A Warning for Biofuel Investors

It's hard to believe a company producing and selling shark liver oil and low-friction tire rubber could be telling a story that we've already heard before, but Amyris' (NASDAQ: AMRS  ) tale is one not unseen in the bio-product industry. Like a poorly written novel, Amyris' financial ups and downs have followed storylines already seen across the industry from both successful and failing companies. Will this version of the story have a happy ending?

How quickly we forget
Amyris recently announced a new round of financing at a low interest rate, and investors responded by bringing shares up over 15% since the announcement. If the plan to sell $75 million of convertible notes with a 6.5% interest payment, convertible to shares of the company at a $3.74 conversion price, turns out to be the nudge that gives Amyris the momentum needed to reach its goals of becoming cash flow positive in 2014 and profitable in 2015, then investors will see gains far exceeding the 15% realized since after the announcement.

However, if this round of financing comes up short, the dilutive effects on stockholders, the need for further funding, and the fears of bankruptcy could have Amyris falling apart quickly. It is these issues that had shares of Amyris trading back at the pre-announcement prices only ten days later.

The market has responded very similarly in the past to similar news from Amyris and other biofuel and emerging technology companies. On the brink of bankruptcy, KiOR secured last-minute funding that brought up shares of the company over 110% in under a week in late March, only to make the seemingly inevitable fall back down to pre-financing levels less than two months later. While shares may not have dropped from their low in late March, dilution has left investors with less value for their holdings and a still unrealized improvement in the future outlook.

In general in the industry, the further a company is from bankruptcy a company, the more negatively the market will look upon convertible notes, knowing that every dollar of additional financing steals from the upside of the company. Solazyme (NASDAQ: SZYM  ) has suffered through a hefty sell-off following the announcement of new shares being offered in April that increase the overall share count by 20%. Investors undoubtedly see potential in Solazyme as they continue to invest in facilities and production ramp-up, but dilution does nothing for the short-term value of the company unless it can translate quickly to profit.

The financing arrangement announced by Amyris, if all of the offered notes are taken up and converted to shares, would increase the number of outstanding shares by over 30%. In other words, the financing agreement reached by Amyris that was received positively by the market could cause greater dilution than the agreement reached by Solazyme, toward which the market responded negatively. The difference isn't due to Amyris being closer to profit or having more upside than Solazyme, but rather due to the speculative nature of both of these companies. The need for financing was perceived to be greater for Amyris than it was for Solazyme, and relieving insolvency fears was enough to bring up Amyris' value whereas Solazyme financing was seen as dilution without the same psychological payback for investors.

The thesis doesn't change
Profitable companies rarely need special financing, and the positive market response to new financing agreements show how speculative Amyris and other biofuel companies really are. Essentially the market is excited by the prospect of the company not going bankrupt. That is not to say that Amyris and similar companies will not be successful. One can think of new financing agreements as the necessary impetus for emerging market companies to realize their best-case scenario of ramping-up production and transitioning to profitable operations. The worst-case scenario is that the company never turns a profit and eventually goes bankrupt.

The most realistic hope lies somewhere in between the best-case and worst-case scenarios, where the return to investors is delayed and diluted each time a company takes on more debt. The big issue investors need to keep in mind is whether the additional resources that new financing may make available are worth the dilution that comes with the funding. Like always seems to be the case in biofuels, the prospect of big rewards inherently brings with it big risks.

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