Be a Solazyme Bull for the Right Reasons

Investors love companies that disrupt the status quo and have the potential to deliver high growth to shareholders for many years into the future. Industrial biotech company Solazyme (NASDAQ: SZYM  ) certainly fits the bill, with its renewable oils platform capable of creating specialty chemicals, nutritionals, cosmetics, fuels, and more. The company is uniquely positioned to tap into the corporate world's increased focus on sustainability and attract investments from the biggest players in a multitude of industries.

Petri dishes of microalgae at a Solazyme research laboratory. Source: Solazyme

Nonetheless, a lot of misconceptions exist about the near-term direction of Solazyme and the timeline on which it will be able to meet its goals. Its growth is undeniable, but silky smooth execution on the road to full-scale commercial production is far from guaranteed. Therefore, I've attempted to provide clarification on three of the most common misconceptions about the company and redirect the focus of investors to better align with realistic expectations.

Solazyme doesn't need to scale to profit or execute its business plan. Additionally, the company will begin to hit its target margins in 2014.
This is a clever argument used to dismiss risks associated with ramp-up, but it isn't true. It is crucial to operate the largest fermenters possible to minimize costs associated with logistics, transportation, input, equipment, construction, and overhead. Perhaps the company states it best: "We will not succeed if we cannot maintain or decrease our production costs and effectively scale our technology and manufacturing processes."  

Solazyme has stated that it believes it needs to reproduce its process in 625,000-liter fermenters to achieve maximum margins in each target market (down from 750,000-liter tanks estimated at the time of its IPO). Solazyme will use its first commercial-scale facility in Moema, Brazil -- built with partner Bunge (NYSE: BG  ) -- to attempt to achieve steady state operations in 500,000-liter fermenters for the first time. Similarly sized fermenters will be employed at its second commercial-scale facility in Clinton, Iowa, currently being built with partner Archer Daniels Midland (NYSE: ADM  ) . Essentially, neither facility will be optimized to achieve the margins in the target markets below, although they should come awfully close:

 

Fuels and Chemicals

Nutrition

Skin and Personal Care

Target average selling price*

>$2,000

>$2,500

---

Target gross margin

>30%

>40%

>60%

Source: Solazyme *per metric ton

Second, neither Moema nor Clinton will achieve their maximum margins until nameplate capacity is reached in mid-2015 and late-2015, respectively. So don't freak out if financials from the first and second quarters next year don't align with the margins above. Can Solazyme scale down its ambitions if 500,000-liter fermenters don't work? Absolutely, but it would deal a blow to revenue and margins, especially since the largest-volume bioreactors operated at steady state to date have been 128,000 liters.

Investors should instead focus on: Successfully reaching commercial-scale operations has proven difficult for the entire industry, but I'm cautiously optimistic Solazyme will be able to cross the hurdle, thanks in large part to its demonstration-scale facility at Peoria. I'm still not convinced everything will go smoothly, however. Investors focused on margins should be on the lookout for announcements concerning ramp-up progress at Moema and Clinton in the coming quarters, which will guide margins for each facility. There's also the eventual inevitability that margins will be improved with new, more robust microalgae strains. Additionally, future facilities will use knowledge gained at the first two commercial facilities to make the leap to the next size of fermenters -- further improving profitability.

Production of nutritional products will drive Solazyme's growth in the near term.
Management stated it would attempt to accelerate the commercialization of nutritional products after the company's nutritional joint venture with Roquette was dissolved earlier this year. In addition to exploring the possibility of installing the processing equipment required for such products at Moema and Clinton, Solazyme is converting the 1,820 metric ton (MT) Peoria facility to produce nutritional products beginning in early 2014. While production and selling prices will be affected by a ramp-up period, average selling prices are expected to eventually hit and exceed $5,000 per MT. Even assuming Peoria produces 1,820 MT of product at those prices next year, sales would amount to just $9.1 million -- a small contribution to the overall production and revenue picture.

Investors should instead focus on: The key drivers to Solazyme's growth will be target markets with high volumes and moderately high selling prices. Finding the right product mix to maximize revenue growth is the tricky part. Cosmetics are incredibly valuable, but the market doesn't support high volumes. Nutritional products have a larger market, but the company has yet to develop strong interest in its portfolio, and expanding production at larger facilities is not guaranteed in the short term. Investors should be on the lookout for commercial sales agreements for lauric and oleic oil profiles, which have a combined annual market size greater than 4 million MT and selling prices as high as $3,000 per MT. If you're focused on nutritional products, then be on the lookout for the construction of a dedicated facility in the coming quarters and years.

Solazyme will be able to convert waste streams from manufacturing facilities into value-added revenue streams in the near-term.
This will be an important long-term goal for the company and could drastically improve the margins achieved in each target market -- reaching heights even higher than those in the table above. The hope is that Solazyme will be able to convert algal biomass created in its process into additional products. Unfortunately, commercializing waste streams will be expensive, competitive, and simply not an early focus for the company.

A patent application published earlier this summer describes Solazyme's intention to eventually develop microalgae biomass into thermoplastics, paper, adsorbants, and absorbants. It doesn't make much sense for the company to throw scarce resources at developing such products, nor does a viable commercial partner seem to have jumped at the opportunity. Why not? Each product is entrenched in a highly competitive market that isn't favorable for smaller, marginal players to enter. Consider the pulp and paper industry, which ironically has large operations in Brazil thanks to its massive eucalyptus plantations.

Procter & Gamble's largest North American manufacturing facility in Mehoopany, PA sources eucalyptus pulp from the South American market. Image source: P&G

While larger companies can afford to ship pulp around the world, many mills are swimming in locally sourced pulp. In fact, the industry has been hammered by incredibly low margins in recent years, which has forced many mills in Canada, Upstate New York, and the Pacific Northwest to close their doors. Solazyme would simply not be able to produce enough waste algal biomass to be a worthwhile partner for a major paper company anytime soon. The same would likely apply to additional waste stream products.

Investors should instead focus on: Solazyme and ADM have actually stated that Clinton will have an initial nameplate capacity of 20,000 MT of renewable oils or dried biomass equivalent. Should Solazyme not fill the capacity with oils, it may be forced to explore these offshoot revenue streams sooner rather than later or sell biomass as animal feed and other products that require minimal processing. I'm not sure if that's necessarily a great thing for margins (traditionally, biomass is at the bottom of the gross margin chain), but it would aid the company in commercializing waste streams at all of its locations. 

Foolish bottom line
At the end of the day investors should be focused on the long-term growth potential of Solazyme. However, the next several quarters will be absolutely critical in dictating the path the company takes in realizing its potential. If it, too, slips in achieving commercial-scale operations on the timeline and at the volumes promised then certain longer term goals could change dramatically or be put on hold altogether. I am still looking to begin a position before the end of the year, but I will play it by ear before building the position substantially. Next week we'll look at three incorrect assertions from Solazyme bears and attempt to redirect the bearish conversation to facts. 

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Read/Post Comments (18) | Recommend This Article (15)

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 21, 2013, at 5:01 PM, centerroad wrote:

    You've barely scratched the surface of the margin squeeze. When one connects the dots from their signed customers to the world price for the products szym will replace, the margins disappear.

    I don't see one, not one, of their signed customers who will pay $2000/ton in bulk (twinlabs is not bulk). The constant referrals to the company's own fanciful projections for $2500 to $5000/ton sales prices simply do not match current real world data regarding the products they are about to produce, based on their current customers. The hook that they someday might be able to achieve the higher prices for more complex products is unsubstantiated, they are in research and development agreements with large companies who can afford to throw money at a long shot, very common. In the meantime they will sell low margin products.

    Further, their supposed high margin food line has flavor problems, that's why they have no customers. Although they have made progress from completely unpalatable as stated by their own employees, it's obvious (lack of customers) they have a ways to go. And its now clear Roquette will be a direct competitor instead of an ally, which, considering there has been no lawsuit regarding the technology after their split, and Roquette is marketing their own algae flour, it calls into question the value of the szym patents.

    Finally, the constant referrals to ADM made by szym officers and the bulls is disingenuous and misleading. ADM is not a customer nor is it involved in product development. Their relationship is to lease the Clinton facility, assist with production technology , and if szym ever makes anything worth selling, assist with marketing.

    I have no position in szym.

  • Report this Comment On October 21, 2013, at 5:58 PM, EmFetch267 wrote:

    That was certainly accusatory, mr no position!

  • Report this Comment On October 21, 2013, at 7:56 PM, centerroad wrote:

    @emfletch

    Hi Kevin-

    How's the szym biomass to paper business going?

    Are you done counting up every stick of butter in the world and implying szym will replace it?

    Lol.

    Please rip my little thesis apart, I'd appreciate it, but I fully understand you can't.

    As for my position, it just seems like I'm short when stating the facts, countering all the baseless cheerleading you like so much.

  • Report this Comment On October 21, 2013, at 8:26 PM, taxiqnotincome wrote:

    Seems to me that the author in his previous article developed a cogent theory that the company would be missing analyst estimates for 2014 by a wide margin (albeit because the company has greatly reduced its expect ations). In that case, the reasonable thing for an investor (not necessary a bull or bear) to do is sit out the rough period and enter when the market is calling a bottom . . . the number of shares bought can substantially greater.

    Position: avoid for now, the market will force the company to prove it can produce those margins (and perhaps even some profits).

    gl

  • Report this Comment On October 21, 2013, at 8:27 PM, EmFetch267 wrote:

    What you smokin, son? If you had some real data to disprove - it might be worth my time. Fool on, Edward! Try again, chump change

  • Report this Comment On October 22, 2013, at 12:37 AM, TheDinger wrote:

    Thanks for a thoughtful article, Maxx. SZYM has a disruptive technology, and while investors can see the potential, history teaches that some technologies (and some companies) fail to own up to that potential.

    [ Love the image of the Petri dishes. A nod to Invandertag: One of 'em dishes looks like chicken fat. ]

    Approach investing SZYM as like a farmer: Temper your expectations. Exercise considerable patience. And pray for good growing conditions.

  • Report this Comment On October 22, 2013, at 12:38 AM, TMFBlacknGold wrote:

    @centerroad,

    Customers will pay whatever the market bears for Solazyme's oils, which will be over $2,000 in some cases. There is no disputing that.

    Perhaps there is a reason to be bearish based on current sales agreements, but the company does have time to sign more. Solazyme could likely fill 4Q13 production with Unilever alone. No reason to bash the company based on current sales agreements.

    Solazyme has hinted at ongoing debates with Roquette in its SEC filings, but until something materializes I'm not sure I would hold my breath. It is a little questionable why there hasn't been more activity on that front, however.

    I'll have to side with Kevin/Emfetch on this one.

    --Maxxwell

  • Report this Comment On October 22, 2013, at 11:54 PM, centerroad wrote:

    Of note to investors-

    Neither motley fool or seeking alpha writers (emfetch) provided cogent arguments discrediting my comments above, which include:

    - the world price of products szym will replace in their signed agreements being below $2000/ton

    -the direct competition from Roquette

    -their lack of food line customers

    -ADM is not a customer and not involved in product development

    However, Kevin did remind us he's young and inexperienced, unable to deal effectively with counter arguments. I'd suggest being careful reading his public relations reports.

  • Report this Comment On October 23, 2013, at 7:24 PM, centerroad wrote:

    Now we're finally getting just a bit of honesty.

    Kevin has raised his production cost from the $1000/ton hes been using found here, just a few months ago:

    http://seekingalpha.com/article/1244181-rising-cocoa-bean-pr...,

    ,

    to $1400/ton in today's public relations release.

    Although his range of sell prices is lower than Maxx's, falling below the $2000/ton at the low end to $1500/ton, he has stated repeatedly the low end range is not applicable, szym will sell above the $2000/ton mark, he believes.

    He and Maxx like to fill space with projections of cocoa butter at $3600/ton and Murisic oil at $3000/ton, with sugar plum fairies in their food line at $5000/ton. Unfortunately none of those products are anything more than a gleam in a researcher's eye.

    Signed contracts look like they are replacing products at $1500-$1800/ton. Using the $1400/ton production cost, I repeat what I've been saying for months,

    "Margins will be shockingly narrow"

  • Report this Comment On October 24, 2013, at 10:44 AM, TMFBlacknGold wrote:

    @centerroad,

    Thanks for the input on margins. I simply use whatever the company projects in its presentations at investor conferences. Whether or not those are realistic remains to be seen, I don't think they are for the next year or so. As you mention, a lot comes down to market forces.

    Additionally, Kevin Quon likes to make projections without taking a big picture view. Each oil profile will have a different production cost. The amount of fatty acid (the actual product) differs for each oil profile, as does yield on a given mass of sugar. Therefore, it's impossible and factually incorrect to say all oils will be made at $X per MT.

    --Maxxwell

  • Report this Comment On October 25, 2013, at 2:40 PM, centerroad wrote:

    The plot thickens.

    Although yields are going to determine production cost, we can all agree there is a baseline, it takes x amount of sugar to produce a simple gallon of oil. In the companies own filings they have stated it take 6600 lbs of sugar to produce one ton of oil.

    (thanks to 8621971 over at sa for pointing this out, he's a sharp cat, invite him over here)

    With sugar at .19/lbs, and the five year average around that price, the baseline cost to produce any oil, in sugar cost alone is $1254/ton. Its fair to point out there will be some savings being located at a sugar facility, and some potential uses for leftover algae, but there are many other expenses as well, including the cost of other inputs, operating cost, amortization, etc..

    At the end of the day, the $1400/ton baseline looks too low, possibly by a lot. So where has the company been getting their $1000/ton figure?

    In other bad news, more insider selling this week, quite a bit, and still no insider buying for months.

    Worse, we've heard no positive news from the Vegas Baker's convention in early Oct. where szym had a booth. Where's the customers?

    Even nastier, at that gig Roquette was featured on video for an industry mag. touting their algal flour, and mentioning they were in a legal case with szym.

    That's right, bring on the lawsuit. Is this going to be a GEVO instant replay? The founder who wrote the patents leaves the company shortly after Roquette broke the deal, selling his stock along the way, and that is a bad coincidence. But now there's more to the story, while everyone has been using the words biotech, gene splicing type of jargon, which makes the patents strong, I go digging and find they are instead, at least in part, stressing the algae to produce oil profiles and that is a whole other ball of wax, the patents are going to be weaker in that case, in my layman's view, a lot weaker, stressing processes are a lot easier to bypass than creating genetically modified algae like a new strain of yeast.

    Finally, is it just me not reading correctly but wasn't the Bunge facility supposed to be up and running for testing in October? Tick...tick...kevin, my projections you trashed are haunting you already.

    HAPPY HALLOWEEN!!

  • Report this Comment On October 25, 2013, at 11:49 PM, centerroad wrote:

    The insult to injuries keep coming.

    The insult:

    Bunge just reported a major loss in their sugar milling division, blamed on the continual low cost of sugar plaguing the market. The low cost has been a serious profit killer industry wide, and Bunge is threatening to shutter capacity.

    It doesn't take a genius to understand how this works. The low cost of sugar causes losses, weaker players close up until the market tightens and prices rise. We are now at that critical stage.

    As I've pointed out, szym is paying $1254/ton in sugar costs per ton of oil, even a small blip in the price of sugar to .23/lbs raises their cost to $1500/ton of oil minimum. Brutal.

    The injury:

    I'm sure any long investors reading earlier were apoplectic over my hyperbole "sugar plum fairies" in the food line, banking on $5000/ton for food products.

    In today's Biofuels article about Bunge, clearly stated,

    "Bunge posted $2.395 billion in edible oils sales, representing 1.692 million tons of product sold at $1,415 per metric ton."

    How are those margins looking now?

  • Report this Comment On October 28, 2013, at 9:43 AM, RogerKnights wrote:

    Centerroad said:

    "Finally, is it just me not reading correctly but wasn't the Bunge facility supposed to be up and running for testing in October?"

    No, that was Clinton, IA.

  • Report this Comment On October 28, 2013, at 9:46 AM, RogerKnights wrote:

    Centerroad said:

    "while everyone has been using the words biotech, gene splicing type of jargon, which makes the patents strong, I go digging and find they are instead, at least in part, stressing the algae to produce oil profiles and that is a whole other ball of wax, the patents are going to be weaker in that case, . . . ."

    All their algae are stressed, both GMO and non-GMO, to make them produce the maximum oil. "Instead" is incorrect.

  • Report this Comment On October 28, 2013, at 9:52 AM, RogerKnights wrote:

    Centerroad said:

    ""Bunge posted $2.395 billion in edible oils sales, representing 1.692 million tons of product sold at $1,415 per metric ton."

    "How are those margins looking now?"

    ----------

    I presume that was for palm oil. Solazyme isn't planning to compete head-on with raw palm oil, IIRC.

  • Report this Comment On October 28, 2013, at 9:59 AM, RogerKnights wrote:

    Centerroad said:

    "And its now clear Roquette will be a direct competitor instead of an ally, which, considering there has been no lawsuit regarding the technology after their split, and Roquette is marketing their own algae flour, it calls into question the value of the szym patents."

    Roquette's algae flour, like Solazyme's, is based on non-GMO algae, to which Solazyme's patents mostly don't apply. Solazyme said that its' own IP returned to it after the split. As for a lawsuit, it's a bit soon for that to be filed, only a couple of weeks after Roquette's move into the market.

  • Report this Comment On October 30, 2013, at 1:57 PM, TMFBlacknGold wrote:

    @RogerKnights

    "As for a lawsuit, it's a bit soon for that to be filed, only a couple of weeks after Roquette's move into the market."

    There is actually an ongoing lawsuit and dispute between Solazyme and Roquette, from my understanding. In a worst case scenario Solazyme will not be able to commercialize its products on the timescale provided. Keep an eye out for information during the company's 3Q13 conference call next Tuesday.

    --Maxxwell

  • Report this Comment On November 04, 2013, at 12:36 AM, centerroad wrote:

    @RogerKnights

    In order:

    1) Latest guidance calls for 4th q. startup for Bunge, with product to be shipped at the start of 2014. Two months left.

    2) The point is their process is non gmo, so they can get the product to market faster, but their process does not have a lot of patent protection, specifically with the case of Roquette.

    3) No that wasn't just for palm oil, palm oil is actually $800/ton right now, szym doesn't have a shot at that market. The Bunge oil price just one of several examples I've mentioned where bulk edible oils trade at a significant discount to szym expectations.

    4) Maxx has now posted a link to the video mentioning the legal case. Further, szym specifically said the breakup was due to szym wanting to speed production and Roquette wanting to take more time. We now find Roquette has accelerated production and is ready to come online at years end.

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