Can Solazyme's Potential Outweigh Its Skeptics?

| About: TerraVia Holdings, (TVIA)

Even as the market braces for a possible downturn, one developing company has continued to rise in recent weeks. Renewable oils innovator Solazyme (SZYM) has been steadily climbing as capital begins to flow back into the clean technology sector. The company has seen its stock rise 48% over the last 6 months as a stronger investment base begins to form. With the anticipation of new production facilities coming online, investors appear to have discovered a greater appreciation over the unique value found in the company's proprietary oil-tailoring capability.

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Armed with the ability to radically change an industry and equipped with a network of leading partners capable of seeing it through, Solazyme has very quickly established itself as a leading biotechnology company which has harnessed the power of designed oil. Solazyme's ability to control carbon chain length, saturation, and positioning within an oil profile has allowed the company a comparative advantage that excels it beyond the reach of oilseed titans such as Monsanto (MON) and DuPont (NYSE:DD). With a significant range of flexibility in comparison, Solazyme can create new oil profiles capable of increasing component yields and offering new ideal properties to industry altogether.

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Skepticism Abounds.

Because Solazyme can cost-effectively create customized solutions addressing multiple markets through a single production facility, the company's potential to tackle numerous issues found in oil supply chain logistics remains a priceless factor recognized by few within the investment community. Part of this stems from the fact that new game-changing technology is always met with some form of skepticism. While the majority of analysts continue to recognize Solazyme's superior balance sheet, short ramp to commercial production, and promising potential found in value-added solutions, there remains those who fail to be convinced by the typical signs of progress.

In early May, Piper Jaffray analyst Mike Ritzenthaler continued to downplay expectations that the company would be able to reach its goals as he reaffirmed his price target of $5 on Solazyme. As the former CEO of an unsuccessful open-pond algae company named Pine River Petrochemicals LLC, Ritzenthaler certainly carries a level of expertise when it comes to understanding autotrophic algae. Yet like so many other skeptics of the industry, one can only wonder if his doubts have served as a hindering factor from acknowledging the numerous practicalities of Solazyme's heterotrophic algae process.

Indeed, Solazyme has not had the easiest introduction to the public markets as it continues to endure the media's ongoing prediction of a failure in algae fuel technology. Despite utilizing a controlled heterotrophic algae process that yields a superior cost of production when contrasted against the raceways and photobioreactors of autotrophic algae methods, Solazyme has had difficulty in winning over public opinion when it comes to its business viability.

The surmounting negativity of public opinion came to a boiling a point when Solazyme and Dynamic Fuels together won a contract to supply the US Navy with alternative fuels for its "Great Green Fleet" demonstration in July 2012. The final cost of the contract amounted to $26 per gallon supplied, which outraged many accustomed to paying $3-$4 at the pump.

However, the politicized coverage failed to mention that the contract cost included compensation for the research and development and was not intended to only price the fuel itself. Likewise, it failed to mention that the fuel was derived from junior facilities that had not yet achieved the economy of scales desired for profitable fuel production. Adding to the irony, a lesser known fact shows that the military has been using $25/gallon fuel all along in some instances.

Pursuing The Most Profitable Interest First.

It is the fear that Solazyme might not be able to offer large amounts of competitively priced product which has turned some investors away from this developing company. To date, Solazyme's primary product revenues are largely derived from its cosmetics sales which carry some of the lowest volumes necessary while supporting some of the highest margins available. Their current operational restriction to this space has practically and largely been due to the limited amount of production capacity at their disposal.

However, the turning away from the fuel markets may have done little to bolster investor confidence. There remains a general presumption that Solazyme retreated into a higher-margin industry on the basis of an inability to produce low-cost commercial fuel. While it may be true that Solazyme is not out to replace gasoline on a pure cost advantage by itself, the company has been saying all along that it has no intentions of abandoning its future in fuels.

Leveraging The Strength Of The Technology.

Rather than understanding that the company retreated away from the large market of biofuels, it appears that investors are beginning to understand that the maneuver was actually a tactical leveraging of the company's technological strength. Working within established markets, Solazyme is now significantly increasing yields of existing materials that may otherwise be hard to derive. Likewise, the company is developing oils capable of imbuing characteristic properties previously unable to be achieved. All of these are likely to provide higher returns than fuels ever could.

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A look myristic acid may not have been the first target market investors expected to see when they first heard of this renewable oil company. Yet the demand for myristic acid far exceeds that of gasoline on a pure price basis alone. In 2012, the average selling price for pure-cut myristic acid was over $4,200/MT resulting in a market worth $600 million annually. With nearly 300 gallons in a metric ton of oil, this suggests that myristic acid was approximately priced around $14/gallon. With gasoline hovering around $4/gallon, the opportunity in the more niche market stands clear.

Because Solazyme's process allows for the company to radically alternate between outputs utilizing the same infrastructure, the company is able to pursue interests in a wide variety of markets at the same time. This is especially so as the company's partners are in control of the market penetration and in the regulation of product demand. For its part, Solazyme's focus therefore lies almost entirely in the pure scientific development of new oil profiles that can radically change markets.

One trend that is becoming ever more clear in the company's pursuits is the ability to enhance lower-grade products. In many instances, Solazyme is able to increase the usefulness of existing products on the basis of blends. In doing so, the company actually adds value which can merit a higher premium in terms of its pricing. A look at the following two future markets of fuel and milk products offer an idea of how this can play out.

Enhancing The Market for Fuel.

Blendstocks are nothing new in the petroleum markets, but they are becoming an ever more important aspect to consider. This is especially the case as the world's output of light sweet crude decreases and heavier oils are used to make more expensive and possibly inferior products that are expected to operate as well as their counterparts. Combined with increasing environmental standards, this outlook should justify a rising dependence on the use of additives capable of increasing fuel performance and meet stricter environmental regulations.

By itself, Solazyme's SoladieselBD can significantly enhance the performance of conventional diesel. In a 20% blend, the company's product not only reduces greenhouse emissions by more than 85%, but it also reduced the amount of particulate matter by 30%, the amount of carbon monoxide by 20%, and the amount of total hydrocarbons by 10% when contrasted against ultra-low sulfur diesel. Compared to traditional biodiesel which has often struggled with cold weather issues, Soladiesel was also tested to have superior cold weather properties when compared against all commercially available biodiesels back in 2008. As such, the company's primary biodiesel brand has effectively already proven itself capable of being able to upgrade an inferior fuel to a higher standard.

A more interesting look into Solazyme's future lies in the company's possible exploration of sea-based fuel blends. In 2012, Maersk tested Solazyme's renewable diesel in a 6,500 nautical mile commercial voyage as part of the US Navy's certification program. Of particular note, the ship tested blends between 7% to 100%. Traditionally, low grade bunker fuel is used by the world's 90,000 cargo ships which contains up to 2,000 times the amount of sulfur used in automobile diesel fuel. One large container ship can emit cancer and asthma-causing pollutants equivalent to that of 50 million cars. Utilizing a blendstock, Solazyme may likely be able to charge a premium for the value-added component used to improve the performance of bunker fuel.

Enhancing The Market for Milk Products.

With the new 5,000 MT production facility expected to come online very soon for Solazyme's joint venture with Roquette, more attention is being placed on the company's nutritional products. The company boasts a line of base materials capable of providing similar textures and comparable taste attributes in finished outputs while significantly improving the health profiles of comparable products. Almagine is intended to be used by manufacturing clients in their pursuit to replace the use of eggs, milk and butter in order to create healthier brands. An example of a chocolate beverage application is seen in the picture below.

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What should stand out is the fact that the company was able to leverage the use of an inferior input in order to accomplish its goal. In this demonstration the company utilized skim milk rather than reduced fat milk (2%) in order to achieve a similar product. Based on consumer trials we see that the sample product was able to achieve statistically similar results to that of the retail product comparison and close results to that of the reverse engineered control product.

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It's by using Almagine that new formulations could be utilized to enhance the effect of lower quality products. The effect could be significant for manufacturing clients. In January 2013, skim milk was priced at $3.14/gallon in Los Angeles whereas reduced fat (2%) milk was priced at $3.45/gallon according to the California Department of Food and Agriculture. In an industry where single-digit profit margins are the norm, the chance to significantly add value through cost reductions and provide product quality improvements stand as valuable tools for developing a competitive edge.

A Glance At The Numbers.

At its current price of $12.62, Solazyme now carries a market capitalization of $780.26 million. The company's revenues are largely derived from research & development payments in the present as construction continues for the first large scale commercial production facilities. Over the coming year, the company anticipates bringing online an additional 125,000 MT of shared production capacity. It currently carries roughly 2,100 MT of capacity in the present with the majority being used for testing purposes and for supporting the company's cosmetic brand of Algenist. Overall, analysts expect revenues of $282 million in 2014, which far exceeds the $54 million expected in 2013. It remains this rapid growth in production and revenues that serve as an ongoing catalyst for investors looking forward.

It will be interesting to soon see the updated figures for the company's short interest. As of May 31, there were 7,099,963 shares short, which represented 18.6% of the company's float. Oddly enough, this figure has not fluctuated much from the December 31 reading of 6,866,081 shares short. Over the same six months, the company's 48% rise in share price is sure to have placed increasing pressure on those short, thereby artificially increasing the demand of the stock. With additional company announcements already expected to serve as catalysts and a longer-term shareholder base appearing to step in, this could be favorable for share price support going forward.


As the Solazyme story continues to be embraced by a more educated investment audience, investors are likely to expect a stronger level of support. Even though the company continues to carry a net loss, revenue growth and profit margins are likely to become much more important factors to consider as the company quickly expands its initial operations. The company has now developed a clear ramp to production and the ability to execute remains one of the last important questions to answer.

Above all, investors should continue to watch for increasing improvements to product profiles. The company's ability to extend its market reach is not limited to its ability to develop its market penetration. Wisely, the strategy to leverage partner expertise has allowed the company to focus almost entirely on product development. Combined with the ability to utilize the same infrastructure in order to address its various market interests, Solazyme's flexibility remains a severely undervalued tool not able to be shown on mere financial statements. It therefore appears that the extent of the company's profitability can be significantly improved by the ongoing development and consumer acceptance of innovative oil profiles going forward.

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.