Aside from a former partnership with Royal Dutch Shell (NYSE: RDS-A ) , industrial biotechnology company Codexis (NASDAQ: CDXS ) has had much more success courting pharmaceutical partners than those involved in fuels and chemicals. The company's enzymes and pharmaceutical intermediates are featured in processes for innovator products such as Januvia/Janumet from Merck (NYSE: MRK ) , former innovator products such as Lipitor from Pfizer, and generics from Teva and DSM. The company's fortunes may change soon with the unveiling of its latest generation of cellulase enzymes. Is a commercial partner just around the corner?
What's a cellulase enzyme?
Before we get into the news let's take a step back and address the elephant in the room: What the heck is a cellulase enzyme?! An enzyme is a complex molecule that improves or enables a chemical reaction at a lower level of energy, thus saving time and money. For instance, Codexis and Merck's new process for Januvia increased yield by 13%, productivity by 53%, and reduced waste by 19%.
Processes in chemical engineering can be completed in three ways: by increasing the amount of heat or pressure, aka "brute force"; by utilizing a catalyst or enzyme; or by a combination of each. Therefore, the point of cellulase enzymes is to break down cellulose and hemicellulose, natural polymers found in biomass, into their basic units during a "brute force" process called hydrolysis. Depending on the type of biomass these units can be sugars such as glucose (corn), sucrose (sugarcane), or xylose (wood crops).
When you hear about cellulosic biofuels and wonder why they haven't gone mainstream yet, cellulase enzymes are to blame. While enzymes increase process yield and profitability and reduce waste, their efficiency is affected by operating parameters such as pH, temperature, and pressure. Cellulosic fuels and chemicals won't be economically viable until enzymes can unlock the sugars mentioned above at a low enough cost. The possibility of incredibly efficient industrial processes has been "a few years away" for a long time as enzymes were coaxed to work in a wider range of operating parameters. Now companies such as Codexis, Novozymes, Genencor, and Dyadic are finally breaking down the door.
X marks the spot
CEO John Nichols mentioned that the company's CodeXyme enzymes had achieved 85% conversion of corn stover at 1% loading (1 g enzyme/100 g cellulose) on the conference call discussing 2012 financial results a few weeks ago. No one seemed to care at the time given the dim 2013 outlook, but characteristics like that would have given the company the market's leading enzymes. I made a cautionary note of this overlooked statement in the earnings recap, although admittedly I'm a bit more in tune with the industry as a bioprocess engineer and investor. Of course, leading enzymes mean little without a commercial partner.
Whether Nichols meant to hint at the latest generation of cellulase enzymes or couldn't contain his excitement will never be known, but Codexis released more data on the products Tuesday. Depending on the source of biomass the company's CodeXyme 4 and CodeXyme 4X enzymes increase performance by 10%-20% over CodeXyme 3 generation enzymes. The "X" in "4X" stands for xylose, a sugar the company was able to unlock in its latest generation enzyme:
The improvement is a big step forward in the company's plans to land a major commercial partner for its cellulase enzymes. In short, it gives Codexis an advantage for maximizing the value of agricultural wastes; especially sugarcane bagasse in Brazil. Xylose is a major component of hemicellulose and lignocellulose, which have been tricky to break down and are often burned to generate electricity. While electricity can be used to power a biorefinery or sold to the grid, the profitability balance often favors value-added products (burning something amounts to the lowest value). The obvious potential partners are Raizen, a major investor in Codexis, or the joint venture between Shell and Cosan (NYSE: CZZ ) .
Rooting for energy with Raizen
Raizen produces more than 581 million gallons of ethanol, 4 million metric tons of sugar, and generates close to 900 MW of electricity in Brazil each year. The company also owns over 4,500 fueling stations, 500 convenience stores, 53 fuel distribution terminals, and sells aviation fuel to 54 Brazilian airports. As you can see, there are a number of opportunities awaiting the lucky enzyme producer who partners with the company.
Last year enzyme and cellulosic ethanol producer Iogen -- also a former partner of Shell and investment of Raizen -- signed a deal to commercialize cellulosic ethanol with the JV. The company shed its enzyme business to competitor Novozymes shortly afterwards to focus on ethanol. Will Codexis be the next to land Raizen and complete the cellulosic ethanol cycle for the four companies? Couple the aligning of the stars outlined above with recent open market purchases by the CEO and it's easy to see such a scenario resulting.
Can Codexis help Merck beat the patent cliff?
Maybe you're wary of yet another cellulosic ethanol promise and are more interested in Codexis' dealings with Merck. The newly approved process for Januvia/Janumet goes into operation this year, which could further boost margins for the $5.75 billion franchise. Still, this titan of the pharmaceutical industry stumbled into 2013 and continues to battle patent expirations and pipeline problems. Is Merck still a solid dividend play, or should investors be looking elsewhere? In a new premium research report on Merck, The Motley Fool tackles all of the company's moving parts, its major market opportunities, and reasons to both buy and sell. To find out more click here to claim your copy today.