Diversa, Celunol Merger Creates Cellulosic Ethanol Powerhouse

| About: Diversa Corp. (DVSA)

A powerful company with a comprehensive basket of capabilities in the cellulosic ethanol industry has been formed by the signing of a definitive merger agreement between Diversa Corporation (NASDAQ: DVSA) and Celunol Corporation. On a pro-forma, fully diluted basis, Diversa stockholders will retain ownership of approximately 76 percent of the combined company, and Celunol stockholders and option holders will own approximately 24 percent. The transaction is expected to be completed by the end of the second quarter of 2007.

The combined company will possess integrated end-to-end capabilities in pre-treatment, novel enzyme development, fermentation, engineering, and project development. It will seek to build a global enterprise as a leading producer of cellulosic ethanol and as a strategic partner in bio-refineries around the world.

New Ethanol Pilot Facility
Celunol has recently commenced operations of the nation's first cellulosic ethanol pilot facility in Jennings, Louisiana and expects to complete a 1.4 million gallons-per-year, demonstration-scale facility to produce cellulosic ethanol from sugarcane bagasse and specially-bred energy cane by the end of 2007. In addition, Celunol's process technology has been licensed by Tokyo- based Marubeni Corp. and has been incorporated into BioEthanol Japan's 1.4 million liter-per-year cellulosic ethanol plant in Osaka, Japan -- the world's first commercial-scale plant to produce cellulosic ethanol from wood construction waste. The combined company plans to bring its first U.S. commercial-scale cellulosic ethanol plants into production in late 2009.

"Merging our companies significantly accelerates Diversa's and Celunol's strategic plans and creates a new company capable of technical and commercial leadership in the emerging cellulosic ethanol industry," said James H. Cavanaugh, Ph.D., chairman of the Diversa board of directors. "I would like to take this opportunity to thank Ed Shonsey and his Diversa management team for establishing and executing a business strategy with increasing focus on biofuels that has paved the way for the creation of our newly configured company."

Huge Market Potential

Carlos A. Riva, the president and chief executive officer of Celunol, will become the chief executive officer of the combined company and a member of its board of directors, and John A. McCarthy Jr., the executive vice president and chief financial officer of Celunol, will become the chief financial officer of the combined company upon closing of the merger. As part of the merger, two members of Celunol's board of directors, in addition to Mr. Riva, will be added to the Diversa board. Due to the complementary nature of the two companies, few staffing reductions are expected to occur as a result of the merger.

"The growth of the biofuels industry, and cellulosic ethanol in particular, is one of the most important developments in today's energy sector," said Mr. Riva. "The global market demand for alternative fuels such as cellulosic ethanol is potentially massive. We believe the combined strengths of both companies will enable us to accelerate commercialization of cellulosic ethanol by leveraging our skills and proprietary knowledge into large-scale biofuels project developments."

The company's press release gave this background for the need for alternative fuels:

The growing need for alternatives to petroleum-based fuels has emerged as one of the nation's most urgent public policy priorities and enjoys strong, bipartisan support among public policymakers at the federal and state level. In the U.S. alone the total market size for automotive fuels is currently 140 billion gallons per year. Of this amount, five to six billion gallons per year of production capacity, or less than five percent, are currently met by ethanol primarily derived from corn and other grains. In January's State of the Union address, President Bush articulated a national "twenty in ten" goal of reducing gasoline consumption by 20 percent over ten years, calling for a seven-fold increase in production of ethanol and other biofuels to meet this goal. The need for increased cellulosic ethanol supplies is due to a variety of factors, including the rising cost and dwindling availability of petroleum, the geopolitical risk of import dependency, and the vast potential environmental benefits from a significant reduction of greenhouse gasses created by non-renewable fossil fuels. The commercialization of cellulosic ethanol creates the potential for the production of significantly larger quantities of ethanol and other biofuels utilizing multiple feedstocks in the long term, and in a wider variety of locations throughout the world.

Financial Terms
Diversa Corp. will acquire Celunol for $154.7 million in stock, plus debt financing. Under the terms of the merger agreement, Diversa will issue 15,000,000 shares to acquire the outstanding equity of Celunol. In addition, Diversa will provide Celunol with up to $20 million in debt financing to fund its operations prior to the closing, which will be assumed by Diversa at the closing. The merger agreement has been unanimously approved by each company's board of directors and is subject to approval by their respective stockholders, regulatory agencies, and the satisfaction of other customary closing conditions.

The merged company will continue to pursue the broad market opportunities for high-performance specialty industrial enzymes within the areas of alternative fuels, specialty industrial processes, and health and nutrition, with a primary focus on enzymes for the production of biofuels that Diversa Corporation pioneered.

The combined company will be headquartered in Cambridge, Massachusetts and have research and operations facilities in San Diego, California; Jennings, Louisiana; and Gainesville, Florida.

Merger Pros and Cons

This merger certainly cements Diversa's position as one of, if not the, leading companies in cellulosic ethanol industry. The original Diversa provides a stream of income that is often lacking in developing industries and its skills to continue to develop enzymes is extremely valuable, in that this technology is one of the keys to reducing the cost of cellulosic ethanol. Their enzymes capability to treat wood chips, as demonstrated in the Japanese plant, is an industry milestone as being the first enzyme demonstrated in a large pilot facility to have this capability.

Further improvements in enzymes are likely to be required to further reduce costs and to treat more feedstocks as the market expands. Celunol's fermentation technology, that enables fermentation of both hexose and pentose sugars, is the only such technology that has been demonstrated outside the laboratory. By having two operating pilot plants and construction underway on a demonstration plant it has very impressive facilities to continue to improve the process.

The only downside I see to this merger is that Diversa gives up its ability to market enzymes to the whole cellulosic ethanol industry. I have often thought that the only companies that are currently making money in this industry were the enzyme companies and that was currently the place your bets currently. I am sure that they have considered this option and see the cellulosic ethanol industry as having a greater potential, in the long run, than just selling the enzymes.

Dyadic International, Inc.. (AMEX:DIL) has a research agreement with Abengoa Bioenergy R&D, Inc under which Abengoa will provide funds for further development of enzymes. Iogen has developed its own enzymes, leaving Novozymes as the only major independent producer of enzymes for the cellulosic ethanol industry.

Mascoma">Mascoma is taking another approach by focusing on collapsing the many biologically mediated steps involved in ethanol production into one simple step. A few companies are using acid to hydrolyze the cellulose. Of course, the companies that are developing gasification process for the production of ethanol do not need an enzyme.