KiOR Inc. (KIOR) has a market cap of $1.7B at the current price of $16.91. In the latest reported quarter, KiOR lost $34M and had an operating cash burn of $25M. These cash burn numbers will increase as the company embarks on building wood-to-fuel converter plants. Cash, net of $31M in debt, was $176M as of June 30, 2011, aided by a June 2011 IPO. This cash will not last through the projected breakeven point which is still years away.
KiOR is a biomass company that plans to convert wood to petroleum. KIOR has similarities with another biomass company, Petroalgae (PALG.PK), that we wrote articles about previously. Both companies currently sport a market cap in the $1.4B to $1.7B range, have no revenue, and are losing a lot of money. On the other hand, KIOR appears to have a decent catalytic cracking process that converts wood into fuel that may somewhat more closely resemble the hydrocarbon fuel used in cars today. Another difference with PALG is that KiOR has a larger funding base to carry out the business plan to commercialization, aided by its IPO underwriters Credit Suisse, UBS and Goldman Sachs as well as the US government. Also, KiOR seems to have a stronger investor pedigree with Vinod Khosla's fund as a seed investor, and Condoleezza Rice as a director. Thus, KiOR does have more intrinsic value than PALG.
But the question du jour is whether KiOR is worth anywhere close to $1.7B. As the company has no revenue, everything is based on hockey-stick financial projections. These multi-year projections are then supported by the validity of its underlying technology, the ability to execute a buildout of five huge production plants, the price of oil at that time versus the cost for KiOR to process its supposed oil-equivalent fuel, access to funding to make this dream come true, how much dilution will current shareholders forego in the meantime, and at what discount rate.
There has been much misinformation and hype about KiOR's technology. KiOR's biomass (aka pyrolysis) oil is not a near-perfect match to crude oil. Biomass contains too much oxygen, that ends up as a lot of carbon dioxide and water during the conversion process. Crude oil is mainly high-energy hydrocarbons, so at least 90% of the crude is turned into a finished product. What will KiOR's yield be? A close peer, privately-held Envergent Technologies, has an estimated biomass-input-to-transport-fuel yield of around 20% to 25%, according to biomass energy expert Robert Rapier. KiOR has a special process that partially upgrades the oxygenated portion of the "cracked" biomass to hydrocarbons. So, KiOR's yield could be somewhat higher than 25%, once KiOR catches up to Envergent on the learning curve. But even enhanced pyrolysis oil has too many physical constraints to get even close to the 90%+ gasoline yield of crude. We have not even addressed the relative quality of pyrolysis oil, which traditionally has been too low-quality for gasoline fuel. On top of that, KiOR's pyrolysis oil has potential transportation costs from the cracker to the refinery that crude oil does not face. Thus, there are some questions on the technology and competitiveness of KiOR's end product.
For argument sake, let's make the unprecedented assumption that there are no snafu's in moving from a small pilot plant in Texas, to five large production plants in the US by 2015. These plants have a planned aggregate capacity of 6500 bone dry tons (BDT)/day of dried-out wood chips. Assuming a conversion rate of 68 gallons of gasoline/BDT, KiOR would produce 161M gallons per year (68 x 6500 x 365). 161.33M x the current wholesale gas price (crude oil plus refiner margin) of $2.95 equates to $476M in revenue in 2016 if all plants are running at full capacity. Over the long run, management hopes to increase the conversion rate to 92 gallons/BDT, but is initially targeting 68. So, maybe revenue could eventually hit $643M assuming the same number of production plants.
The combined average EBITDA margins of companies like oil refiner Valero (VLO) and agro processor Archer Daniels Midland (ADM) range from 4% to 5%. So using a 5% long-term EBITDA margin x $643M yields $32M in annual EBITDA starting in 2016 in the most optimistic scenario.
A production plant costs $350M to build. Five production plants would cost $1.75B. So, even if by some miracle KiOR overcomes the above-mentioned technology issues, obtains very competitive yields and production costs, and achieves this $32M EBITDA, the payback period is quite long. Holding pricing constant, the only other way to increase revenue and EBITDA, and shorten the payback, would be to add capacity, but that costs $350M with a similar long payback.
In the meantime, KiOR will burn a lot of cash over the next few years. Consensus analyst estimates are:
| KIOR $,M | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|
| Revenue | -0- | -0- | 23.5 | 92.0 |
| EBITDA | -30.1 | -53.2 | -58.7 | -19.0 |
| EPS | -$0.62 | -$0.72 | -$0.70 | -$0.78 |
Viewed another way, over the past year VLO has traded on average at 0.2x revenue and about 5x EBITDA and ADM has traded at 0.4x revenue and 7x EBITDA (both have lower multiples currently). KiOR is entering a non-glamorous cyclical business with high fixed costs and corresponding modest valuations. 7 x best-case 2016 EBITDA is a $224M valuation, and 0.4 x best-case 2016 revenue is a $257M valuation. Discount that back to today at a 10% to 15% discount rate, and we come to a present fair valuation of $120M to $150M in the best-case scenario, versus the current $1.7B valuation. In fact, we can even make a case for an even lower fair value given the negative cash flows in the next few years. But the point is that KIOR's present fair value is less than 10% of the current market valuation.
So why does KiOR trade at a $1.7B market cap? Hype. First-mover - but there are more biomass IPOs to follow. Dedicated sustainable energy and cleantech funds have to invest. The company has a good pedigree. Socially responsible investors. And possibly insider pricing actions.
The float is only about 10% and shrinking. Rumors are that Artis Capital Management, the second largest owner of KiOR after Khosla, has been buying up the float since late August. I don't know if this rumor is true, but the price action sure suggests something strange is going on. While we are short the shares, they have become very hard to borrow, and we have had the manipulated forced buy-in behavior that is usually reserved for OTCBB stocks (KIOR is Nasdaq quoted). Specifically, the last hour of trading before the next-morning's forced buy-in, the shares are ramped on low volume. We still have managed to hold onto half of our short position with the help of our prime broker.
While this goes against the Artis rumor, I have to believe that at least Khosla Ventures will be unloading some of its low-cost shares when the lock-up expires in late December, pulling down the share price. Longer term, KiOR will have to issue more shares to help finance expansion plans. I don't think that the US government will make attractive loans for over $1B to one company after the Solyndra debacle. But who am I to predict what the Federal government will do?
Rob Kalman contributed to this article
Disclosure: I am short KIOR.
