April is nearly in the books, and renewable oils company Solazyme (SZYM +0.00%) has yet to announce that its manufacturing facility built with feedstock supplier Bunge (BG 1.60%) in Moema, Brazil, has initiated operations. The announcement heralding start-up was expected this month after the commissioning of downstream oil separation equipment, but investors are still awaiting an official update. While it's possible everything is on schedule for the facility that will sport an annual nameplate capacity of 100,000 metric tons, there are a few very logical reasons investors would want to prepare for a delay.
Source: Company Presentation
First, Solazyme just completed a massive offering of debt notes and common stock that will give it roughly $300 million at the end of the second quarter. That could be used for any number of reasons, including an expansion of manufacturing capacity, but it may have been raised as a cushion for manufacturing problems at Moema. Second, the company has never operated a commercial scale facility, and certainly not one as large and complex as what is planned in Brazil. The process scheduling for such a massive facility -- using 625,000-liter tanks for the first time -- presents many potential sources for problems. Third, biology is difficult to scale. Some misinterpreted my earlier effort to characterize the problems encountered in the industry to date, but industrialization isn't about scale (volumes of the tanks); it's about reproducibility.
Couple the quick thought experiment above with the interesting schedule of events in the next week (Solazyme announces first quarter earnings on May 5, while Bunge holds its first quarter conference call on May 1), and investors may want to consider what it would mean if the companies have experienced a delay. Here are three potential consequences.
1. Expansion of manufacturing capacity and product partnerships could be halted.
Does Solazyme have enough cash on its balance sheet to push through potential problems at Moema? It's very likely. Is it reasonable to assume the company has enough cash to push through potential problems and court partners for manufacturing capacity expansion? Again, that is also very likely. Those aren't the only concerns investors should have, however. Not all potential delays at Moema would have to be technical in nature, but technical delays could result in a bigger headache for Solazyme and investors than, say, personnel or permitting issues.
Depending on severity, potential expansion partners could decide to wait things out before committing to a manufacturing joint venture or facility. The same could be true for companies eyeing Solazyme's renewable oil products. There would be little incentive to ink a supply deal with Solazyme and Bunge if there was uncertainty surrounding the ability to reliably produce goods. Then again, if problems are dealt with quickly, or relatively quickly (sometime in 2014), then Solazyme's strong cash position would certainly help it recover any lost ground.
2. Solazyme Renewable Oils may go unconsolidated in 2014.
Moema will have an annual nameplate capacity of 100,000 metric tons, although ramp-up will take 12-18 months. Investors are well aware of that. However, investors are still in the dark about what needs to occur for Solazyme to consolidate the joint venture with Bunge and reflect sales from the facility on its own income statement. Rather than occur at start-up, consolidation is tied to production milestones achieved during ramp-up. We cannot yet answer questions such as "what are the conditions?" and "when will the conditions be achieved?", but a start-up delay could jeopardize the ability to meet those milestones in 2014.
Source: Solazyme.
With production volume heavily weighted toward the end of ramp-up, it seems reasonable to ponder the ability to meet consolidation milestones in the event of a delay.
3. Wall Street revenue estimates invalid (again).
I am 1,000% sure that the average Wall Street estimate for 2015 revenue for Solazyme will be lowered -- even if Moema begins production in the next several days or weeks. However, things get interesting for 2014 estimates if Solazyme and Bunge encounter a delay. I believe the margin for error to meet the current revenue estimates of $117 million for this year would be incredibly small if Moema begins operations in the beginning of May. A delay would almost certainly make that figure unattainable due to lost product sales (compared to previous start-up dates), the potential for unconsolidated results from the Solazyme Renewable Oils JV, and wary customers.
Source: Solazyme.
Additionally, delays at Moema have the potential to delay cash-flow positive and profitable operations for Solazyme by several quarters or more. Similar to production volume, the optimal margins will only begin to be achieved in the second half of ramp-up activities. How would Wall Street react to such risks to the company's income statement?
Foolish bottom line
Please don't misconstrue my analysis of the fallout from a potential delay at Moema as a bearish sentiment -- I'm simply helping investors objectively consider the consequences of a delay. As you can see, it may not be as simple as pushing through problems with a strong cash position. Nearly $300 million in cash at the end of June will help, but manufacturing partners and customers don't care about Solazyme's balance sheet, they care about how reliably it can produce goods. So, what news will break about Moema? We don't know yet, but we will soon. Sit tight.
