As a developing name in the field of industrial biotechnology, Solazyme (SZYM) has spent the last decade readying a flexible platform capable of converting carbohydrates into renewable tailored oils. The company has scaled its technology and is now constructing its first large commercial-scale facilities. As it brings online these production plants with leading agribusiness partners Bunge (BG) and Archer Daniels Midland Company (ADM), Solazyme's progress leaves its investors with one remaining question to answer: Can the company meet its margin guidance?
Solazyme's margins remain the subject of significant investor anticipation, largely because the extent of its potential carries the possibility of much upside. The company has been vague about the details in order to protect both the privacy of its partners and its ability to effectively negotiate. However, Solazyme's financial expectations for its new facilities have been broadly projected in terms of the gross margins one should expect. These can be seen in the graphic found below.
When we look at the company's lowest-priced market found in fuels & chemicals, it remains worthwhile to note that a 30% gross margin would suggest a production cost of $1400/metric ton [MT]. A more in-depth look at the costs and revenue below will help to show that it is realistic for Solazyme to meet its margin guidance. In particular, let us consider as a model the Solazyme Bunge Renewable Oils joint venture facility now under construction in Brazil.
Keeping The Cost Of Sugar Low
The most expensive raw material cost for Solazyme is found in the company's use of sugar. In the company's S-1 filing, Solazyme stated that 8 million metric tons of annual sugarcane crush capacity could support the production for "over 400,000 MT of oil per year." With Brazilian sugarcane typically yielding 10%-15% sucrose, this indicates that Solazyme needs somewhere between 0.8 million MT to 1.2 million MT of sugar to produce more than 400,000 MT of oil annually. This suggests that 1 MT of Solazyme's oil roughly requires anywhere between 4400 to 6600 pounds [lb.] of sugar.
At the current market cost of approximately $0.19/lb., this would suggest Solazyme's sugar input would cost anywhere between $836 to $1,254 per MT of oil. However, it remains highly unlikely for the company to be utilizing sugar at these price levels. If that were the case, there would be little benefit to being located on-site at Bunge's sugar mill in Brazil. Indeed, there are several additional factors to consider:
- Does The Technology Require Raw Sugar? Solazyme's platform may be able to skip several costly steps if it can use the cane syrup in its vats rather than raw centrifugal sugar. Several expensive processes may be avoided if the sugar does not need to be purified, stored, and dried.
- Transportation Costs Are avoided. Sugar futures are priced with physical deliver free on board to the receiver's vessel. These costs may not be necessary.
- Are There Conversion Advantages? The conversion of sugar into another product could provide several cost-saving advantages. For example, in 2012 Brazil paid import duties of $1.4606 cents per kilogram when exporting to the United States. With 6600 lb. of sugar, this would save an additional $43.73 for ever 1 MT of Solazyme's oil.
Offsetting Costs Through Biomass
While the remaining costs outside of the sugar input is difficult to estimate, there are several additional offsets to consider. One of the most important of these is the use of excess biomass. Bagasse, the fibrous matter that remains after sugarcane is crushed, is burned in order to create electricity and steam. Should Solazyme's technology skip several sugar processing steps as mentioned above, this would actually result in an income stream for Bunge. Rather than using the electricity generated from bagasse on additional processes, it would result in increased electricity sold on the grid. This profit could be used to help further subsidize the cost of sugar.
As for the joint venture, much of the utilities have already been covered through the agreement with Bunge. According to the joint venture framework agreement, Bunge will supply the new facility with treated water, steam, electricity, and wastewater treatment. These supplied utilities further reduce the cost of production. Several of these are made possible through the use of bagasse.
However, there is also one more important use of biomass to consider. Solazyme's process creates leftover algae biomass after the oil has been extracted. The use of this valuable product has yet to be detailed in a public announcement, but the concepts for its utilization can be found in the company's filed patent applications and trademarks. One such patent application goes as far as to describe the value expected to be derived from Solazyme's leftover biomass. It reads as follows:
"The present invention is based on the realization that biomass, particularly residual biomass that remains after cell lysis, especially of microalgae cultured heterotrophically, is a valuable product, the utilization of which confers substantial overall economic advantage to using the cells as production organisms for making fatty acids or other high value products. Indeed, the economic advantage gained may outweigh the expense associated with the lysis of the cell walls. Judicious use of the residual biomass may compensate for loss of efficiency in the process resulting from conversion of sugar and cell-energy to cell wall synthesis rather than toward production of the desired product. Embodiments of the invention also allow for recovery and potential recycling of valuable nutrients used in the culture of the microalgae, including phosphorous, potassium, and nitrogen. The materials so formed may have the added advantage of being biodegradable."
Therefore, we see that Solazyme expects for its algae biomass to carry a significant amount of cost-saving propositions. It can be used to recycle nutrients, offset part of the cost of extraction, or even compensate for the loss of efficiency found in sugar conversion. The one thing that is clear is that such biomass will not be wasted.
Consider The Revenue Premiums
While cost-cutting is one approach to increasing margins, extending the value of the product being sold is another. Through the company's filed 10-K, Solazyme has provided an overview of the target average selling prices found in the global market. Examples of its target markets are shown in the graph below.
While these prices reflect the existing market potential, there are numerous other advantages found in Solazyme's technology that could merit additional premiums. Depending on agreements and negotiations, the following are several factors which could positively influence the revenue actually coming into the company.
- Increased Performance. Through its tailoring capabilities, Solazyme is able to customize products with significant performance enhancements. For example, Solazyme's high oleic oils carry three times the oxidative stability of high oleic sunflower oil without the use of antioxidant packages.
- Increased Yields. Also through its tailoring capabilities, Solazyme is able to push the yield of oil derivatives beyond their natural occurrence. The company's high myristic acid level oil carries more than three times the level of myristic acid found in conventional oils like coconut or palm kernel oil.
- Renewable/Sustainable Products. Companies utilizing Solazyme's products gain branding advantages for being environmentally conscious.
- Cost Savings In Supply Line Logistics. This can be found through reduced storage costs, reduced transportation costs, or reduced costs found in geopolitical risks.
- Increased Quality Control. Consistency in product quality can be a valuable asset when compared to products grown in variable conditions. Weather's influence and growing conditions can often cause conventional products to vary in quality.
- Government Incentives. While they may not be relied upon, the additional revenue from incentives like renewable identification numbers could prove to be valuable premiums.
While it is impossible to tell if the company's margin guidance will prove to be accurate prior to actual production, the existing information does suggest that these estimates appear in line with reality. By aiming at markets with average selling prices above $2000/MT, the company is setting for itself a practical cost estimate of $1400/MT. As I pointed out above, there are numerous factors that align favorably for Solazyme in terms of reduced costs and increased revenue potential.
In some instances, Solazyme has already negotiated with its partners to secure its margins. The latest agreement with Sasol (SSL) mentioned that pricing would be indexed to Solazyme's raw material costs. Likewise, the contingent offtake agreement with Dow Chemical (DOW) also included that pricing would be linked to Solazyme's sugar-based feedstock costs. Such guarantees help to secure margins at the cost of restricting some upside potential.
Solazyme now trades with a $717 million market capitalization based on the closing price of $11.51 as of October 22. Investors should continue to dwell on the long-term trend now forming in the fats and oil industry. This can be seen in the price index chart found below. With such a stable growth trend, the company is likely to see rising selling prices for its products going forward. As long as Solazyme can maintain a similar cost structure, their is little doubting of the company's prosperous outlook down the road.