Has Wall Street Doomed Solazyme?

Renewable oils manufacturer and industrial biotech darling Solazyme  (NASDAQ: SZYM  )  is building out its first wave of commercial scale capacity: a total of 120,000 metric tons (MT) of annual capacity on two continents. The company currently operates a 1,820 MT demonstration facility in Peoria, although production is allocated between the growing Algenist skin care line, working out kinks from lab-test oil profiles, and fulfilling customer test quantities. When you consider that some oil profiles in development can fetch more than $3,000 per MT and 2013 sales will be about $55 million, there is no denying that investors are in for a quantum leap in revenue growth.

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If you take a look at Wall Street expectations for 2014 revenue you'll see that the average of 10 estimates is $232 million. That's down from $282 million just a few months ago, although it still marks a massive improvement from 2013 sales. Some investors may incorporate Wall Street estimates into their investment decision making, but that isn't always a good idea.

Let's be clear: Solazyme is poised to experience incredible growth next year and beyond. However, I believe Wall Street expectations for next year's revenue set the bar impossibly high for Solazyme and may only harm shareholders. To illustrate my concerns, we will look at a simplistic production model to determine the volume of renewable oils investors can reasonably expect and back track to calculate the average selling price required to fall in line with Wall Street. Unfortunately, the company can do everything right and still fall short. The devil is in the details.

Those devilish details
The first thing to note is that Solazyme doesn't own all 120,000 MT of capacity under construction. Half of the 100,000 MT with Bunge  (NYSE: BG  )  belongs to the company, while it owns all 20,000 MT being developed with Archer Daniels Midland  (NYSE: ADM  ) . Bunge will generate revenue on the sale of oils generated from the jointly developed facilities, while ADM will be paid by Solazyme in cash or stock for its mentoring. In the end Solazyme's share amounts to 70,000 MT of annual capacity.

The second distinction to note is that biorefineries do not begin producing at nameplate capacity the instant they open their doors, which I explained earlier this year. To recap, a facility with 10,000 MT of annual capacity that begins operations on January 1 will not produce a total of 10,000 MT by December 31. For that reason we know the Solazyme Bunge Renewable Oils facility in Moema, Brazil will not produce 100,000 MT of product in 2014.

Can analysts be right?
The revenue projections depend on when biorefineries commence operations, the initial volumes utilized, and success of the equipment. We cannot possibly know everything (nor can analysts) and Solazyme management has been careful not to promise too much too soon before getting a glimpse of commissioning and start-up. With that in mind I made several assumptions that provide a best-case scenario for Solazyme's production potential in 2014.

  1. Ramp-up only takes 12 months, not 18 months.
  2. Initial volumes are half of working volume and ramped linearly.
  3. All facility equipment is available for ramp-up. 
  4. Solazyme Bunge (50,000 MT) has product by October 31, 2013.
  5. Solazyme Clinton (20,000 MT) has product by February 28, 2014.

Monthly production volumes would look something like this.

Date

Moema Monthly Production (MT)

Clinton Monthly Production (MT)

Cumulative Production (MT)

September 2013

0

0

0

October 2013

2,083

0

2,083

November 2013

2,272

0

4,356

December 2013

2,462

0

6,818

January 2014

2,652

0

9,470

February 2014

2,841

833

13,144

March 2014

3,030

909

17,083

April 2014

3,220

985

21,288

May 2014

3,409

1,061

25,758

June 2014

3,598

1,136

30,493

July 2014

3,788

1,212

35,493

August 2014

3,977

1,288

40,758

September 2014

4,167

1,364

46,288

October 2014

4,167

1,440

51,894

November 2014

4,167

1,515

57,576

December 2014

4,167

1,591

63,334

Source: Author's calculations

The biggest weakness in this model is not knowing where to begin production. I arbitrarily chose to start at half of the maximum and set ramp-up to occur linearly -- with the same production gains occurring each month until nameplate is reached. In reality, ramp-up is an ongoing and unpredictable process that progresses as equipment is fine-tuned.

That aside, this is truly a best-case scenario. The model sets start-up and saleable product dates to the earliest possible, streamlines ramp-up to just 12 months, and assumes no problems occur during commissioning, start-up, or ramp-up. We can even imagine that the company sells all 63,334 MT of product created in the 15 months above in the 2014 fiscal year to help analysts further. We'll also discount revenue estimates $60 million to account for current operations. That way we are looking solely at revenue growth from new production. Average selling prices required would breakdown as follows:

 Revenue Estimate

Estimate minus $60 million

Average selling price needed

Average (10 analysts)

$172 million

$2,713 per MT

High

$245 million

$3,865 per MT

Low

$42 million

$655 per MT

Source: Yahoo! Finance for analyst estimates 

Is that a realistic goal for the company? Here's how some of the oil profiles created by the company are valued by the market:

Oil Profile

Average Selling Price ($/metric ton)

Market Size

End Markets

Specialty fuel oils

$1,000-$1,500

>1 billion metric tons

Diesel, jet, and maritime fuels

Oleic oils

$1,800-$3,000

>1 million metric tons

Lubricants, oleochemicals, retail food oils

Lauric oils

$1,500-$2,500

>3 million metric tons

Surfactants, oleochemicals, personal care

Myristic

$3,000 and up

>150,000 metric tons

Surfactants, oleochemicals, personal care

Cocoa butter

$3,600 and up

>1 million metric tons

Packaged foods, personal care

Source: Solazyme 4Q12 Earnings Presentation

recent sales agreement with Unilever will help absorb 10,000 MT of early production with high valued oils for personal care products, although actual prices have not been disclosed. While I believe Solazyme could very well hit average selling prices of $2,713 per MT, I'm not sure the company can achieve the right combination of production and average selling prices to make the numbers work. Consider that for Moema to have saleable product by the end of October, commissioning (a 1-2 week event) would likely have to have been completed by now. I think analysts are a little too optimistic. 

A Foolish lesson on analysts
The next time you think about relying on analyst projections consider the following. The fact that Solazyme doesn't actually own 120,000 MT of capacity must have eluded at least one analyst: the high estimate for total revenue in 2014 was $443 million before the latest revision. Even in the best-case scenario illustrated above that would work out to a staggering average selling price of $6,044 per MT -- well above what is possible. The same analyst revised their 2014 revenue estimate downward to $305 million, or (a still bubbly) $3,865 per MT in the model above. Remember that the next time you base an investing decision on Wall Street estimates.

This shouldn't be too surprising given the perpetual poor performance of analyst estimates. As my colleagues John Reeves and IIan Moscovitz pointed out, analysts are not paid to make accurate projections or set definitive price targets. Additionally, individual investors are not even the targeted audience. A total of 51.52% of analysts said retail investors were "not important" while only 13.3% said they (meaning me writing this and you reading this) were "very important".

Foolish bottom line
Solazyme could have a tremendous 2014 with $125 million, $175 million, or $200 million in total revenue -- all very possible. Unfortunately, we know all too well what happens when company guidance comes in below the expectations of analysts. I just don't see the company hitting the average Wall Street estimate of $232 million in sales next year. Think about it like this: the company could do no wrong, continue to hit milestones, absolutely smoke 2013 revenue, and still get smacked because analysts got ahead of themselves. Is that absurd or what? That being said, I am still looking to begin a position in the company this year because there is a great amount of long-term potential. Just don't be too surprised if shares get jolted when the company provides guidance for 2014.

Don't let Wall Street estimates scare you
I don't think Wall Street is right about this one, but I don't think steering clear of investing is a wise choice, either. Millions of Americans have waited on the sidelines since the market meltdown in 2008 and 2009, too scared to invest and put their money at further risk. Yet those who've stayed out of the market have missed out on huge gains and put their financial futures in jeopardy. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.


Read/Post Comments (11) | Recommend This Article (34)

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 October 01, 2013, at 1:51 PM, gs77 wrote:

    Great article, thanks! As excited as I am about the future investment potential of SZYM, you provide a welcome "heads up".

    Wish MF would post more of this kind of piece that has actual analysis and insight! Unfortunately in the last year I've seen a lot of cookie cutter pieces that are quite worthless, and this kind of quality on their competitor site, SA

    Keep up the good work! Fool on!

  • Report this Comment On October 01, 2013, at 3:09 PM, centerroad wrote:

    Finally we get an article with some real analysis. Thank you. I'm sick of the hype, particularly at SA. Perhaps you've read my recent comments there.

    Your projections for still too high (in fairness you said "optimistic") for several reasons:

    1) A trouble free start up would be the first of its kind, see Kior, Range fuels, Amyris, Gevo, etc. Its a long list, some facilities never made it, the rest are years behind.

    2) The deal with Unilever is terrible news, they are using the szym oil in their cheapest products, Brylcreme and Dove, in which they use palm kernal oil. The world price for palm oil is $700/tonne, only a fraction of the current estimates for per tonne healthcare oil prices factored into the szym game plan.

    3) The deal with Dow for transformer oil is much the same, the high price for that oil is $2000/tonne on world markets, and it's far more likely szym will come in well below that price, around $1500/tonne, way below their projections.

    4) The ph the szym process works at causes potential contamination issues, this can not be overlooked, its what almost killed off gevo. Yields will be limited until this is fully worked out.

    5) The Algenist line only gained 20% last year and their market penetration is high, at $79/oz. this is a very limited market and is more of a fad product than one to build on.

    6) There is virtually no demand in place for the Clinton facility so even assuming they can produce a product they have to create a market for it, which will have to include low prices.

    Szym will not sell anywhere near the tonnage expected next year, and even worse, they will not get anywhere near the projected price.

    My estimate is they will be lucky to get to $150 million in sales, with margins that are shockingly low.

    Finally, there is something that makes no sense to me, why did one of the founders just leave and sell all his stock right before what is supposed to be the start of a major upside. He is the patent guy, are the patents worthless?

    I have no position in szym.

  • Report this Comment On October 01, 2013, at 3:45 PM, EmFetch267 wrote:

    Let's try some more math to evaluate the analysts:

    80,000 (67% capacity) needs $2150/mt

    90,000 (75% capacity) needs $1911/mt

    100, 000 (83% capacity) needs $1720/mt

    I can start at an arbitrary capacity level too. My numbers look just as reasonable.

    Where is your math for the nutrition revenues? You applied no value to the roquette dissolution even though it accelerates an expensive product line.

    Why do you assume theyll throw away the leftover algae? I see no revenue for that either.

    Also, do you even know how joint venture accounting works???

    The analysts are not "dooming" SZYM. Writers like you are. Stop trying to scare people who dont know better!!

  • Report this Comment On October 01, 2013, at 4:01 PM, TMFBlacknGold wrote:

    @EmFetch267

    "Let's try some more math to evaluate the analysts:

    80,000 (67% capacity) needs $2150/mt

    90,000 (75% capacity) needs $1911/mt

    100, 000 (83% capacity) needs $1720/mt"

    It is physically impossible for Solazyme to produce anywhere near those levels in the next 15 months, let alone in 2014. That's a pretty big point in the article. Read my previous in-depth explanation:

    http://www.fool.com/investing/general/2013/07/10/a-solazyme-...

    Maxxwell

  • Report this Comment On October 01, 2013, at 4:24 PM, EmFetch267 wrote:

    Your other article did not list a single reason why my possible capacity numbers could not be met. I encourage everyone to read it as it says nothing other than than 100% capacity wont be met, which I fully agree. But 67%? 75%? 83%? Prove me wrong.

    Why arent you addressing my other points as well? Its convenient to ignore the nutrition revenue when you rather show the lower fuel revenue isnt it? Im out of here. Trying to talk to you is a waste of my time.

  • Report this Comment On October 01, 2013, at 5:17 PM, TMFBlacknGold wrote:

    @EmFetch267

    If you add up the numbers above it amounts to 75% of final nameplate capacity over the first 12 months of operation -- and it still doesn't work. My table provides an overly optimistic scenario that is likely not very realistic. We can probably already push production back at least one month (October), so cumulative production falls from 63,334 MT through December 2014.

    On your other points: I don't see sales of biomass (a waste stream) really fueling sales in any significant way. It adds value, but not much. Further, let's see if management can truly expedite its progress in nutritionals without a dedicated facility. With only 2,500 MT of nameplate capacity planned at the former SRN facility, how much more is the market willing to bear on such short notice? Secondary points in the big picture for 2014.

    Since I don't see analysts providing explanations for their numbers and price targets I thought I would use my technical knowledge to close the gap. You don't have to agree, but we'll have a better gauge on production soon enough.

    --Maxxwell

  • Report this Comment On October 01, 2013, at 5:45 PM, centerroad wrote:

    @EmFetch267

    "Prove me wrong"

    -The weight of historical evidence proves you wrong, every other company in this industry has had major start up problems.

    -Szym has stated 12-18 months until full capacity, so tell us why we should estimate them higher than their own projections.

    -Putting a higher price per tonne than their current deals makes no sense, those deals are far lower than projections. Further, they are supposed to be one month from start up but have deals in place for only a small fraction of capacity.

    -What value should be established for the Clinton facility? They have one small deal in place with Twinlabs as an additive for a minor product, after their former partner Rochette completely backed away from commercialization. We can't ascribe high revenue numbers without demand present, especially after an obvious rejection by Rochette.

    -I haven't seen anyone put a value on the used algae, care to offer a case for it being worth anything?

    - Joint venture accounting looks like you are throwing up a red herring, the deal with Bunge looks straight forward with a split of profit after operating costs.

  • Report this Comment On October 01, 2013, at 6:13 PM, dennyinusa wrote:

    This is why wall street analysts are not to be listened to.

    Company may miss some earnings estimation set by some idiot analyst who pretends he knows the internal workings of a company he’s not employed by, what a job, guess what the earnings of the productive people of society should be quarter to quarter.

    I thought the idea of someone predicting the future was debunked centuries ago.

  • Report this Comment On October 01, 2013, at 6:45 PM, TroyCash wrote:

    I too would like to see more articles like this one. Also thanks to "centerroad" for adding some interesting insights as well. I think SZYM may well prove a great investment but only after reality sets in.

  • Report this Comment On October 03, 2013, at 8:13 AM, centerroad wrote:

    The petulant cheerleader stomped across the street and looked like a prima donna having a tantrum.

    He didn't even have the courage to use his real name.

    " Im out of here. Trying to talk to you is a waste of my time."

    To put some more perspective on this, Kevin made a lying personal attack on me as well when I criticized szym, saying I was recommending a short when they were at 7, when in fact the record is quite clear, I recommended short when they were at 12, right before they went to 7.

    His excuse when I called him on it was as unprofessional as his other actions regarding this stock. I hope this conversation continues because there is a lot more to this situation, and it does not reflect well on szym to have him as their carnival barker.

  • Report this Comment On October 07, 2013, at 1:25 PM, techpatriot wrote:

    The article is thought provoking but the title is childish histrionics. There is no "doom" here. There is only progress, and as you rightly pointed out, the prognosis of just how much progress will be made next year varies wildly. I'm good with that. Most clear thinking investors are expecting the greater revenue ramp up to be in 2015 or 2016 (I am leaving most "analysts" out of that crowd on purpose.

    What is also clear is that they are in the process of proving the scalability of their processes and concepts, and the proof of that means much more than the revenue they will derive from that ramp up.

    Once they prove they have commercially viable and scalable disruptive technology in their IP, this train will leave the station very rapidly.

    Today is a good buying opportunity....not a fear of "doom" kind of day.

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