Can Solazyme Inc Successfully Scale Biology?

Solazyme (TVIA) recently announced that it had started ramping commercial operations at its first industrial scale facility in Clinton, Iowa. The biorefinery will sport an annual nameplate capacity of 20,000 metric tons of renewable oils or biomass equivalent within the next 12-18 months, while a larger 100,000 metric ton facility in Brazil is expected to start-up in the first quarter; perhaps any day. Investors cheered the patiently awaited news and shares shot over 30% higher on Friday as those betting against the company raced to cover short positions.

Start-up is an important milestone for Solazyme. It brings the company one giant step closer to generating hundreds of millions of dollars in annual revenue and proving its platform to various industries around the globe that could benefit from the disruptive technology. However, investors may be wondering if the company can hurdle obstacles associated with commercial operations faced by fellow industrial biotechs such as Amyris (AMRS -46.43%) and Gevo. There are obvious differences between each platform and Solazyme boasts key advantages, but one underlying obstacle unifies them all: the ability to scale biology.

Biology. It happens.

Synthetic biology holds a tremendous amount of promise to transform the manufacturing of foods, chemicals, materials, and more; shifting the challenge of producing commodities from finding resources to programming DNA. While the field has enjoyed several high-profile successes to date, entrepreneurs and industry watchers are careful not to over-hype their technologies. Why? Despite all of the potential, our limited understanding of how organisms work makes biology a difficult thing to scale.

Experiments and processes that work in academia may not be commercially viable -- from economic or engineering standpoints -- relegating them to lab trick status. Since we're talking about three companies that are already ramping production at commercial facilities, we'll assume they've passed that litmus test. But that doesn't mean they've succeeded in scaling biology or even understanding their platforms.

A worker stands next to the holding tanks at Amyris' facility in Brotas, Brazil. Industrial scale fermenters loom in the background. Source: Amyris

Buying, designing, and modeling the function of DNA is easier and cheaper than ever before. Amyris can screen 100,000 unique combinations of microbial genomes each month and has screened over 3 million unique strains since 2005 on the quest for advantageous traits to incorporate into its industrial strains. While scientists and engineers can tinker with genetic codes on a scale never before imagined, there is still no way to ensure the result will be industrially robust microbes that will perform as designed with the processes and equipment in the ground. Not yet, anyway. 

The difficulty of scaling biology (i.e. technology) is an important drawback of industrial biotech that investors need to acknowledge because it directly affects a company's ability to execute (i.e. business). Amyris and Gevo have learned that lesson the hard way.

Importance of execution

Amyris, the first synthetic biology to hold an IPO, captivated early investors with its potential to produce drop-in, premium fuels and a range of other high value products with its industrial biotech platform. The company had already created a successful process for producing artemisinic acid, the precursor to the most potent malaria drug available, in yeast and had raised over $150 million as a private company. Why wouldn't success be replicated for farnesene, the company's renewable hydrocarbon building block molecule, and fuel markets?

CEO John Melo led the charge to build two commercial scale facilities in Brazil. While investors waited for construction to be completed, Amyris would produce large quantities of farnesene at several contract manufacturing sites in the United States and Spain. Melo, the former president of U.S. fuel operations at BP, believed his company could produce at least 6 million liters of farnesene by 2011 and at least 40 million liters by 2012 -- chump volumes in the oil industry. That set expectations high for investors, but microbes don't care about Wall Street.

When Amyris' process finally moved to 200,000 liter fermenters in Brazil -- before the completion of its first facility in Brotas -- it was unpredictable. Sometimes it worked, sometimes contamination (introduced from feedstock and made worse by less-than-robust yeast strains) got in the way. The unsustainably high costs of toll manufacturing exacerbated the problem of spreading resources across multiple construction sites. Amyris and its shareholders were in for a reality check.

Amyris expected to be fueling buses and planes with renewable diesel and jet fuel by 2012. Then biology happened. Source: Amyris

In 2012 and 2013 the company hit bottom; burning through cash, diluting existing shareholders through several offerings, pausing construction at its largest facility with partner Usina Sao Martinho, and running into production problems shortly after start-up at Brotas. Melo learned from the experience, later admitting "The regret is not realizing how hard it was to get the scale up."

Biology is difficult to scale. Amyris has now learned that lesson. Although the company has burned through piles of cash for its mistakes, it has made big strides in production and development. It will take several years, but when the company's first two commercial scale facilities reach nameplate capacity, Amyris will have between 100,000 MT and 120,000 MT of annual production capacity. With Brotas alone, the company expects to reach cash flow positive operations this year and profitability in 2015. 

Can Solazyme scale biology?

Shares of Solazyme popped on the news of start-up at Clinton and the shipment of the first truckloads of product -- and will likely move higher when Moema start-up is announced -- but the company still needs to prove it can execute in 2014. Production volumes and product margin will be laughably small for the first six months of ramp-up activities at each facility, which is the most likely time for potential obstacles to arise. Couple that with past obstacles in scaling biology and I find it difficult to agree with Cowen & Co. analyst Rob Stone who told investors, "Startup problems have hampered many peers, so this news should be a significant trigger."

Peers haven't had problems with start-up -- the announcement just made by Solazyme -- but with the ensuing ramp-up. Consider the uncanny parallels between the press release from Solazyme and those of fellow industrial biotechs. Gevo announced that it had produced its first commercial batches of isobutanol in July 2012, stating:

We are pleased with the progress to date in our initial start-up campaign. We've shown that we can successfully ferment isobutanol in large (250,000 gallon) commercial fermenters, isolate the product and get it into tanks and railcars. The learnings gained in achieving this milestone are enormous and further derisk our technology.

A little over two months later, the following press release from Gevo hit the news wires:

To date, we have proven we can produce bio-isobutanol, and do it on a commercial scale-years ahead of the competition. This start-up is very typical of other start-ups we have done: you have to learn a lot in a very short period of time, both what works well and what needs to be adjusted. Early indications are that, while we are making significant progress toward economic production levels, we will not achieve our desired year-end run rate-instead we would expect to achieve that during 2013.

While we have made significant progress toward economic production levels, we have decided to optimize certain specific parts of our technology to further enhance bio-isobutanol production rates... In order to maximize cash flow, we believe it makes more sense to temporarily shift to ethanol production.

Gevo continued to run into issues and unscheduled downtime in 2013, but is looking for a solid year of production ahead. Meanwhile, Amyris followed in December of 2012 by starting production at Brotas. The simultaneous closing of a financing round dampened the news, but a future announcement spoke of the first truckload of products being shipped (the industry's minimum requirement for bragging rights?):

This initial shipment marks the successful completion of our start-up activities. We have operated multiple tanks without contamination or surprises through several production runs during the first month of operation.We are now focused on ramping up Biofene production and delivering product to our customers, from renewable diesel for bus fleets in Brazil to squalane emollient globally and soon a range of specialty chemical applications.

The company successfully brought all six-200,000 liter fermenters online in the second quarter of 2013, but still encountered drawbacks during ramp-up. Melo informed investors of the obstacles during the quarterly conference call:

I'm pleased to report we now have all six fermenters operational. Yet, the second quarter was challenging as we dealt with the remaining start-up issues at the plant and methodically worked through the full ramp-up and dealt with all the expected fermentation issues of contamination and regular disruptions.

Looking back at ramp-up problems encountered by unrelated platforms doesn't mean Solazyme is doomed to failure, but it's a humble reminder that the company's announcement of start-up doesn't take that much risk off of the table. Nonetheless, there are numerous reasons to be optimistic about the company, which boasts several advantages heading into ramp-up that Amyris and Gevo did not.

First, the company is loaded with cash and has maintained a conservative cash burn rate. That means investors won't have to worry about share dilution in the event that ramp-up hits a snag -- a benefit that should not be understated. Consider where each company's cash and short term investments stood (roughly) at the announcement of start-up.

Source: SEC filings

Solazyme burns about $20-$23 million each quarter, which means it likely had about $165 million at the end of January (assuming commissioning and start-up costs didn't inflate the total slightly). That's good news; the company will need that cash to pay for increased costs of running two commercial scale facilities as it races to cash flow positive operations.

The second thing to consider is the host organism utilized by each platform. Solazyme is programming algae to produce oils, whereas Amyris and Gevo are programming yeast to produce farnesene and isobutanol, respectively. Yeast and E. coli may be the most widely used fermentation organisms in the world, but Solazyme may face slightly less risk with its algae. Without knowing the proprietary details of each biocatalyst (organism), I'll go out on a limb and say it's easier to engineer an industrially robust algae strain to produce oils -- something algae naturally produce within their cell walls -- than it is to engineer industrially robust yeast for producing farnesene or isobutanol. Why?

For each platform's organism(s), new genetic material has to be added to the biological machinery already present to optimize the production of molecules. It seems as though Solazyme can take advantage of more naturally occurring puzzle pieces initially, although Amyris has made tremendous progress in better understanding its yeasts since its initial failures. Nonetheless, that may explain why Solazyme can utilize roughly 500,000 liter fermenters versus the 200,000 liter fermenters at Amyris, or why Solazyme expects ramp-up to take just 12-18 months versus 36 months at Amyris and BioAmber. I wouldn't expect future facilities to take that long for any company, but Solazyme is clearly cruising compared to others in the industry.

Foolish bottom line

Amyris and Gevo faced different obstacles while attempting to execute on their business and technology goals, but the similarities affect all companies pioneering synthetic biology platforms for industrial biotech applications. Despite what Wall Street analysts say, start-up means relatively little in the way of derisking a platform. It's the execution of ramp-up that matters. While Solazyme investors shouldn't get too excited just yet -- and consider how much short covering had to do with the share spike -- the company's strong financial position and its ability to take advantage of more naturally occurring genetic machinery could hint at a smoother road to commercial production than those traveled by peers. We'll have to patiently wait for the results to trickle in over the next 12 months, but Solazyme remains perhaps the most Foolish stock to own that I know.