sales, correct? Total sales are down because of a significant drop in R & D sales. The author makes the point that their planned growth is with joint partnerships and therefore they won't have all the sales. That is correct also. The advantage of that model though is that they are limiting their own capital risk and sharing that risk with others who have deeper pockets. I very much unlike the comparisons to other companies in this field because Solazyme has unique and different technology. I happen to be a stock holder of Rentech. Rentech is so different from Solazyme that it is ridiculous that he mentions them in the same article. All of the money they are making is from producing fertilizer, not biofuels, farnasene, or bio-oils. Rentech's biofuels developments are money-losing like most everyone's at this point. (BTW, I am not a stock holder of Solazyme, Amyris or A123.)

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