VeraSun Dawns

"Power to the people." It's an old saying, steeped in Communism, but soon to become capitalism manifest.

Sometime next week, America's people will get a chance to invest in a pure play on the nation's latest, greatest hope to break our "addiction to oil," with the market debut of the first of three ethanol companies that have filed to go public. VeraSun Energy's claim to fame -- in addition to being first to the public markets -- is that with the exception of agro-giant Archer Daniels Midland (NYSE: ADM  ) , it's the nation's largest producer of ethanol, controlling 5% of the production capacity in the U.S. That's a whopping 230 million gallons per annum. Thus, once it goes public next week, the firm will be the largest "pure play" on ethanol available to investors.

In the following weeks, we'll see the advent of No. 2 and No. 3 "pure players" Hawkeye Holdings and Aventine Renewable Energy. Speaking of Aventine -- wasn't this supposed to be a story about VeraSun? But in the hours since I started typing, Aventine, too, has also set a tentative price range for its shares. While one column discussing two companies wasn't what I intended to write, this is actually a good thing, because it lets us play a game of compare and contrast. Let's get to it.

Middle of pricing range

Shares outstanding after IPO

Market cap

VeraSun

$19

77.3 million

$1.5 billion

Aventine

$39

42.8 million

$1.7 billion



Who's selling now?
When VeraSun goes public next week, it will sell 11 million shares for its own account, generating about $209 million in proceeds before paying the fees incidental to the IPO. After fees, VeraSun expects to put about $191 million in the bank. Simultaneous with VeraSun's new share offering, current shareholders will offload 6.2 million shares to the public. According to the firm's S-1 filing, once the IPO has taken place, the firm will have 74.7 million shares outstanding.

That would give the firm a market cap of $1.4 billion, if things ended there. But considering the fever pitch that ethanol investing has reached in this country, and the likely strong demand for the shares once they're offered, we have to consider also the possibility of an "overallotment."

Ordinarily, when a firm goes public, it offers its underwriters the option of buying additional shares at the IPO price (which you'd expect the underwriters to take the firm up on, if the IPO is successful). In VeraSun's case, though, the overallotment option wouldn't raise extra cash for the company. Underwriters Morgan Stanley (NYSE: MS  ) and Lehman Brothers (NYSE: LEH  ) will be buying as many as 2.6 million extra shares directly from their current owners.

Add those to the pot, and we're most likely looking at 77.3 million shares outstanding after the IPO, and a market cap of $1.5 billion. Expect more if the shares are priced toward the top of their range, more still if that range is raised at the last minute in response to strong demand, and perhaps much more if the IPO is successful and the shares rocket in price.

Aventine says, "Me, too"
Now, let's look at Aventine. The No. 3 pure-play ethanol producer expects to charge $37 to $41 per stub for its shares. According to its S-1 filing, Aventine will issue 7.7 million shares in total; the company will issue 6.4 million, while 1.3 million will come from existing shareholders who are cashing out.

Once the dust has settled on the IPO, 8.9 million shares of "AVR" should be available for trading by investors, out of 41.6 million shares total. But as with VeraSun, Aventine and its underwriters expect to see strong demand. Underwriters Bank of America (NYSE: BAC  ) , Friedman BillingsRamsey (NYSE: FBR  ) , and Goldman Sachs (NYSE: GS  ) may acquire as many as 1 million additional shares from the company and 200,000 from current owners, or 1.2 million total. Thus, our post-IPO total share count should work out closer to 42.8 million, giving the firm a market cap of $1.7 billion if it prices at $39 per share.

Door No. 1 or Door No. 2?
At this stage, the choice seems obvious. The "No. 1" pure play in ethanol is pricing itself $200 million cheaper than the "No. 3" pure play. But that's just the price. What about the value?

Market cap

Revenues

P/S

Earnings

P/E

VeraSun

$1.5 billion

$236.4 million

6.3

$0.2 million

7500

Aventine

$1.7 billion

$935.5 million

1.8

$32.2 million

53

All data derived from the firms' S-1 filings. Data refer to end-of-year 2005 results.

From this perspective, what initially looked like a pricey Aventine actually seems far cheaper than VeraSun on both a price-to-sales and a P/E basis. But something doesn't look quite right here. VeraSun is supposed to be the No. 1 pure play, right? So why is Aventine selling so much more stuff?

The answer is revealed in Aventine's S-1. Aventine doesn't just produce ethanol; it also markets and distributes ethanol that other companies produce. Combined, Aventine distributes about 14% of all ethanol currently produced in the U.S.

But not for long
Also revealed in Aventine's S-1 (and echoed in the "risk factors" section of VeraSun's S-1) is this little tidbit: "Two of our alliance partners (VeraSun Fort Dodge, LLC and VeraSun Aurora Corporation with annual ethanol production of 230.0 million gallons) have elected not to renew their marketing alliance agreement with us upon termination on March 31, 2007." That's right, folks. Aventine may distribute 14% of the nation's ethanol today, but come next year, VeraSun will be taking more than a third of Aventine's business in-house.

What's it mean to the potential IPO investor? Things are very much in flux with this industry, and with these companies. An investor in VeraSun can't simply ask how big VeraSun is, how quickly it can expand, and whether the IPO price is right. That investor also needs to wonder how well VeraSun can manage the transition to distributing its own products without Aventine's help.

Conversely, the investor in Aventine needs to understand that the valuations shown above, while true today, are bound to change within the next year, when Aventine loses a third of its business to a freestanding VeraSun.

Moral of the story: Tread carefully here, Fools. As much as investing in ethanol sounds like a "lock" right now, there are more variables, and more risks to the businesses, than meet the eye.

Further fuel-ish Foolishness:

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Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool is investors writing for investors.


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