For Solazyme, It Is All About Control

| About: TerraVia Holdings, (TVIA)

It is very easy to misunderstand Solazyme (SZYM). The "algae company" may specialize in the design of tailored oils, but it is a common mistake to believe that the innovator's future success will be dependent upon its progress in biofuel production. In another sense, the company's name now serves as a misnomer as the Sun no longer has a direct role in Solazyme's technology. Worst of all, Solazyme continues to be associated with the poor economic models of first generation ethanol producers when investors first learn of the company's use of sugar as a feedstock.

Through all of the distracting misconceptions, investors appear unable to appreciate the most unique advantage of Solazyme's technology that differentiates it from its industry peers. Solazyme is able to effectively control the genetic design and production environment of microalgae. Whereby algae remains one of the most proficient producers of oil in nature, Solazyme has harnessed the microorganism's rapid growth and flexibility in order to control it's output and favorable economics. After all, it is entirely about control.

If you can control how algae is made, then you can control how oil is made. If you can control how oil is made, then you can control the characteristics of products made from such oils. This can effectively create comparative advantages that never existed before such technology was commercialized. As a result, this enables your downstream partners to favorably control the markets of such next-generation products.

Controlling The Production

Within a few years of being founded in 2003, Solazyme turned its back on the Sun. Once an open-pond company attempting to profit off of the "free" cost of sunlight and carbon dioxide, Solazyme quickly realized that algae produced oil from sugar far more efficiently than it could create such sugar through photosynthesis and ultimately convert that sugar into oil. At the same time, open ponds flew against the notion of creating an environment that could be controlled at scale.

Today, Solazyme's technology utilizes heterotrophic algae which grows in the darkness of enclosed fermentation vessels via a sugar feedstock. This has allowed the company to most efficiently control the production of oil by controlling the numerous factors which could otherwise amount to cost burdens. For example, consider the contamination of invading species and the inconsistency of weather.

Without controlling the environment, other algae species and microscopic pests can severely limit the output yield of your target algae. Additionally, the lack of sunlight during the night and the occurrence of bad weather during the day can play a large part in lengthening the production process while inhibiting production consistency. Solazyme's contained production environment helps to not only reduce the risk of these issues, but also improves upon the manufacturing conditions which nature is unable to provide.

Using fermentation, Solazyme can evenly distribute sugars to its algae rather than relying on the Sun's light to penetrate the dense waters to "feed" algae at a more shaded depth. The consolidation of algae in a large tank rather than on the surface of an open pond also makes oil extraction more cost effective. For example, consider the process of lysing a cell (breaking the cell wall for oil release). Filed in a US patent found here, Solazyme describes one of its several lysing methods in the description found below:

"In another embodiment of the present invention, the step of lysing a microorganism comprises autolysis. In this embodiment, a microorganism according to the invention is genetically engineered to produce a lytic protein that will lyse the microorganism. This lytic gene can be expressed using an inducible promoter so that the cells can first be grown to a desirable density in a fermentor, followed by induction of the promoter to express the lytic gene to lyse the cells. In one embodiment, the lytic gene encodes a polysaccharide-degrading enzyme. In certain other embodiments, the lytic gene is a gene from a lytic virus. Thus, for example, a lytic gene from a Chlorella virus can be expressed in an algal cell; see Virology 260, 308-315 (1999); FEMS Microbiology Letters 180 (1999) 45-53; Virology 263, 376-387 (1999); and Virology 230, 361-368 (1997). Expression of lytic genes is preferably done using an inducible promoter, such as a promoter active in microalgae that is induced by a stimulus such as the presence of a small molecule, light, heat, and other stimuli."

Take a minute to ponder the implications of this particular technique. Because Solazyme knows how to genetically engineer algae, it was able to encode into the DNA the ability for the cell to self-destruct. By creating an enzyme that degrades the cell wall, the cell can release its stored oil. By merely changing the algae's environment when it so chooses (ie. by exposing it to light or applying more heat), the company can instruct the cell to release its oil. Considering that oil extraction remains one of the most challenging aspects for algae companies, it remains clear that this fusion between control over production and control over design can lead to some advantageous synergies.

Controlling The Design

The bold choice to develop a biological tool kit for its algae pursuits has placed Solazyme in a very unique position. Unlike the well-known microorganisms of yeast and e. coli, the knowledge of how to genetically engineer algae was far less explored. Solazyme made the early choice to develop a genetic engineering platform for its highly productive algae strains from scratch. While the large amount of time and resources required to do so continues to limit future competition, Solazyme is now emerging with an advanced ability to improve upon the quality and quantity of its oil production.

Like agroscience companies Monsanto (MON) and Syngenta (SYT), Solazyme can essentially optimize plants that customize oils. However, companies like Monsanto and Syngenta stop at the production of genetically engineered seeds for farmer use. With its partners, Solazyme bypasses the farmer altogether by harvesting these unique oils directly within its fermentation vessels. As such, the company bypasses numerous costly steps of extracting oil from low-valued crops.

Not only can this significantly increase the efficient use of land based on oil yields, but Solazyme's process can also improve upon the output consistency by introducing a controlled environment. Unlike the volatile nature of weather on farms in an exposed environment, Solazyme's "crops" face the same conditions. Above all, Solazyme can improve the overall quality of its oil products. Solazyme's technology provides transformational changes to specific oil traits. For example, the company was able to vastly improve the yield of myristic acid in one oil profile as seen below.

Therefore, whether compared to petroleum or vegetable oils, Solazyme's technology retains an immense advantage found in its unique ability to significantly uplift the value of its oil. As shown in the picture below, the problem with petroleum today is that a typical barrel is a composite profile of many oil cuts. Solazyme can uplift this value by creating whole barrels filled with oils of the most desireable cut. While oils used for tar may not find as much value as oils used for plasticizers, Solazyme can create barrels of plasticizer oils that have been further improved for performance.

A Look At The Company Now

As of December 20, Solazyme now trades with a market capitalization of $682 million. The company is currently in the process of bringing online two large production facilities with its partners, Bunge (BG) and Archer Daniels Midland Company (ADM). These two facilities will increase manufacturing capacity from 1,800 MT to over 120,000 MT annually. As seen in the chart below, the company expects to produce oils with target average selling prices of $2,000/MT and higher.

While ramping up production at these facilities, which are expected to begin commercial production in early 2014, Solazyme will continue to operate at a reduce capacity and a reduced margin to its expected target. This will occur over a 12-18 month time period. The company expects to be cash flow positive in 2015.

Even while producing at a limited capacity in the present, Solazyme continues to prove its ability to produce at a high margin. For the quarter ending September 30, the company tallied product revenue of $4.8 million at a cost of $1.45 million. Solazyme continues to maintain adequate cash on hand with roughly $194.4 million in cash, cash equivalents, and marketable securities.

Ongoing research and development cost the majority of the operational loss of $24.1 million. Of this loss from operations, R&D expenses represented $17.6 million. Such R&D continues to add value to the company's future through the establishment of additional products and intellectual property.

Final Thoughts

Solazyme sits in the middle of many favorable trends. The company can be renewable, sustainable, organic, green, health-conscious, and disruptive. It can produce comparative advantages for its partners, reduce logistical headaches, address distressed food markets, decrease the use of greenhouse emissions, uplift oils of poorer quality, and produce intellectual property faster than its competition.

Above all, the company can introduce a new wave of innovation into an existing market that is fully established and aware of its needs. Solazyme has developed a technology that can allow its partners to do more with less. It can allow them to find efficiencies within their own respective processes in order to address the markets of tomorrow.

All of this is accomplished through the ability to control the source and production process for one of the most fundamental resources used in our society. Solazyme's ability to tailor algae offers a new approach to how oils can be designed, produced, and utilized. The company's largest advantage lies in its control over algae production. As simplistic as this thought may sound, the subsequent ramifications of addressing a $3.1 trillion market opportunity may be profound. For investors, Solazyme appears to offer a clear long-term opportunity to buy and hold.

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.