Shares of Solazyme (SZYM) have taken an absolute beating in the past 6 months, down approximately 45% as of Friday January 18th's close. For those unfamiliar with the company, SZYM engages in the production of renewable oil with a focus on chemicals and fuels, nutrition, and skin and personal care markets. SZYM's proprietary technology transforms a range of plant-based sugars into oils. Its renewable products could replace or enhance oils derived from petroleum, plants, and animal fats. SZYM's industrial biotechnology platform harnesses the prolific oil-producing capability of microalgae. Its biotechnology platform also helps in the production of bioproducts, which are made from the protein, fiber, and other compounds produced by microalgae. SZYM utilizes industrial fermentation equipment to scale and accelerate microalgaes' natural oil production time to a few days. It focuses on selling renewable oil as drop-in replacements for marine, motor vehicle, and jet fuels, as well as replacements for chemicals that are traditionally derived from petroleum or other conventional oils. SZYM also develops microalgae-based food ingredients, including oils and powders that enhance the nutritional profile and functionality of food products, and a portfolio of microalgae-based products for skin care and develops algal oils as replacements for the essential oils used in skin and personal care products.
One strength to SZYM's renewable oils is that its oils address many of the challenges associated with traditional oils, such as limited supply, unpredictable and fluctuating pricing, as well as deleterious environmental effects. SZYM's tailored oils offer significant compatibility with existing production, refining, and distribution infrastructure in each its target markets.
According to the company's website, SZYM highlights the greatest market needs where its technology platform can be employed and include specifically fuels, chemicals, nutrition, and skin and personal care markets, as described above. More information regarding each of these market areas is described below, highlighting the potential of an investment in the company's stock.
Global demand for alternative fuels is expanding due to population growth, increased attention to energy security, and environmental policy mandates. One tailwind for SZYM's products related to fuel and energy is the recent 2011 EPA regulations on renewable fuel standards setting volume requirements at 1.35 billion gallons of advanced biofuels. The EPA renewable fuel standards and recent modifications to the regulations can be found here. Further, SZYM management has reminded us several times that the U.S. Navy's goal is to operate at least 50 percent of its fleet on clean renewable fuel sources by 2020. Achieving this objective will require a significant use of biofuels, which SZYM stands to contribute to significantly.
The industrial and petrochemicals are another oil market SZYM is targeting as this subsector is estimated to be $611 billion of the oil market. In addition, attractive opportunities exist in the chemicals derived from fats and natural oils. In 2009, about 9 million metric tons of palm kernel and coconut oils were consumed globally for food and industrial applications such as laundry detergent, soap, and shampoo. SZYM's oils can be tailored for these markets and represent significant opportunity. Major contracts in place to develop these oils for this market are in place with Unilever (UNLV) and Dow Chemical (DOW) as both companies have placed major bets in this market niche.
Skin and personal care
SZYM is specifically targeting the global skin and personal care market with its tailored oils, a market sector that SZYM estimated to be $323 billion. SZYM is attempting to produce makeup, hair care and skin care products. SZYM has developed skin care products and signed distribution deals with Sephora International and Sephora USA (privately held), and QVC shopping network, a wholly owned subsidiary of Liberty Media (LINTA). What SZYM brings to the table in this market is their own branded products, such as Algenist.
SZYM believes the packaged food industry is actively seeking more natural, sustainable sources of fiber and healthful fats without compromising value, quality, taste, or nutrition and thus SZYM believes its oils can fill this niche in various ways. SZYMS customized oils can be formulated specifically to improve the shelf-life properties of food products. SZYM has partnered with Roquette Freres (privately held), a French company which produces more than 650 by products from the starch extracted from corn, wheat, potatoes and peas, to launch Solazyme-Roquette Nutritionals, a joint venture which seeks to commercialize a whole host of microalgae based food ingredients.
What caught my attention?
The first time I had heard of this company was when Jim Cramer featured it on his CNBC program Mad Money, back on March 9th, 2012. Cramer explained the basics on how it uses microalgae to transform plant matter, specifically sugar, into tailored and specialty oils. He further described how it can replace anything from petroleum, to plant oils as well as how the company can tailor its products to improve upon existing oils. Given that it was still a very early stage company with no profits whatsoever and not much in the way of sales, I chose to add it to my watch list. Given there are a ton of potential applications for what they do in a host of different end markets, I was instantly intrigued by the company's prospects. However, I had not decided to really consider a position, until now.
Why consider SZYM now?
On January 16th SZYM issued a press releases detailing that along with its partner Bunge (BG), a financing arrangement was reached with a development bank to borrow about $120 million to fund a commercial scale renewable oil facility in Brazil. At the market open that next morning, shares were obliterated, dropping nearly 10% on news of an offering of convertible senior notes set to be claimed in 2018. Two days later on January 18th, the specific terms of the agreement were announced. The price of the conversion notes were set at approximately $8.26 each with a fixed interest rate of 6% and will mature on the first day of February in 2018. Further, the development bank has the option of purchasing another $10 million of convertible notes in the next 30 days.
SZYM intends to use the proceeds of the offering to a cover the bulk of project related costs and capital expenditures as well as for general corporate purposes. It stands to reason that the price of shares should at minimum converge around the price of the convertible notes, and does not even take into account future sales or future contracts the company will have. Thus from the current price of $7.25, shares should be reasonably expected to gain at least 14% from current levels to converge to the note offering price. However, I think the company has much more potential than this. The company had approximately $165 million in cash and short-term equivalents as of September 2012 according to the balance sheet. The addition of $110 million to $120 million will raise the cash SZYM has on hand to $275 million to $285 million (the latter figures assuming another $10 million of notes are purchased).
SZYM's most recent quarterly performance
Some highlights from the most recent quarterly earnings report:
- SZYM entered into a new commercial capacity agreement with Archer Daniels Midland (ADM) with production schedule to begin in 2014.
- SZYM was on schedule with BG and the Roquette capacity build outs
- The company's Peoria, IL facility is now producing and delivering multiple tailored oils to customers.
- Created a new tailored oil profile which was a high value algal butter to serve as a cocoa butter replacement.
- Algenist, SZYM's skin product expected to double revenue in for the year over year 2012 versus 2011.
- SZYM's Soladiesel fuels piloted and available at multiple cities in California.
- For the quarter, SZYM had revenues of $8.6 million - $3.8 million from products and $4.8 million from research and development programs.
- The company incurred costs and operating expenses of $28.0 million resulting in a net loss of $19.4 million - this mainly reflects the company's efforts at expansion and increasing capacity toward future production and future revenue growth. I see this investment as very positive for shareholders, as future revenue growth will be rewarded by Wall Street in the form of a higher share price.
As products come to market, I would expect to see improvement in the quarterly performance of the company in the next year or so. I will be watching the Q4 report closely which is expected to be released on or around February 18th.
While SZYM is still incurring losses stemming from its investment and expansion endeavors, it is taking the appropriate steps to reach future revenue growth and profitability. The product line that SZYM is involved in has demand, given the desire for renewable fuels, a growing beauty business and an expanding world population which will require extensive investment into nutritional sciences. SZYM has pioneered an industrial biotechnology platform that harnesses the prolific oil-producing ability of microalgae and this unique business approach once perfected could require little up-front costs and thus feed the bottom line of the company in years to come.
A process that used to take months in the past, SZYM's standard industrial fermentation equipment allows the company to efficiently scale and accelerate microalgae's natural oil production time to just a few days. With the recent offering of convertible notes to raise a significant cash position, SZYM is working toward its goal of becoming the global market leader in the design and production of renewable oils and bioproducts. While I have sat on the sidelines watching the company's developments in the past year, I believe now is an excellent time to initiate a long position in the company. In the long-term the company's efforts to expand capacity will pay off in the form of higher revenues and profits. In the short-term, I expect the company to appreciate at least 14% to return to its senior note offering price. Overall, the company shares are a buy, both for a short-term trade and certainly a long-term investment.