Industrial biotech pioneer Amyris (AMRS) appears to have successfully walked a risky tightrope in the last year to deliver some impressive gains to shareholders. The stock is up 80% year-to-date and up 104% since completing a reverse stock split in June 2017 that reduced the number of shares outstanding by a factor of 15.
Appearances are one thing, the details tucked away in financial filings are another. Investors that dig deeper into the business will likely come away with more questions than answers. That's especially true considering that the company's independent auditor prepared its annual report while casting "substantial doubt" on the business' ability to continue operating.
How is that possible if revenue is growing and the share price is increasing? Does Amyris have a sound business model?
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The business model, explained
Amyris is an industrial biotech company. That means it utilizes micro-organisms to convert a substance of lesser value (usually sugar) into a product of higher value. It's similar to petrochemical manufacturing (lower value crude oil is upgraded to higher value chemicals), just with renewable materials and living organisms.
In the past, there wasn't a robust supporting technology ecosystem in place for industrial biotech companies to lean upon. That forced Amyris to vertically integrate much of its business, meaning it had to become an expert in everything from genetically engineering organisms to manufacturing chemicals at commercial scale. Those specialty areas require two different mindsets and knowledge bases, and the company didn't execute well. It showed. By the end of 2017, it had an accumulated deficit (the sum of all losses incurred since inception) of $1.2 billion.
That helps to explain why the company has transitioned to its current, simpler business model. Today, Amyris only focuses on engineering organisms capable of producing a chemical for a specific partner, while the partner then has to worry about manufacturing and how the chemical is used. In other words, the company is narrowing its operational scope in an attempt to leverage its strengths and build a sustainable business.
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The business model hinges on two key points of value creation. First, Amyris generates collaboration revenue for hitting milestones during development, which offsets a portion of R&D expenses. Second, profit sharing royalty revenue is generated from sales of a partner's product that incorporates an ingredient developed by the company. This is where the great majority of its value is generated. Or, that's the idea anyway.
While there are plans to develop and commercialize flavors, fragrances, vitamins, and sweeteners under the current business model, so far no commercialized products have hit the market. That means no royalty revenue is being generated under the profit share agreements in place -- the most important part of the current business model. Unfortunately, much like putting a potential drug through clinical trials, there are no guarantees that Amyris' R&D will result in products on the market when all is said and done.
The risks inherent to this business model were on full display in the fourth-quarter of 2017, as were other red flags investors shouldn't overlook.
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Red flags to consider
In the final quarter of 2017, Amyris reported $57.5 million in royalty and licensing revenue, compared to just $15.8 million in all of 2016. Management offered the impressive growth as proof that its profit share business model was working as planned. But that's not at all what happened.
Instead, the entire fourth-quarter 2017 category came from two one-time transactions. Amyris agreed to sell its manufacturing facility for $27.5 million and its Brazilian subsidiary overseeing the facility for $30.6 million, both to partner and major shareholder DSM.
Liquidating assets is not a sustainable business move, nor is it the same as royalty revenue from the sale of commercialized chemical products, despite being reported in the same revenue category. Wall Street seemed to overlook that significant detail when full-year 2017 earnings were announced. It's not the only red flag investors should be aware of.
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Accounting shortfalls: Amyris admitted that it has uncovered a "material weakness in [its] internal control over financial reporting". In other words, there was reason to believe that it had been misstating its financial numbers in reports filed with the SEC. This further demonstrates that its business model may not be doing quite as well as the high-level numbers seem to indicate.
History of missing guidance: Amyris has been the poster child of "overpromise, underdeliver". For instance, the company originally guided for $90 million to $105 million in revenue for 2016, but only managed to deliver $67 million.
Runaway dilution: The reverse stock split was necessary because Amyris became a little too fond of issuing shares to fund operations over the years. The transaction reduced the number of shares outstanding from 286 million to just 19 million. But it didn't last long. The total number of shares outstanding at the end of 2017 -- just seven months after the reverse stock split -- stood at almost 50 million.
So although the stock has gained 104% since the reverse stock split, the company's market cap has risen 389%. In other words, shareholders lost out on even better gains due to continued dilution.
Toxic balance sheet: Amyris has long struggled with debt, and lingering doubts about the viability of operations forced its independent auditor to issue a "going concern" warning. A suffocating level of debt at the end of 2017 resulted in a sobering statistic: the company's debt and liabilities exceed total assets by $200 million. The business needs to deliver incredible growth in a short span to clean up its balance sheet, significantly dilute shareholders, or both.
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Avoid this biotech stock
Amyris appears to have convinced Wall Street that it has turned a corner. It helps that the profit sharing business model has become pretty popular among analytical companies in the field of synthetic biology, including more reputable start-ups Ginkgo Bioworks and Zymergen.
While these three companies are becoming experts at rapidly designing organisms, few designer microbes have led to commercialized ingredients, much less those capable of generating significant revenue. That's a problem since failing to get chemicals on the market means there won't be much profit to share. Despite the hype, the fact is that the profit share business model is largely unproven and may not work for any company.
In addition to an unproven business model, Amyris has several other notable red flags that investors shouldn't overlook. An ongoing accounting issue, a history of missing guidance, a lack of being straightforward with shareholders, and runaway dilution should provide enough cause for investors to avoid this biotech stock.
