The most important information about Syntroleum (NASDAQ:SYNM) didn't come from the conference call, but from an article quoting an executive from Tyson (NYSE:TSN). According to TSN's CEO Donnie Smith, the reason the Dynamic Fuels plant hasn't restarted as planned is because SYNM is in discussions to sell its 50% share of the plant.
Tyson Foods CEO Donnie Smith said this week the plant is ready to open, but restart has been postponed as its partner, Syntroleum, is entertaining offers to sell its 50% interest in the project.
Smith said the plant would not be restarted while Syntroleum is shopping its interest with potential buyers.
He said Tyson remains ready to work with Syntroleum or a new partner to get the plant up and running again, once the co-ownership issues are resolved.
I've written multiple times that the economics were extremely favorable for SYNM to restart the plant, and SYNM's management's explanations for keeping it shuttered have always left me scratching my head. I've never thought their explanations passed the "stink test" and if the quote from the TSN CEO is to be believed, it looks like my skepticism has been justified. Had that information been released during the conference call, I doubt the stock would have sold off late in the day, closing down over 6%.
With the cat apparently out of the bag, we can now turn to analyzing SYNM's sale of its 50% of the Dynamic Fuels plant.
Because SYNM is engaged in multiple patent disputes with Neste (OTC:NTOIF), I would place them as the most likely buyer. I found it interesting that there was no mention at all about the lawsuits during the conference call, but there is discussion in the 10-Q. A purchase by NTOIF.PK would be a win, win, win situation, and most likely allow SYNM to demand top dollar for its share.
Buying SYNM would put an end to the lawsuits, and instantly provide NTOIF.PK with exposure and established contracts in the US. It is a win win situation for NTOIF.PK, so NTOIF.PK would a logical source of one of those "unsolicited" offers.
NTOIF.PK also may have hinted of the planned purchase in its conference call where it stated that it was making good progress towards gaining access to the U.S. market.
The market fundamentals remained favorable and we continued to make good progress on our entry into the North American market.
Second on my list of potential buyers would be Renewable Energy Group (NASDAQ:REGI). REGI is an expert at buying up distressed biodiesel plants, upgrading them and rapidly expanding its production capacity. The pending NTOIF.PK lawsuits, however, would most likely prevent them from paying top dollar for SYNM's 50% share. I simply can't imagine a firm paying top dollar for a multi-million dollar plant with the cloud of a patent dispute hanging over the deal. A ruling in favor of NTOIF.PK would effectively make much of the Dynamic Fuels plant scrap metal, especially the parts used in hydrolyzing the fats and oils. Unlike NTOIF.PK, REGI doesn't have the technology to produce renewable diesel, and would most likely require an ongoing licensing agreement with SYNM.
Both TSN and SYNM have expressed confidence that the Dynamic Fuels plant is ready to run, and the SYNM conference call provided some needed information on which to value the plant. In the conference call, the margins for the Dynamic Fuels plant were discussed.
By comparison the current Geismar cash margin is a loss of $1.35 per gallon before $2.55 per gallon from RINs and $1 subsidy.
Because the fuel produced by Dynamic Fuels is a blend of fuels, I believe the above quote applies to the 88% that is ultra low sulfur diesel or ULSD. 6% is liquid petroleum gas or LPG and another 7% is naphtha, neither of which get the full $1/gal tax credit, or 1.7x a D4 RIN. The $2.55/gal is also based upon a D4 RIN price of $1.50. Current D4 RINs go for $0.83. Because feedstock prices have been stable, we can work backwards from the $1.35/gal loss. This table shows the annual profits using the numbers from the conference call and the numbers updated for 08/07/2013 values. These numbers also ignore any profits from the LPG or naphtha, so they are low estimates.
|Loss||$ (1.35)||$ (1.35)|
|Ann Profit||$ 63.89||$ 30.81|
Using both the numbers from the conference call and the 08/07/2013 quotes, the ULSD margin ranges between $2.20 and $1.06/gal, highlighting the volatility and risks of this industry discussed in the conference call. The margins adjusted for the 88% production are $1.94 to $0.93/gal. The Dynamic Fuels plant has a capacity of 75 million gallons per year, 66 million gallons of which are ULSD. SYNM owns 33 million of those gallons, so its annual profit for the ULSD production would range from $64 to $31 million per year using stated and current RIN prices.
One would expect SYNM to sell its share for a multiple of those earnings, so I would not be surprised to see SYNM double upon the announcement of the sale. SYNM has a capitalization of only $56 million, which is less than the $64 million annual profit calculated above. With the RFS2 production numbers remaining essentially unchanged after the recent EPA decision, the ethanol blend wall has the possibility of keeping RIN prices high for at least the next two years if adjustments are not made in the future.
Reviewing those earnings estimates above, I feel pretty confident that investors should eventually see a pop in the value of SYNM once the disappointment of the failure to restart wears off and now that the real reason for the failure to restart is known. Removing the uncertainty should provide a big boost in the confidence of investors, and the earnings estimates justify a significant premium in the value of SYNM.
Other significant information from the conference call are:
1) Not all of the tax credit has been received. Dynamic Fuels is still waiting on $3.6 million. That represents $1.8/8.7 = $0.20 EPS to SYNM.
Dynamic Fuels payment received of $3,615,969 on June 5, 2013. Dynamic Fuels payment outstanding are $3,091,000 diesel under audit, expected to take place during August and $582,000 for Naphtha, again under audit expected to take place during August.
2) SYNM may have a commercial use for its phase change material (PCM) soon. I saw a product in Target (NYSE:TGT) yesterday similar to what I would imagine SYNM's product would be like, and some are available on Amazon (NASDAQ:AMZN). SYNM may be in talks with companies like Nike (NYSE:NKE) and Under Armour (NYSE:UA) to develop products similar to those already on the shelves.
We are also developing temperature regulated clothing which has a lower barrier of entry. As part of our work in this area, we have prepared prototypes of PCM (inaudible) inserts, which have found to reduced heat gain, 10 to 15 degrees Fahrenheit. We think there is a tremendous demand potential for this product in the sports, construction and leisure market...One of them we think is fairly successful. It's a (inaudible) insert. We think it's applicable in hot weather, in a ball play, for example, 100 degrees out in the sun, if you can reduced this temperature 20 degrees it's pretty significant. That is less periods of time, we expect that 12 to 18 months.
3) There was no mention of the NTOIF.PK lawsuit in the conference call which I thought was odd. That may be a clue as to who the eventual buyer may be.
4) In my opinion, the real promise for SYNM if it is going to focus on the RFS2 based industries is for them to focus on where the RFS2 is headedClick to enlarge, that being cellulosic fuels. Biomass based diesel is basically an afterthought, having only a 1.28 billion gallon mandate and its production capacity highly limited if it doesn't want to disrupt the soy bean market. Cellulosic biofuels, however, make up almost all of the RFS2 mandate increases going forward, increasing from basically 0 gallons today to 16 billion gallons by 2022. That amount is greater than the peak amount of ethanol in the mandate. SYNM has the technology and ability to produce cellulosic RINs which are almost certain to be in short supply, especially in the early years. In the past, the EPA has granted waivers because of the lack of cellulosic RIN production. Shortages are usually very bullish for prices... if a waiver isn't granted.
So there could be a conversion or supplement at Geismar to achieve cellulosic status for the fuel...we've been unable to make the economics work, but as you do point out, the EPA and the industry has had discussions around two items. One is enhanced economics for cellulosic material and two even more enhanced for cellulosic in drop-in. So we are actively listening to that debate, because that applies right where we are, which would be a cellulosic material that is a drop-in fuel.
5) SYNM is pursuing smaller scale gas to liquids or GTL facilities. Currently the economics are better for GTL than they are for the biosynfining at Dynamic Fuels, and GTL doesn't require EPA regulations to succeed. I've always thought GTL or coal to liquids (CTL) was a better route for SYNM to follow. The biofuels industry is going through a learning curve and has many moving parts; feedstock, fuel prices, tax credits, RINs, blend walls, quotas and ever changing mandates and waivers. SYNM is a microcap company, and simply doesn't have the deep pockets required to successfully navigate this ever changing heavily regulated market where a stroke of a pen can dramatically alter the economics as the recent drop in ethanol RINs from over $1.40 to under $0.80 in a matter of days demonstrates. Late last year, margins were actually negative, forcing firms to either be responsible and shut down, or gamble on the passage of the tax credit. Most risky, however, is that yellow grease can't be effectively hedged, and until recently neither could RINs. Once again, to succeed in that kind of environment, one needs deep pockets to survive when the markets turn against the process and margins go negative. On the other hand, with GTL and CTL both the intake and offtake can be hedged, greatly reducing the risks of these plants. Combined with the lack of reliance on a regulatory structure and higher margins, GTL and CTL simply provide a far better risk and return than does biofuels.
GTL cash margins at current diesel prices are approximately $1.30 per gallon for purchased natural gas and $1.50 per gallon on self-developed natural gas. By comparison the current Geismar cash margin is a loss of $1.35 per gallon before $2.55 per gallon from RINs and $1 subsidy.
6) From the 10-Q, SYNM has invested and loaned a total of $56 million into the Dynamics Fuels plant, and has chosen not to write down any of its value. That may imply that it is at least expecting to recapture all of its investment if a sale does in fact occur.
We have contributed cash in the amount of $46,950,000 to the capital of Dynamic Fuels since inception and have remaining working capital loans to Dynamic Fuels of $9,166,000. Although management remains positive about the future of Dynamic Fuels our entire investment could be subject to loss...Under the equity method, losses from our investment in Dynamic Fuels are limited to the carrying value of our investment in and loans to Dynamic Fuels plus any outstanding receivables which were $42,232,000 and $3,000, respectively at June 30, 2013...Primarily as a result of the extended period the Plant has been in standby mode, Dynamic Fuels determined that the carrying amount of the Plant may not be recoverable. As such, recoverability was assessed using a probability weighted undiscounted cash flow model based on historical results and current projections. Based on this assessment, it was determined that the carrying value was recoverable and no impairment was recognized.
In conclusion, it is doubtful that SYNM would be getting serious consideration for its share in the Dynamic Fuels plant if its technology didn't work and the plant can't run. While the economics are volatile, they are currently extremely strong, so even with the recent drop in RIN prices, SYNM should be able to negotiate top dollar for its share of the Dynamic Fuels plant. The sale of the Dynamic Fuels plant would provide SYNM needed resources to focus on the more profitable, stable and less risky CTL and GTL ventures. Biodiesel and renewable diesel has limited upside in the RFS2 mandate, so SYNM had limited growth potential in that industry anyway, whereas CTL and GTL are virtually unlimited. If SYNM is going to continue to explore the RFS2 based industries, I would imagine that cellulosic diesel would provide better opportunities with less risk. If SYNM was able to develop a GTL, CTL and cellulosic diesel portfolio of plants, SYNM would be a well diversified alternative energy firm, focused on the areas with the least risk and greatest growth potential.
Disclosure: I am long SYNM. 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.
Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.