Solazyme: Primed To Succeed

Jun.20.13 | About: TerraVia Holdings, (TVIA)

Solazyme (SZYM) has a disruptive proprietary technology that uses algae to produce tailored, high-value oils that add value to a number of industries. Solazyme went public in May 2011, traded at a high of nearly $26 during its post-IPO exuberance, fell to a low of $6.45, and has recently been fluctuating in the $11-12 range. The market may now be beginning to recognize Solazyme's long-term business prospects. However, until recently the company has traded mainly on short-term events rather than future potential. Solazyme could reasonably grow into a successful, 21st century renewable energy leader. In this article, I will describe the company's current position and potential for success.

Financials

Income Statement FYE 12/10 FYE 12/11 FYE 12/12
Revenue $37,970.0 $38,966.0 $44,108.0
% Growth 314.5% 2.6% 13.2%
EBITDA ($53,115.0) ($14,573.0) ($81,584.0)
% Margin (139.9%) (37.4%) (185.0%)
EBIT ($53,901.0) ($16,280.0) ($85,103.0)
% Margin (142.0%) (41.8%) (192.9%)
Net Income ($16,280.0) ($53,901.0) ($83,132.0)
% Margin (42.9%) (138.3%) (188.5%)
Balance Sheet (03/31/13)
Cash & Cash Equivalents $239,111.0
Total Assets $317,363.0
Total Debt $131,213.0
Shareholders' Equity $164,289.0
Public Market Overview
Price as of 06/19/2013 $12.65
52-week High $14.34
52-week Low $6.45
Click to enlarge

As is evident from the performance over the past three years, Solazyme has been posting substantial losses. This has caused many analysts and speculators to doubt the company's product and its management team. However, this is not surprising because it is very easy to employ short-term narratives to write off promising companies in the early innings. It is standard for early stage, growth focused companies to grow revenues while sustaining losses in the early years. Solazyme is currently building up its commercial capacity and is far from mature. Keeping this in mind, it would be much wiser to assess how Solazyme performs in the second stage of its business cycle -- the company plans to produce saleable product in the second half of 2013 and early 2014.

Revenue "Makeup"

Thus far Solazyme's revenues have been generated from R&D programs and commercial sale of their skin and personal care products (Algenist brand). R&D program revenues represented 60%, 69%, and 63% of total revenues in 2010, 2011, and 2012, respectively. The R&D efforts have been focused on improving the science, the cost efficiency of producing oil, and scaling up for commercial production.

The product revenue presents some interesting data points. Product revenues were 18% and 37% of total revenues in 2011 and 2012. Algenist, Solazyme's brand of anti-aging skin moisturizer featuring alguronic acid -- an effective regenerative compound produced by microalgae -- has seen revenues grow by 133% from $7 million in 2011 to $16.3 million in 2012. Algenist's gross margins expanded from 66% in 2011 to 68% in 2012, and the Algenist line is expected to post 60% gross margins into the future. Interestingly enough, Solazyme management hadn't initially planned to enter skin care. According to the New York Times, Solazyme's researchers "stumbled" into alguronic acid, the key ingredient in Algenist. Algenist is now being widely distributed in Sephora retail stores and on QVC.

Algenist's success is powerful and underappreciated. Solazyme's technology allowed it to enter the beauty industry, a vertical most would never expect a renewable energy company to enter or compete effectively in. Nevertheless, Solazyme has proved its competence by commercializing a high-end product and successfully distributing it in the unfamiliar luxury skin care market. Algenist is a small but relevant example of Solazyme's potential. I guarantee there will be future innovative products/services that will penetrate a number of different industries.

Market Range

Solazyme is currently targeting the fuels, chemicals, nutritionals, and skin and personal care markets. Once Solazyme proves it can commercialize and deliver product in these markets, the future opportunity scale is enormous. The global demand for oil is huge and growing; and oils are present in almost everything we eat, see, and touch. The basic oils that we have traditionally relied on to meet our needs are plant oils, animal fats, and petroleum. Solazyme's ability to replace and/or enhance these oils to fit directly into existing infrastructure will allow the company to leverage its technology immediately, and on a very wide scale. Also, Solazyme's technology enables the company to convert and compress these oils in days -- much faster than natural petroleum production. Therefore, in addition to global oil demand, Solazyme's fuel making speed will certainly be attractive to various industries.

Strategy

Solazyme has an intelligent and measured market entry strategy. The company plans to first penetrate the high-margin personal care and chemicals market, and later shift into the low-margin fuels business. By starting in a low volume/high margin market and transitioning to a high volume/low margin market -- the company positions itself to build cash early and prove its ability to execute before timing its entry into the competitive fuels space.

Solazyme's business model relies on numerous strategic partnerships. The Solazyme-Roquette JV commercializes food ingredients, the Unilever and Dow Chemical partnerships commercialize food and soaps, Solazyme-Bunge blends sugarcane and algae to produce oil, and Solazyme-AkzoNobel commercializes paints. Solazyme has a number of other partnerships with well-known companies and government agencies such as Qantas, United Airlines, Chevron, Ecopetrol (Colombia), and the U.S. Navy.

Management made a sound decision to pursue a partnership strategy. The numerous partnerships have taken some project financing pressure off of Solazyme and allowed the company to bypass the "scale up tension" suffered by similar companies such as Amyris and Gevo. Also, it has avoided the problematic cash burn situation of KiOR (NASDAQ:KIOR), a similar company that's pursuing a go-it-alone strategy of heavily investing in its own production facilities. Strengthened by its partners' capex support, Solazyme has found a measured operational pace to scale up while maintaining a relatively strong balance sheet and cash position. Solazyme currently has $239 million in cash and a cash/debt ratio of 1.8x.

The downside of Solazyme's partnership model is a loss of full production control. However, this seems to be the cost of doing business and the only way the company can expand at an acceptable rate. Also, there is certainly a partnership fallout risk that should be appreciated. Just like married couples, corporate partnerships can have problems and don't always last forever.

Competitive Price Trend

SZYM Chart

When comparing Solazyme's stock price performance over the past year to its closest competitors Amyris (NASDAQ:AMRS), KiOR, and Gevo (NASDAQ:GEVO), there's a noticeable breakout starting in April. Solazyme starts trading upward and its competitors trade sideways. Although it's still hard to draw any strong conclusion based on this trend, I believe it's the market beginning to appreciate Solazyme's long-term potential.

Conclusion

Solazyme could be one of the most significant renewable energy players of the future. The company's technology is innovative and has a breadth of industrial applications. As long as the company continues to expand, meets its operational milestones, and maintains execution consistency, the company will be rewarded by the market. Solazyme has met its targets thus far and will continue to mature into an exceptional, profitable company.

Disclosure: I am long SZYM. 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.