Solazyme's Long-Term Value Provides Opportunity Through Misconception

| About: TerraVia Holdings, (TVIA)

As an innovator of renewable oils, Solazyme (SZYM) exists in a niche industry that can effectively influence the supply chains for a multitude of sectors in the global economy. The company has developed the world's first carbohydrate-to-oil technology platform. This has allowed not only for the replication of existing types of oils, but has given the company an accelerated research edge into the creation of tailored oil profiles, which are useful to the industry, but simply do not exist in nature. With an inherent first-to-market advantage, Solazyme's untapped potential has been developed alongside the growing demand for renewable alternatives for crude oil. Yet as the company begins to enter into a production phase, Solazyme now faces one of the most challenging aspects of its new life as a public company -- the shortsighted investor.

Through The Eyes Of The Bear

For traders and investors who have been trained to act upon trends, historical data, and operational performance, Solazyme mistakenly appears to be an attractive target for those looking to short the company's stock. As seen in the graphic below, revenue growth has not only appeared to slow, but even retract when broken down on a quarter-by-quarter basis. From a cursory glance, this would stand out as a big warning sign to those unwilling to dive deeper into the details. As a growth company in a new industry, revenue growth remains one of the most important factors for a solid investment. This apparent setback is further compounded by the fact that the company's assets have also steadily declined over the years at an increasing pace. Additionally, analysts currently project that Solazyme will have a net loss of $1.33 per share by the end of December 2013.

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Conceptually, the company has also erroneously and often frequently been associated as "just another start-up biofuel company." As it stands, biofuel companies carry the negative connotation of first generation failures such as that found in the example of once prominent VeraSun Energy. Additionally, Solazyme bears the burden of advanced biofuel company failures such as that found in the recent example of Amyris (NASDAQ:AMRS). To make matters worst, the biofuel sector itself has been under attack on a political scale that has done little to bring about investment capital or investor confidence.

The Deception of Myopia

But for all the erroneous thinking of the mainstream investment base, the accuracy of the present situation remains hidden to those operating on the fallacy of relying on imperfect representations of Solazyme's performance. Let us first take a look at the issue of revenue growth. Rather than looking solely at the picture of total revenues, investors would get a better picture of the reality by breaking them down further, as seen in the graphic below.

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In the present, the company solely remains restrained by lack of available of manufacturing capacity. This challenge exists as Solazyme leaves the development stage of having to prove the technology and now finds itself in a rapid construction phase of building the facilities needed to commercialize it. The necessary capital expenditures and lengthy time of construction have also been the reason for the falling asset totals and prolonged lack of profitability.

Therefore, what makes the above distinction in revenues so important is that the product revenues have continued to increase under triple digit growth. On the other hand, the stale and recessionary trend in R&D revenues is largely due to the nature of one-time milestone payments and the scaled-back programs of the U.S. Navy as it endures the aforementioned political backlash. Yet from a performance standpoint to which the company should be held accountable, Solazyme has continued to progress under strong growth conditions.

The conceptual mistakes of the investment community have also served to negatively associate Solazyme to a loose batch of supposed peers found in Amyris, Gevo (NASDAQ:GEVO), and KiOr (NASDAQ:KIOR). Despite an accurate association of linking the company to conversion technology, the fact remains that Solazyme is errantly linked to a group of poor comparables that are only loosely correlated by their technology concepts. As explained in the article found here, each of these companies has vastly different technologies and outputs. None of the supposed peers have the capabilities of creating tailored oils or share the same technology risks as Solazyme. Yet one thing each of these companies do have in common is that they have all pursued the development of renewable biofuels.

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SZYM data by YCharts

The mistaken concept that these companies are alike has hurt Solazyme, as seen in the trending prices found in the graphic above. This has occurred despite having never missed a milestone and actually demonstrating increased success in obtaining quality partnerships. Yet the failure of Amyris to scale up its yeast fermentation technology is automatically associated with fears of Solazyme as it scales up its algae fermentation technology. This unfortunately comes despite distinctly different organisms, growing conditions, and contamination possibilities.

Likewise, the association with biofuels is what has brought about the same condemnation to Solazyme as it has to the perceived peer group. In many ways, a company like VeraSun and its subsequent failure as a first generation biofuel play still negatively affects Solazyme as an advanced biofuel play. Both are seen as having the same issue of using a food feedstock. This ignores the fact that Solazyme uses a low-cost feedstock that can be sourced from multiple waste materials that are becoming ever more available through advancing technology. The biofuel connection has also scared away investment capital in light of political volatility, despite the fact that Solazyme is first and foremost an oil company.

This association has also largely discounted the innovation capabilities of the company. Because investors seem to immediately think of fuel first when they hear of Solazyme, they largely dismiss the high-margin earnings power linked to the goal of introducing revolutionary products to the company's target markets of food, chemicals, and skin and personal care. Many see the likeliness for "mass-produced commodity" when they should really be thinking "high-margin monopoly." In fact, the company has already begun to demonstrate its capabilities, as seen in the article found here.

Ultimately, the inability for investors to accurately view the company with regard to its long-term future potential can be seen in the falling share price. Since its IPO in late May 2011 at $18/share, Solazyme has fallen over 58% as of November 29, 2012 to $7.45/share. This was despite clear disclosure at the time by management that the company wouldn't be profitable for several years. They also noted that company progress should be judged by its commercialization accomplishments and partnership successes. Yet despite expanding its opportunities and showing no failure in these areas, Solazyme and its falling stock price remains a reminder of what happens when an industry falls out of favor. Ironically, the company now stands priced at a level that far underperforms a fair valuation of its future when one considers what lies ahead.

Providing A Financial Outlook of Tomorrow

There are many difficulties that come with attempting to quantify the future value of Solazyme. Because the company is developing so many years out and operating across multiple industries with a wide range of profit margins, the numerous factors involved in the calculations could make for a large margin of error. The company's flexibility in product mix also makes it difficult to know with certainty its future revenues. This in itself often dissuades investors from pursuing a rational assessment of the company's future earnings power.

What further complicates the issue is the complex subsidiary system being developed through multiple joint venture relationships. The charts below therefore illustrate the earnings potential of the capacity being introduced rather than being representative of actual company earnings that are to be expected. For the sake of illustrative simplicity, I've included their capacity as a expression of how the revenues would have been attributed to the parent company were they to be merely allotted on the basis of ownership interest. In conducting the following analysis, I've also taken the liberty of including several assumptions that others may not have considered or even agree with:

  1. I anticipate that the company will announce another upstream partnership for 100,000 metric tons in order to reach its original goal of 550,000 MT by the end of 2015.
  2. I also assume that the recently announced expansion with Bunge (NYSE:BG) will result in two additional facilities of 100,000 MT. Despite the original goal of 550,000 MT by 2015 and plans to expand the Bunge plant capacity to 300,000 MT by 2016, I've also made the assumption that an unforeseen delay will mean that one of these plants will come online in early 2016.
  3. Additionally, I've also made the assumption that the company will continue to be build out its production capability into 2016 and that this will result in 200,000 MT of additional capacity divided into two plants of 100,000 MT each. I've anticipated that neither of these plants will have a full year of operation by the end of 2016. I believe this reflects a more accurate picture of 2016's earnings potential rather than believing the current growth plan comes to a halt in 2015 just as the company's technology gains widespread approval. I also believe that the company will be in a much better financial position at this time, and would be willing to assume full ownership over the aforementioned capacity.
  4. Included in my calculations were the introduction of possible co-product revenues that are likely to be announced over the coming years. Investors need only to search through existing patent applications to see that several are likely in the process of being developed. One such possible development could be read in my article found here.
  5. Each of these plants is expected to take about a year after construction to scale up to its nameplate capacity. As a result, I've heavily reduced the presumed production capacity used in a given year in order to accommodate for this time period.
  6. I also expect Research & Development programs to increase in the coming years, despite its current trend. As the company's technology gains acceptance, it will be able to tap into this increased interest to further develop products with its partners. On the other hand, this also increases the cost of such R&D.
  7. Last of all, I expect dilution to be a seemingly inevitable necessity in order to scale up in a timely fashion and at a strong pace. As a result, I've accounted for approximately 10 million shares by the end of 2013, with cash flows to support additional projects going forward.
Plant # of Metric Tons JV Ownership % Capacity Attributed To Solazyme
Peoria 1,800 100% 1,800
SRN 55,000 50% 27,500


50% 50,000
Clinton 100,000 100% 100,000
Bunge #2 100,000 50% 50,000
Bunge #3 100,000 50% 50,000
Expected Plant #1 (TBA) 100,000 50% 50,000
Expected Plant #2 (TBA) 100,000 100% 100,000
Expected Plant #3 (TBA) 100,000 100% 100,000
TOTAL 756,800 529,300
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The data used to come up with my estimates are partially derived from the target margins provided by the company, as seen in the graphic below. While the company is likely entitled to incentives and subsidies, I've avoided including them here in my calculations. As a reminder, these figures are representative of my opinion only and derived using my best estimates based on the information made publicly available. They may include assumptions that prove to be inaccurate and should be not solely relied upon as the primary basis for any investment decision.

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When we take a look down the road, we see that Solazyme has actually established a pathway for a very strong outlook. The company has already secured multiple partners capable of taking its technology to the next level and is accomplishing this through 50-50 joint ventures. Starting in 2014, the company is likely to become profitable and will continue to grow at an accelerated rate. The expected EPS is likely to vary depending on product mix, but the company has asserted that chemicals and nutrition remain a high priority in the coming future.

Overall, Solazyme is a difficult company to fully understand. This in itself has likely discouraged many investors from fully seeking to understand the earnings power and growth potential that lies in store for the company in a relatively short amount of time. In the midst of poor associations and a general distrust of new technology, Solazyme continues to make steady advances with some of the most reputable leaders in their respective industries.

The recent drop of the company's stock suggests that there is little reason to expect shares to securely hold their value. Yet the value at its current prices is appearing to seep out, as witnessed by the latest insider purchases. Investors should also bear in mind that the rapid growth to follow in the coming years is also capable of driving significantly high investor interest whenever it is recognized. The company holds onto unique technology in a relatively unexplored field that is rapidly growing in demand. For those willing to invest into a solid trend, Solazyme presents a long-term opportunity that currently remains masked behind numerous distractions in the present.

Disclosure: I am long SZYM, BG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.