After my first article on Senomyx (NASDAQ:SNMX), I have received many comments on both sides of the aisle. Instead of responding individually, I thought it would be more practical to address them as a group. It is fair to say that there are a healthy number of bears to match the bulls. Although each investor is entitled to his or her own opinion, the purpose of this article is to mostly address factually inaccurate arguments that still seem to be floating around in the market.
The following Q&A style commentary is based on my input as well as publicly available information.
Question: Are Senomyx's products genetically engineered? Do they use human embryos?
Answer: None of Senomyx's flavor ingredients are genetically engineered, genetically modified, or use human embryos. The claim that Senomyx is using any of this is factually incorrect, and is actually a bit shocking that people still believe these rumors. If there is any reputable evidence of this claim besides the allegation from the Internet site examiner.com, please let me know and I would be more than happy to investigate in further depth.
Further, it is outright illegal to use human embryos for anything related to the discovery or production of food ingredients. Senomyx has over 400 issued patents and several hundred patent applications, and not a single one mentions the use of human embryos or genetically modified foods.
Question: Is FEMA GRAS approval legitimate? Is Sweetmyx safe?
Answer: FEMA has served the flavor industry, the U.S. Food and Drug Administration (FDA), and the public since 1960 as the primary body for the evaluation of the safety of food flavors. Under the authority granted in Section 201(s) of the U.S. Federal Food, Drug, and Cosmetics Act, qualified experts like the FEMA Expert Panel can determine that certain food ingredients, such as flavors, can be added to food if their safety evaluation meets the FDA's requirements. The FEMA Expert Panel is comprised of independent experts in the fields of chemistry, toxicology, pharmacology, medicine, pathology, and statistics; all are also experts in flavor safety assessment. The Expert Panel grants a "generally recognized as safe" GRAS status to ingredients that meet the FDA's qualifications. The FEMA GRAS determination is either accepted or is recognized as supporting evidence of product safety in roughly 30 countries.
Regarding general safety, on top of receiving FEMA GRAS status, Senomyx has also received positive safety evaluations from the European Food Safety Authority (EFSA), which allows usage in EU countries. In addition, Senomyx flavor ingredients received positive safety evaluations from JECFA, which is the Joint FAO (Food and Agricultural Organization) / WHO (World Health Organization of the United Nations) Expert Committee on Food Additives. JECFA determinations allow immediate usage of new ingredients in many countries and enable regulatory approvals in other countries.
Question: Does FEMA GRAS status limit usage of Sweetmyx to very low levels, i.e. parts per million concentration, thus is not appropriate for commercialization?
Answer: Like other flavors, Senomyx's ingredients are used in the low parts per million range; this is because they are EFFECTIVE in this range. For example, in webcast taste tests conducted by Senomyx, 10ppm of S9632 or S6973 is used to double the sweetness of iced tea or Frappuccino-like coffee prototypes. If there is simply no need to use higher concentrations, why would anyone do this?
Question: Sweetmyx may be able to replicate the same sweetness, but can it replicate other characteristics that sugar creates, i.e. viscosity, which contributes to an overall different taste sensation? Does this make it difficult for Pepsi or anyone else to create a viable carbonated drink?
Answer: Beverage, food, and flavor companies have been using artificial sweeteners that do not provide the viscosity and other properties of sugar for DECADES. These companies have the expertise to tweak their formulations to create the desired effect. If this was indeed a critical issue, there would be NO carbonated beverages with no- or low- amounts of sugar. Clearly this is simply not the case.
If it were true that the functional attributes of sucrose cannot be replicated, there would be no foods or beverages with artificial sweeteners. As noted above, mimicking the attributes of sugar-containing products is within the expertise of food, beverage, and flavor companies that have been doing this for decades. Products with artificial sweeteners are not more expensive than their sucrose counterparts.
Question: Why has the uptake and ramp up of Senomyx's products been so slow if they are really so revolutionary? Why aren't any of Senomyx's products being commercialized?
Answer: This is factually incorrect. Senomyx's products are absolutely being commercialized today. Please refer to excerpts from the company's 10-K filings.
1. "Nestlé (OTCPK:NSRGY) is commercializing products that include our savory flavor ingredients. Nestlé's marketing strategy is focused on countries where regulatory approval is in place, and targets products that contain high levels of MSG. Nestlé's commercialization activities continue to be focused on incorporating S336 into established products that contain MSG. These products are currently being sold in the Asia, Latin America, Africa, and Middle East regions."
2. "Ajinomoto (OTCPK:AJINY) has been introducing products that contain a Senomyx flavor ingredient in several Asian countries including China. Ajinomoto has continued to explore additional opportunities to expand their customer base and the number of product offerings within Asia."
3. "Firmenich has exclusive worldwide rights to market S2383, Senomyx's modifier of sucralose, in all food and beverage product categories. Retail products incorporating S2383 are currently being marketed in North America and Latin America."
4. Firmenich also has worldwide rights to commercialize Senomyx's S6973 sucrose modifier for virtually all food and specified beverage categories. As of 2013, retail products incorporating S6973 are being marketed in the U.S., Latin America, Asia and Africa. These products span a variety of categories including ready-to-drink and powdered beverages, dairy products and baked goods. Products launched with S6973 are showing promising performance based on re-order patterns and additional launches of products containing S6973 are expected during 2014.
The pace of the ramp has been slow because until recently, only a few companies had rights to Senomyx's ingredients and were conducting commercialization activities. This is changing with the direct sales program, under which Senomyx will sell ingredients to multiple flavor companies for resale to food and beverage companies.
1. With only one flavor company (Firmenich) introducing Senomyx's sweet modifier ingredients to its clients, it took some time to make introductions and demonstrate the value of these unique products. However, according to Senomyx's Q4 2013 earnings release (March 13, 2014) the following commercialization activities are currently underway:
a. The S6973 sucrose modifier is being commercialized in a variety of categories including ready-to-drink and powdered beverages, dairy products and baked goods in the Americas, Southeast Asia, Africa, and Australia.
b. The S2383 sucralose modifier is being used primarily in beverage products marketed in North America and Latin America.
2. Firmenich is the second largest flavor and fragrance company in the world, but they only have about 13% of the flavor market share. (See the transcript from Senomyx's Q4 2012 earnings call (March 15, 2013)
a. This is why Senomyx's direct sales program is important - Senomyx is selling its ingredients to numerous flavor companies, each of which will be introducing these ingredients to their clients.
b. Initial commercial-scale quantities of Sweetmyx SR96 (S9632) were just received from the contract manufacturer in the fourth quarter of 2013 for Senomyx's direct sales. (See Senomyx's Q4 2012 earnings press release, March 15, 2013.)
c. Senomyx just acquired rights to sell Sweetmyx SR69 (S6973) during the second quarter of this year. (See Senomyx's Q4 2012 earnings press release, March 15, 2013)
3. Until the fourth quarter of 2013, only Nestle and another company had rights to Senomyx's savory flavors. (See Senomyx's Q3 2013 earnings press release, Nov. 12, 2013.)
a. Even so, the S336 savory flavor is being used in new and reformulated established products that were launched into the retail, industrial, and food service channels in selected countries within Africa, Asia, Latin America, and the Middle East. (See Senomyx's Q4 2012 earnings press release, March 15, 2013.)
b. Commercial-scale quantities of Savorymyx UM80 (S807) were not available for Senomyx direct sales portfolio until the end of the first quarter of 2014. (See Senomyx's Q4 2012 earnings press release, March 15, 2013.)
4. Only one company has rights to Senomyx's bitter blockers, and only for a limited product category.
a. The S6821 bitter blocker is currently being used in several products in a country in Southeast Asia.
b. Senomyx announced during the January 14, 2014 Needham presentation that the company is just beginning to introduce Bittermyx BB68 (S6821) to flavor companies.
Question: Is PepsiCo (NYSE:PEP) really even going to use Sweetmyx? Have they even mentioned their intentions on any of this?
Answer: Absolutely. Refer to PepsiCo's 2013 Q3 conference call remarks by the CEO. "We are staying on the path of innovating along natural sweeteners and thinking about flavoring agents to make sugar taste more sugary and so that's all we are focused on. We talked about our products coming to market in 2014. That's really the track we are on and we are not talking about it now, because we haven't yet got a launch date. Once we have a launch date, you will hear a lot more about it. And our goal is to bring to the market a product that tastes great. We don't want to rush a product to the market and then have to wonder why we launched something that wasn't that great tasting. So that's our focus."
Senomyx has not been extremely vocal about its plans with PepsiCo because it is under strict confidentiality agreements. Of course it is not allowed to make public statements and forecasts regarding its customer's new product line up.
It has however mentioned the following about Sweetmyx usage in PepsiCo's products during the March 13, 2014 earnings release:
Senomyx compartmentalizes commercial revenue opportunities into three categories: the Company's royalty-based collaborations with Firmenich, Nestlé, and Ajinomoto; direct sales; and the PepsiCo Sweet Program collaboration. Commercial revenues are modeled based on projections from Senomyx's collaborators plus current estimates for sales potential from the direct sales initiative. From these three categories of commercial revenue opportunities, Senomyx continues to expect approximately $10 million in commercial revenues in 2014, and approximately $25 million in commercial revenues in 2015, with gross margins to range between 75% and 85%. This growth in commercial revenues will be primarily driven by the Sweet Program collaboration with PepsiCo and direct sales. Commercial revenues from direct sales and commercialization of the new S617 Sweetmyx flavor ingredient will be heavily weighted toward the end of the year
As per my previous article, Senomyx has the potential to generate $152.58 million in gross profits from its tie up with PepsiCo alone over the next 3-5 years. This translates to a share price target of $45 given a 20x PE multiple, for an upside of over 400%. Any downside from this target is limited due to the ramp up of all of its other products with other customers via its direct sales marketing campaign. Given this outlook, the company will be trading at a PE of roughly 3.6x. For those of you that are waiting for the spectacular announcement that confirms PepsiCo or other customers are indeed commercializing products using Sweetmyx on a large scale, it is likely you will have missed your opportunity.
The evidence and historical data suggest that Senomyx's products are both viable and safe. The quarterly timing of revenues and ramp up is more difficult to predict with precision, as should be the case for a company undergoing a structural shift in its distribution strategy. Short term traders are buying and selling based on headlines and market rumors. Trading based on current quarterly numbers is, more or less, meaningless. The company has made it clear that it is not supposed to be fully ramped up yet, and that we should expect to see real momentum towards the latter half of the year. This is when numbers will show real substance. So, if you are an investor with at least a six month horizon, I imagine the company and its shareholders will be enjoying quite a different situation as their ramp up materializes.
Disclosure: I am long SNMX. 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.
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