On February 20, renewable oils innovator Solazyme (SZYM) released its quarterly earnings results. Despite meeting the company's own forecast, the results fell short of the average revenue and earnings expectations from analysts. In the prior conference call, CFO Tyler Painter stated that the company expected to hit $44 million for 2012. This was executed upon as Solazyme ended the year and met its own expectations with $44.1 million in revenues.
Despite these met expectations, those placing any undue emphasis on the earnings were quick to react. By the next morning's open, Solazyme's stock quickly fell 7% on the news but ended the day only down 3% on above-average volume. Such a poor read on the results appears to stem from a lack of understanding as to what they reflect. After all, such reports have a lack of relevance when pertaining to the future state of the company's operations.
As it stands now, the company is largely a research and development enterprise combined with a rapidly growing retail cosmetic brand. Yet with production capacity now underway in being built, Solazyme is transforming into becoming a global supplier of value-added oils and bioproducts. The company's technology is able to improve on existing supply chains and produce products capable of replacing and improving a wide spectrum of oils derived from petroleum, plants, and animal fats.
However, with a market capitalization of $513 million, it's clear that a 7% drop suggests the market is still thinking on a short-term basis neglecting the long-term potential that is now being realized. The company now carries about $260 million in cash and has total assets of about $328 million. While its joint venture with Bunge (BG) has received a favorable $120 million loan from the Brazilian government, the company of Solazyme itself virtually carries no long-term debt. Presently, the company has defined a pathway to become cash-flow positive by 2014, and above all its technology continues to scale accordingly as it also improves.
Building Upon The Win-Win Scenario
Solazyme has already built an impressive portfolio of partnerships with leading companies in their respective field. These same partners have also largely backed their interest in these relationships with a financial - or asset-related commitment. Indeed, the real focus of the latest conference call revolved around the value that the company is able to provide for these partners and how these relationships can benefit Solazyme. Armed with the unique "win-win" proposition, what investors appear to continually undervalue is the fact that companies are beginning to wholly embrace what Solazyme's platform is capable of accomplishing.
Just a little over a year ago, Solazyme was still expressing in its conference calls a very different story. Around this time, management was stating that potential partner companies were only beginning to distinguish the unique capabilities that the company had to offer. This was a reference to understanding Solazyme's ability to control carbon chain lengths, saturation levels, and functional groups in order to manufacture unique oil characteristics with higher margin capabilities. At the time, low-margin fuels were still the talk of the town as the company advanced its relationship with the U.S. Navy and received a letter of intent from United Continental Holdings (UAL) to buy 20 million gallons of oil per year from Solazyme.
Yet growing recognition of these higher value capabilities were already in motion. In late 2011, Unilever (UN), signed an expanded commercial development agreement for tailored oils. By mid-2012, Dow Chemical (DOW) initiated its own contingent offtake agreement for tailored oils used for dielectric fluids. Towards the back end of 2012, Archer Daniels Midland (ADM) signed a development agreement for tailored oils. Bunge also expanded its relationship to include tailored food oils. In early 2013, Mitsui & Co. (MITSY.PK) initiated a development agreement for a portfolio of tailored oils.
Development On An Accelerated Schedule
The one trend that continues to grow is that partners are pursuing more complex value-added products from Solazyme. What makes this so intriguing is that these products are all oils with traits that are unable to be found anywhere else. To appreciate the speed at which these products are being developed, let us consider the capabilities of the competition. As a developer of genetically modified seeds capable of producing new plant oils, Monsanto (MON) states the following on their website found here:
"On average, companies typically invest between $50 million to $100 million and spend approximately 8 to 10 years in order to bring a biotechnology product from concept to reality. Additional time and expense is often required to produce breeding stacks."
On the contrary, let us consider what Solazyme's management stated in the most recent conference call. In his prepared statements, CEO Jonathan Wolfson had the following to say about the company's speed in development:
"In under 12 months, we identified a high valued potential oil, made rapid progress in developing it to a point where it delivers a far superior composition to existing oils in the market, and announced a funded development partner that is one of the world's major players in that market area."
In clear contrast to conventional oilseed developers, Solazyme has created a platform that is proving capable of bringing to the market oils with specialized purposes. In many instances, it is what is inside the oil that imbues additional value. If the world's most productive oil for myristic acid comes in the form of coconut oil and palm kernel oil, imagine the margins Solazyme may be able to fetch for increasing this amount by more than 200%. What if it was able to increase it by 400%? The thought becomes less theoretical by the day.
Maximizing Value In Production
It is ironic that the company has faced criticism for the lack of off-take agreements when the demand for its products is clearly high. Indeed, part of the beauty for a "value first" approach might very well lie in being the on-demand supplier for added-value products. Let us not forget that there is more than enough demand in the fuels market alone to exhaust current supply if need be. But when you have multiple partners with unique customized oil solutions being developed and having very limited supply available, one has to wonder if merely locking down that supply arrangement is the wisest business decision to make. Wolfson stated the following during the last conference call in response to a question from an analyst:
"On its face, the volumes of these non-binding agreements is actually larger than the capacity we'll be having online for awhile. One of the really important value propositions for our platform is the ability to produce a variety of different tailored oils with different value propositions. And that means that we can use the diversity of product to increase our margin opportunities."
Take a minute to think about that. How does one increase margin opportunities through the diversity of added-value products? In the end, it's deciding when to manufacture what that the increased margin opportunity comes about. Part of the value of Solazyme's process is about staying flexible in supply. Part of it is also about being prudent in addressing the highest demand.
In part, this is also why Mitsui & Co.'s relationship with Solazyme marked another improvement in partner comprehension. Just as Bunge later extended its relationship to include tailored oils thereby increasing its product diversification, Mitsui & Co. addressed this concept upfront. Rather than focusing on a particular oil and adding more later, the company initialized the development of a suite of tailored oils. In doing so, this increases the diversification and value opportunity for both companies through their eventual product sales.
The volatile action immediately following the company's earnings release suggest that short-term traders continue to heavily influence the company's stock for better or worse. This remains expected given the lack of meaningful revenues to date and the near-sighted coverage of some writers in particular. But for those taking a longer-term view on the company, the future continues to look even better as Solazyme demonstrates its flexibility in customizing tailored oil solutions.
Solazyme is already exercising a level of sophistication in its oil profile development that some more established players in related industries simply cannot compete with. Yet in the same regard, it's important to remember that this industry of renewable oils and bioproducts remains a new endeavor altogether. There are certainly risks to face and the possibility of setbacks to come despite having executed on a near flawless level to date. Yet in the same regard, the potential now being realized in practice has not yet found its ceiling. Based on the market's reaction, it would also appear that the same potential has not yet found a more understanding audience.