Why Renewable Energy Group Bought out Tyson Foods, Inc in This Fuels Venture

A worker evaluates equipment at the Dynamic Fuels renewable diesel facility. Source: Syntroleum Corporation

If you were just going off the headlines, then you may be scratching your head as to why the nation's largest biodiesel producer made a deal with a company that produces 20% of all chicken, beef, and pork in the United States. You would have to dig a little to deeper to understand the true importance and consequences of the agreement that would allow Renewable Energy Group (REGI) to purchase the 50% interest of Tyson Foods (TSN 0.61%) in a 75 million gallon per year renewable diesel facility. While the acquisition will only be triggered under certain conditions, it would be another key catalyst for the long-term growth plans of Renewable Energy Group.

The (overly complex) pending acquisition
Renewable Energy Group will purchase Tyson Foods' 50% ownership position in Dynamic Fuels if and when it finalizes the acquisition of Syntroleum Corporation -- held up since being announced in December -- which owns the other 50% of the venture. When Syntroleum shareholders vote on accepting the acquisition on June 3, Renewable Energy Group will start with 800,000 "yes" votes from Tyson Foods (part of the deal). So investors need to familiarize themselves with the terms of two separate acquisitions for the same renewable diesel facility, which can be summarized as follows:

• To acquire all of the assets of Syntroleum Corporation, including its half of the Dynamic Fuels venture, Renewable Energy Group will shell out shares with a net value of approximately $46 million. Unless, of course, new terms are agreed to at closing. 
• To acquire Tyson Foods' 50% ownership position in the Dynamic Fuels venture, Renewable Energy Group will pay, at closing, $18 million in cash and an additional $12 million to fund repayment of Tyson's debt related to the project. Tyson Foods will also receive up to $35 million in production milestone payments through the end of 2026.
• Renewable Energy Group will also be required to replace the letter of credit Tyson Foods obtained to capture $100 million in Gulf Opportunity Zone Bonds used to pay for the renewable diesel facility. The biodiesel producer will need to do so by the end of 2014 and may use any combination of cash and/or public or private debt financing.

In all, Renewable Energy Group will need to pay at least $46 million in stock to acquire Syntroleum, $18 million in cash to Tyson Foods upon the closing of the Syntroleum acquisition, an additional $12 million in either cash or stock to repay Tyson Foods' indebtedness, a potential cash payment or debt raise (or a low-cost financing deal with no immediate impact) to replace Tyson Foods' letter of credit, and an unknown amount to get the 75-mgy renewable diesel facility running again. The known figures total $76 million in immediate financing, which represents about $1 per gallon of fuel at nameplate capacity. Is it worth it?

Renewable diesel > biodiesel
There's a lot of confusion about renewable diesel and biodiesel, so let's clear that up. Renewable diesel is not the same as biodiesel. It's chemically similar to petroleum diesel and thus, more compatible with automobile, truck, and airplane engines. It qualifies for higher value Renewable Identification Numbers, or RINs, on a per gallon (volumetric) basis, which are sold to ensure blenders meet their required volumes of renewable fuels each year. But it is granted the same $1.00 per gallon tax credit as biodiesel. Consider the following comparison of renewable fuels:

Source: Renewable Energy Group SEC Filings, author's calculations

The chart above explains why oil refiners decided to purchase biodiesel RINs instead of ethanol RINs to meet their volume requirements as they approached the nation's Blend Wall for ethanol: Doing so helped them meet their obligations more quickly. It also explains why renewable diesel has been selected as a growth market for Renewable Energy Group -- it's more valuable than biodiesel.

The company would generate the same number of RINs from its pending 75-mgy renewable diesel facility as an 85-mgy biodiesel facility, which could be worth an extra $5 million-$10 million per year based on the recent range of RIN prices. In addition to a boost in RIN values, renewable diesel can be sold to a broader customer base, soon to include the massive aviation industry, than biodiesel. The acquisition would boost the company's nameplate capacity by nearly 30% from 257-mgy today to 332-mgy -- not to mention swipe away one of its potential competitors.

Source: Renewable Energy Group

I'll admit the potential acquisitions make me a little uneasy because this assumes Syntroleum Corporation's problematic-to-date technology will work. However, I trust management at Renewable Energy Group to not waste money on a lame-duck platform (it surely validated it before making an offer). On that note, the acquisition seems to be a no brainer for the long-term value creation.

Let's assume Renewable Energy Group pays up to $100 million to purchase 100% of the facility and get it to steady state operations ($76 million in known costs, $24 million in estimated unknown costs). It would be spending $100 million for 75 million gallons of annual renewable diesel production, or $1.33 per gallon. In 2013, the company generated $1.5 billion in revenue from selling 259 million gallons of biodiesel, or $5.78 per gallon.

It's a simplified way to view the acquisition, but it sure makes a lot of sense when you consider the value potential. Granted, the Blender's Tax Credit was in place last year and has yet to be reinstated this year, but there is no reason to believe it won't be reinstated in the near future.

Foolish bottom line
It's important to note that Renewable Energy Group and Tyson Foods have a substantial relationship already in place: The company sourced 83% of its feedstocks from animal fat, used cooking oil, and inedible corn oil in 2013. Tyson will continue to supply the Dynamic Fuels facility through its rendering (animal fat) business. The only thing that changes is the ownership of the facility, which would be completely owned by Renewable Energy Group. Investors are still in the dark about if or when the acquisitions will close, but I believe they can create substantial long-term value and growth if or when they do.