Syntroleum (NASDAQ:SYNM) is a micro-cap firm that has a 50/50 joint venture with Tyson Foods (NYSE:TSN) called Dynamic Fuels. The Dynamic Fuels plant has a boilerplate capacity of 75 million gallons per year, but has been plagued with problems since it opened over 2 years ago. Late last year however it was able to put together some pretty solid production runs, installed some new equipment, recently upgraded to a more efficient catalyst and management claims to be ready to re-start if desired. The problem is the plant had a re-start date of mid to late July, which was missed because of undisclosed reasons. One can speculate from the recent comments from the TSN CEO, SYNM conference call and recent SYNM press releases that SYNM may be attempting to sell its 50% stake in the Dynamic Fuels venture.
Valuing SYNM's 50% share of Dynamic Fuels is not easy, there are may moving parts, so I am not surprised that it is taking an extended period of time. The major obstacle is likely to be the pending patent infringement lawsuit with Neste Oil (OTC:NTOIF). Every finding so far, including a recent ruling in SYNM's counter suit in Singapore has been favorable to SYNM, but the final verdict is still pending. A ruling against SYNM would be a major setback, and likely force Dynamic Fuels to pay a penalty for each gallon of fuel it has already produced and royalties on any gallons going forward at a minimum. It could render the current Dynamic Fuels obsolete and inoperable along with penalties as a worst case scenario. Because of this, I would imagine no final sale would be made until a final verdict is reached in the lawsuit if the Dynamic Fuels plant would continue using the contested feedstocks. It is important to note that the Dynamic Fuels plant can be upgraded to use feedstocks other that what the lawsuit covers.
The lawsuit however may not be as bad as it appears, even if NTOIF.PK wins. The EPA's RFS2 RVO for biomass based diesel is a modest 1.28 billion gallons for 2013, and future RVOs are not known. The best days for biomass based diesel may have already passed. Looking forward the EPA's RFS2 is shifting its focus away from food based biofuels and towards cellulosic/non-food biofuels. The RFS2 RVO for cellulosic biofuels goes from effectively 0 gallons in 2013 to 15 billion gallons in 2022. If you are going to be in biofuels, cellulosic biofuels is where you want to be going forward, and SYNM has the ability to upgrade the Dynamic Fuels plant to use cellulosic feedstocks, which would make the NTOIF.PK lawsuit effectively null and void. SYNM would have to somehow find a way to fund the upgrade to use cellulose, but that may be where SYNM and TSN want to take the Dynamic Fuels plant anyway. The market for yellow grease developed without Dynamic Fuels' demand as the biodiesel industry built flexible feedstock plants that use the fats oils and greases (FOG) that TSN wants to sell. TSN doesn't need the Dynamic Fuels plant to buy its FOG, it can sell it to Renewable Energy Group (NASDAQ:REGI), so TSN could just use the Dynamic Fuels plant as a way to participate in the future of alternative fuels.
Assuming the lawsuit gets settled in a manner favorable to SYNM, we will attempt to value SYNM's 50% share of the Dynamic Fuels plant. 50% translates into 37.5 million gallons per year of an 88%/7%/5% blend of ultra low sulfur diesel (ULSD)/naphtha/Liquid Petroleum Gas (NYSE:LPG). Using current market rates and adjusting for the embedded D4 and D5 RINs as well as the embedded tax credits for the ULSD and naphtha, 1 "blended" gallon made from yellow grease sells for approximately $5.21/gal (see graphic below). Annual revenues would then be $5.21 x 37.5 = $195 million. SYNM has a carrying value of Dynamic Fuels of $42 million dollars, so 1 year's revenues are about 5x SYNM's carrying value. Using a conservative 0.47x revenues, it works out to $92 million, or over 2x the current carrying value.
Princeton then categorized the businesses in the same revenue ranges, and determined the value they received based on a multiple of Selling Price to Revenue (revenue multiple). The revenue multiple for the lowest range was .47, and the revenue multiple for the highest range was .55 on average.
Using net margin as a proxy for EBITDA and 80% production, EBITDA would be $1.24 x 37.5 x 0.80 = $37.2 million. Using a conservative multiple of 3.81x EBITDA, it works out to $141 million, or over 3x the current carrying value.
The businesses sold in the lowest revenue range received a value based on a multiple of Selling Price to EBITDA (earnings multiple) of 3.81 for their businesses on average. For the highest revenue range, the businesses were sold for a value that was equivalent to a 6.99 earnings multiple on average.
Using conservative multiples and current market prices, clearly there is a lot of value in SYNM's 50% share of the Dynamic Fuels plant...if they can get it to run at full capacity and the lawsuit is settled in SYNM's favor. The problem using the revenue and EBITDA approach however is that things are always in flux in this industry. Tomorrow the net margin could be negative if there is an unfavorable EPA ruling, so variability in earnings must be considered with using the above numbers, but even so, a range of 2 to 4x carrying value gives a lot of room for error and the deal still be profitable.
One could use other methods like discounted cash flow, but those models like the revenue and EBTDA models are only as good as the cash flow estimates, and there is a wide range in those estimates, especially the further out one goes, so I will stop with the revenue and EBTDA estimates. Those two methods give a decent ball park figure to use as a basis of valuation.
Who might be interested in SYNM's share of the Dynamic Fuels plant?
1) "Big Oil" has a huge incentive to invest in biofuels plants, especially with the recent ethanol "blend wall" being reached. Valero (NYSE:VLO) is already leading the way. With the EPA's RFS2 shifting to cellulose based biofuels, the real value in the Dynamic Fuels plant may be in an upgrade. Because there is a lack of cellulose based biofuels on the market, the regulatory cost of compliance may increase substantially in the future depending on how D3 RINs are priced and if the EPA stops granting waivers. "Big Oil" may be willing to pay a premium for the Dynamic Fuels plant because it can speed the process towards reducing the regulatory costs. Buying the Dynamic Fuels plant can save years of regulatory costs to a "Big Oil" firm as building a plant requires sight selection, design, approval and needs to be built. That process that can take years, and isn't guaranteed to go smoothly. SYNM's FT process is also highly scalable, so "Big Oil" would have the resources and process to expand production to a level that would greatly reduce if not eliminate the regulatory burden with the added benefit that SYNM's fuel works well with all "Big Oil's" infrastructure unlike ethanol. Most important is that RIN prices are usually highest in the early years, as the RVO exceeds existing capacity. Once the EPA stops granting waivers for D3 Cellulosic RINs, the regulatory cost could be substantial.
2) NTOIF.PK may be the buyer. Buying SYNM's share of the Dynamic Fuels plant might be a way for NTOFIK.PK to end the lawsuits and gain access to the US markets. NTOIF.PK has had all the major rulings go against it so far, and a loss in the Singapore case would put it in the box it has been trying to put SYNM in. If SYNM wants to exit this market anyway, a deal with NTOIF.PK would allow SYNM to do that as well as possibly sell NTOIF.PK the patents SYNM has that would no longer be needed. What better way to end a patent infringement lawsuit than to buy the patents you are be accused on violating? It is a win win situation. If I was a betting man, I would bet on NTOIF.PK being the most likely buyer.
3) Renewable Energy Group may be a buyer. REGI doesn't have any renewable diesel plants, so this would help REGI diversify its portfolio of plants. Access to SYNM's technology would open the door for REGI to retool/rebuild its plants to higher margin renewable diesel plants if they are near essential infrastructure especially a reliable hydrogen source. As the table above demonstrates the SYNM process can add value to REGI's net margins, a benefit that gets magnified in the colder months when the spread between SYNM's "blended" fuel and FAME biodiesel widen. REGI has over 250 million gallons of capacity, so the licensing fees to SYNM and the marginal benefits to REGI could be substantial. Additionally, REGI knows the EPA's RVO for biomass based diesel has its limits, and may be near a peak. If REGI wants to continue being a major player in the RFS2 game, it needs to find a way to make cellulosic biofuels. Teaming up with SYNM would allow them to do that. REGI may be SYNM's needed source for a plant upgrade...as long as TSN agrees.
4) TSN may be a potential buyer. TSN may simply want to be in control. TSN being full owner would allow them to continue to license the SYNM technology, but be more in control of the Dynamic Fuels plant which it backed with a $100 million GOZONE bond. If NTOIF.PK is successful in its lawsuit against SYNM, TSN would still potentially be able to save the Dynamic Fuels plant by partnering with NTOIF.PK. TSN would then have to cross its fingers that SYNM didn't win in the Singapore case. A TSN, REGI and SYNM partnership would also be attractive because REGI is a big buyer of yellow grease, and SYNM provides the technology for TSN and REGI to participate in the RFS2 as it turns to cellulose.
5) A long shot would be Rentech (NYSEMKT:RTK). RTK has technology that would is well suited for the EPA's RFS2 shift to cellulose and it recently purchased some wood i.e. cellulose processing assets. RTK has the gasification technology and the feedstock, now all it needs is a plant to form the FT wax and refine it into fuel. RTK wouldn't be hindered by the NTOIF.PK lawsuit because the FT process makes the NTOIF.PK lawsuit irrelevant. The benefit buying SYNM has to RTK and others is that is can speed the way into enter biomass based diesel or cellulosic biofuels. The construction and design of the plant is already done, and as noted above, the RINs are usually highest in the early years.
6) Another long shot would be a natural gas company. SYNM has already stated that they are in discussions, planning and has signed a memorandum of understanding for a GTL plant. The Dynamics Fuel plant would provide a relatively quick path to a GTL plant. A coal company would also fit that model. That of course would require TSN's approval.
How likely is the sale?
I would imagine that after the last 2+ years of troubles and cash burn, micro-cap SYNM has reached the conclusion that the unpredictability of the biofuels industry isn't conducive for a firm without deep pockets. The SYNM CEO alluded to that concept with his comments about the less risky and more profitable economics of gas to liquids (GTL) in the last conference call.
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.
Being a micro-cap, SYNM should be in the plant design, construction and technology licensing business, not the putting all its capital in one basket business. There are simply less risky ways for SYNM to benefit from its technology and patents.
Because of that, I would imagine SYNM would like to exit the renewable diesel plant owning and running business, and focus on less risky ventures with greater returns. I think SYNM most likely would sell if it can get a good price for its asset. The current economics and pending lawsuit allow SYNM to drag its feet in order to ensure it can negotiate top dollar in the deal. The one clue investors should watch for signaling that a sale may be developing is a surge in insider buying, which hasn't happened yet.
In conclusion; SYNM most likely would sell its share in the Dynamic Fuels plant if the price is right. There are multiple win win scenarios, especially if the lawsuits are settled in favor of SYNM. Selling the Dynamic Fuels plant would allow SYNM to exit a very risky industry, and provide it with much needed capital to focus on lower risk, higher return ventures. From the revenue and EBTDA estimates above, shareholders should get a sizable pop in the value of their shares if margins remain high and the lawsuit is decided in SYNM's favor allowing it to negotiate from a position of strength and for top dollar. Unfortunately the end date of the lawsuit is unknown, as are the prospects that the margins will remain elevated. I would watch for insider buying as to a clue to how things are progressing. Even if the lawsuit isn't settled in SYNM's favor, the shifting focus of the EPA's RFS2 towards cellulose may make the lawsuit moot anyway. The Dynamic Fuels plant greatest value may be in that it can be upgraded to produce cellulosic biofuels, which would make the lawsuit irrelevant, and allow the buyer to speed its process into the cellulosic biofuels industry saving possibly years of regulatory costs. In my opinion, SYNM is in the driver seat and is holding a winning hand...if it plays its cards right.
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.
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.