Mixed Emotions As Solazyme Roquette Nutritionals Breaks Up

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 |  About: Solazyme Inc. (SZYM)
by: Kevin Quon

There should be no doubting that Solazyme's (SZYM) most recent announcement of its joint venture dissolution was anything but disappointing. However, to leave the sentiment at this fails to appreciate the situation now unfolding. On Monday, renewable oil and bioproducts developer Solazyme announced that it would be dissolving their joint venture with Roquette Freres, S.A. in what appeared to be an amicable end to the mutual relationship.

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Even so, investors weren't willing to take any chances. The company's stock sold off more than 20% at one point during the day reaching a low of $10.06 before rising to close at $10.94. In recent history, noteworthy disappointments have plagued the industrial biotechnology sector. For many of these instances, these setbacks often revealed more troubling implications either to the company's process, market, or technology.

Yet upon inspection of the break-up, it appears that the damage may have only been due to a growing lack of compatibility. Solazyme claims that the two companies have begun to differ in terms of production timelines and in their pursuit of an acceptable commercial strategy. Reading into the feedback from Roquette through an article found here suggests a similar sentiment.

Though that request for comment provided a chance for Roquette to lay out a different story, the company's response actually falls in line with that of Solazyme's. It conveys a similar thought that financial resources and timing were core issues of the problem. Taken from the same article, one spokesperson stated that, "[Roquette] remains committed to meeting market demands, while aligning the timing of its market launch and financial resources with its overall business objectives."

Judging the Fallout

It's safe to say that Roquette and Solazyme began to disconnect in terms of their objectives. In their collaborative goal to commercialize non-genetically-modified microalgae food ingredients, timing issues may have originated from Solazyme's public nature. As a private company, Roquette's ability to slowly integrate new technologies into its existing market space may have afforded it the luxury of time. But this doesn't necessarily apply to Solazyme.

As a public company, Solazyme remains obliged to shareholder interest therefore enduring a greater degree of scrutiny and a higher expectation of rapid profit development. The joint venture between the two companies was initiated prior to Solazyme's IPO in 2011. Additionally, it was Roquette that was on the line for making available the capital financing for a phase III production facility that may have cost north of $100 million. There may have been little incentive for Roquette to move as fast as Solazyme wanted. Whether it was prudence or mere hesitance, Roquette's differing objective may have ultimately grown as an opportunity cost for Solazyme.

What all of this leads to today remains somewhat of a burden for investors to decipher. On the one hand, the short-term implications are clearly negative for shareholders. On the other hand, the long-term gain may actually be more valuable than others comprehend. The following is a list of negatives and positives that I believe emerge from this dissolution:

Evaluating the Negatives:

  • Pushing back on the proof of execution. As a developing company in a struggling sector, Solazyme's prior market performance suggests that the company is "guilty until proven innocent". As seen by the price action since the company's IPO, doubt persists that the company may be able to perform in its primary markets on a large commercial scale. This setback shifts the focus away from Solazyme Roquette Nutritionals [SRN] which had just launched additional manufacturing capacity which investors were longing to evaluate. Instead, investors must now refocus their attention back onto the relationship with Bunge (BG). Unfortunately, the first large scale manufacturing plant will not be running until Q4 2013.
  • Loss of production capacity. With the end of SRN, the additional production capability not only takes away the new phase 2 facility but also the phase 1 facility already established. The largest blow comes from the idea that this capacity expansion came at virtually no cost to Solazyme, as this was largely to be financed through Roquette. Therefore, the amount of production capacity presently utilizing Solazyme's technology drops from almost 6,800 metric tons [MT] back down to 1,800 MT.
  • The need for additional drying equipment. Moving the new production rights into Solazyme's other plants requires additional machinery. This ultimately costs the company both in terms of time and money, although neither input is truly known. However, this will likely amount to unexpected expenses in some form.
  • Increased speculation and doubt. The timing of the dissolution could not have come at a more unfortunate moment. Over the weekend, the company received broad headline exposure in the New York Times. Just as more people begin to watch this company, it appeared to significantly lose face through this announcement. Previously, the company had a knack for consistently meeting expectations. However, this event is likely to reintroduce an amount of speculative concern back into the company's share price due to the rise in uncertainty.

Evaluating the Positives:

  • The company regains the rights to produce oils using non-recombinant technology. Read another way, Solazyme now regains the full spectrum of products derived from non-genetically-modified organisms. Specifically, the rights to human foods, animal feed, and nutraceuticals were all covered under this agreement. With nutrition poised to be one of Solazyme's largest markets, the ability to gain full rights of production here may be a significant positive for the company. This gives the company significant ease of access into the market with product lines that are less likely to face regulatory concern or delays.
  • No negative impact to revenue outlook for 2013. According to management, the dissolution will have no impact on Solazyme's revenues for the present year. Indeed, phase 3 would've had the most significant impact to revenues but would likely not have come online until late 2014 at the earliest.
  • Retaining the human capital. With the majority of SRN's staff being offered positions and all of the offers being accepted, Solazyme gains one of the most valuable assets of the company. Not only does this further reaffirm that Solazyme's technology was never in question, but it also helps to accelerate the rapid deployment of the company's regained operations.
  • Additional approval from key partners. CEO Jonathan Wolfson affirmed that the company's key partners provided feedback that was "very positive." Combined with the intentions to further incorporate drying equipment into the facilities owned by these partners, their approvals may even suggest that the break-up opens new opportunities for them as well. The introduction of non-recombinant products to go alongside Solazyme's tailored oils may further fortify the relationship with each company.
  • Accelerated revenue growth and timeline. Recall that in the conference found here that CFO Tyler Painter stated that SRN's selling prices would be "north of $5,000 a metric ton." On the other hand, Solazyme had been targeting a variety of products in its other markets that were likely $2000-$3000 per metric ton. The ability to apply these product lines directly into the capacity now under construction could advance the revenue outlook going forward.

Closing Thoughts:

Undoubtedly, Solazyme surprised its shareholders in a very alarming fashion this past week. The company's dissolution with one of its oldest partners raises a loud warning for those now judging the company's ability to execute on its business plan. However, as disappointing as this maneuver might have been, it also appears to be quite beneficial for the company's plans down the road.

Formed prior to its IPO and well before its numerous high-quality partners came to light, the joint venture with Roquette may have slowly been impeding the company's growth potential going forward. Indeed, Solazyme's management may have even realized that it had given away a larger piece of the pie than it should have during a time period in which it was desperate for quality partnerships.

At the current stock price of $10.94, Solazyme now trades with a market capitalization of $676.39 million. Over the next year, the company remains on track to bring online at least 120,000 MT of additional production capacity with its partners Bunge and Archer-Daniels-Midland Company (ADM). More so, it appears that management plans to integrate its reclaimed production rights back into these facilities thereby driving revenues faster than what was previously expected.

Overall, it remains difficult to imagine how the market will digest this news. Barring any additional catalysts, over the near-term I expect for the market to view this development as an excuse to pull back the stock. Until this last Monday, Solazyme's stock had climbed almost 48% over a 6-month period. With the momentum interrupted, traders looking for a pullback may have now found the perfect excuse.

However, fundamentally it also appears that the company may have repositioned itself into a more favorable stance going forward. Depending on the product mix, the revenue outlook going into next year may have actually increased despite the production capacity drop. Personally, I plan to add to my position should any additional weakness in the stock persist.

Disclosure: I am long BG, 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.