It would be ideal to preface this article with an important understanding about Solazyme (SZYM), a renewable oils company currently transitioning into large scale commercial operations. To date, the company has not experienced a setback in regards to its scaling efforts, and more importantly, it continues to show evidence that the technology can be pushed ever further. Indeed, the company was even among the first to comfortably reach the large commercial scale level of 500,000 liter tanks as noted in the article found here and has continued to express confidence in it's ability to press forward.
Guilty By Association
Yet as witnessed by the company's continued poor performance on the market, it remains evident that the fears of technology risk continues to prevail throughout the minds of investors despite all contrary indicators. After all, linear scaling efforts remain the last perceived barrier of the industry to tap into low-margin, high-volume markets such as biofuels from a viable cost perspective. Likewise, the "perceived peers" of the industry have had much difficulty in accomplishing this uphill climb.
As seen in the chart above, Solazyme has continued to closely trade alongside Gevo (GEVO) and Amyris (AMRS), two companies who themselves have experienced technology scaling issues to date. Why scaling even matters comes down to a simple concept of lowering costs and staying competitive. But more importantly, it also means expanding the market size for each of these companies. It means being able to expand into the lower-margin markets that ultimately support the largest volumes of product (such as fuels).
To date, Solazyme trades 54% lower than its IPO price of $18 back in May 2011 despite having more cash on its balance sheet, more long-term partnerships, more technological capabilities, and more secured access to cheap feedstock for future operations. Ironically, as the company approaches the launch of its first truly large scale commercial operation with partner Bunge (BG) by the end of 2013, it remains evident that investors continue to discount Solazyme in light of the technology risk.
Does The Company Need To Produce Biofuels?
As Solazyme remains errantly associated the most with biofuels rather than as a producer of novel oils, a somewhat challenging question to ask lies in the following thought: Does Solazyme even need to produce biofuels? On the one hand, producing biofuels was the original pursuit of the company founders and undoubtedly it remains a target market of the future. But when one considers that Solazyme expects to be cash flow positive by next year with little (if any) of its manufacturing capacity being dedicated to the production of fuels for the next several years, one has to wonder if biofuels play a vital part at all in the long-term success of the company.
As it stands, Solazyme expects to address the higher margin markets of chemicals, food, and personal care products. Clearly, these markets are also quite large in regards to their size. A look at the chart above shows that if Solazyme were to achieve its 400,000 MT of capacity, this supply would still only address a less than 8% market penetration through these niche oils alone. Yet let us remember that these oil profiles are just scratching the surface as to which markets are able to be addressed through Solazyme's technology.
From a sales standpoint, the company could already prove to deploy a solid technology were the company to concentrate just on these markets. Assuming an average sales price of $2500/MT, such capacity would draw in $1 billion in annual revenues through the company's current plans as they stand. A look at the chart below also demonstrates the expected margins to eventually be reached at these levels under proper scaling. All said, it's clear that the markets are large enough for the company to thrive outside of a lower-margin realm such as biofuels.
What If The Company Experienced A Scaling Setback?
While the outcome is favorable under expected circumstances, it becomes more difficult to determine under a less than ideal scaling dilemma. Even still, we can take a look at some of the facts of the present in order to make an educated guess as to what is possible. Assuming that the company fails to scale beyond the level of 128,000 liter fermenters, let's assume the worst-case scenario. Here are some thoughts to consider:
- Solazyme is currently operating the small 1,800 MT facility in Peoria with 128,000 liter fermenters.
- Algenist is being sustained through ongoing operations in Peoria.
- Through Solazyme Roquette Nutritionals [SRN], the company expects average selling prices to be "north of $5,000/MT"
- Partner Roquette is funding all capital expenditures and working capital required for production for SRN.
In 2012, Algenist brought the company $16.5 million in revenue and is expect to grow more than 35% in 2013. The company's current gross margin for product revenue is averaging about 70% according to the latest quarterly results. It's more than likely that the company could exceed $30 million in revenue and support a comfortable operating margin within a few years' time.
It's also more than likely that Solazyme could go ever deeper into the cosmetic industry with another line altogether. But this aside, let us remember that Algenist is being supported through Peoria, which is also serving as a trial facility for scaling purposes. This suggests that a single product brand requires very limited capacity. It would also mean the company would require very limited working capital and capital expenditures in order to expand out its operations.
Additionally, SRN provides an immense opportunity for Solazyme. As CFO Tyler Painter noted in the interview found here, Solazyme basically "sold" half of the non-tailored, global nutritionals business to Roquette through the formation of the joint venture. As a result, one might even perceive Solazyme's interest in SRN as a 50% royalty on Roquette's endeavors in this space given that Solazyme contributed no capital to the JV.
The more surprising fact might be the detail provided in the same conference that management expects average selling prices to be north of $5000/MT. Painter suggested that management is expecting about $250 million in annual revenues to be attributed to the partnership when the final facility reaches nameplate capacity. As it stands, the technology's costs are expected to be below $1000/MT when built in a fit-for-purpose commercial facility according to the original S-1 filing found here. But even after adding a significant premium to the cost for a missed scale-up effort, this would still likely suggest a healthy business to ensue under these expected prices.
To date, Solazyme has already demonstrated the ability to scale its technology to a relative level (500,000 L) at which its cost profile allows for production at lower-margin industries. Yet even if one was to presume an unlikely scenario by which the company was confined to the 128,000 liter level, Solazyme still appears able to thrive in a smaller market space. Even before discounting the theoretical savings of lower staff costs and lower R&D expenses through such a scenario, the company appears capable of developing a profitable enterprise through its existing relationships.
Therefore, as Solazyme currently trades with a $511 million market capitalization, one has to wonder if this figure remains an adequate reflection of the business outlook. Under the worst-case scenario of a scaling failure that confines the company's technology to the current levels, Solazyme can still essentially be attributed with nearly $155 million in annual revenues through Algenist and SRN alone. Likewise, one can still expect a reasonably high profit margin given the ongoing precedence being set through Algenist.
However, when one takes a look at the larger picture it is clear that Solazyme continues to excel well beyond this "bleak" picture. The company appears to remain undervalued when one considers the advancements it brings to the oils industry alone. Yet even when we look strictly at the expected revenue and anticipated profit margins, it's clear that the market is failing to acknowledge the revenue growth that appears right around the corner. Thus, it appears that Solazyme provides a possible value play for the long-term investor who believes the company is able to reach its anticipated scaling goals.
Disclosure: I am long BG, SZYM, AMRS. 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.