On Friday, March 9, 2012, I had the privilege of being able to talk to CEO Jonathan Wolfson on a visit to Solazyme's (SZYM) research headquarters facility in San Francisco, CA. The short articles of this series will focus on our conversation in the hopeful attempt to further align the investment base alongside the true value proposition offered by this growing company.
The following commentary is solely based on my own understanding as an independent investor in the company, and this should be taken into account prior to forming any of the reader's own conclusions.
In my last article, I tried to emphasize a critical point in that Solazyme appears to carry an innate ability to research much more rapidly than the competition would be able to do. This is the case as these companies utilize a plant-based process that ultimately modify seeds as their means of changing the output. On the other hand, Solazyme uses microalgae, which grows very rapidly and offers the ability to significantly reduce the discovery and modification process time when it comes to developing genetically tailored results.
This speedy research advantage could be very important for the company who is currently working with Unilever (UL) to develop tailored oil profiles. With cash and short-term investments of $244 million as of the last quarter, the company isn't exactly in the position to be sitting around for years burning cash in order to develop new products. This is especially the case when a significant amount of this cash will have to be used for building production capacity that could require more capital than the company has, or in the very least require some debt financing in order to accomplish.
It's also important to remember that in the realm of genetically tailored oils, we're talking about finding competition in some of the large genetically modified seed corporations found in Monsanto (MON), DuPont (DD), Syngenta (SYT), Bayer (BAYRY.PK) and Dow Chemical (DOW). Ultimately, these are likely some of the main competitors that Solazyme will compete against in terms of developing specific tailored oil outputs. Such is the case to be made when we consider the similar research focus, technology capacity, and large financing capabilities that these large companies carry.
Getting into this field requires going up against some the most established in the business who are able to use their financial weight to buy up the capabilities they may currently lack. DuPont for instance has an operating cash flow of $5.15 billion. Monsanto has an operating cash flow of $3.3 billion. Even Syngenta has an operating cash flow of $1.87 billion. In comparison, Solazyme's entire market capitalization itself was only worth $862 million as of March 13, 2012, and a far cry from coming close to establishing that kind of cash generation in the near future. Is it likely for the company to meet challenges from Big Agriculture as Solazyme explores this frontier market? One can only imagine it to be possible.
However, in ongoing conversation, Mr. Wolfson explored another comparative advantage that Solazyme is able to retain when considering this very important field of oil production capability:
We separate the growth and oil production phases, which means we can accumulate oils that are very different from the oils that the cell would originally make for its cell membranes and all these other things. And that doesn't work for plants...
...What we're able to do is dramatically change the profiles, whether it's chain lengths or saturations. [We're able to do this] in ways that you could never do in a seed plant, because those genes would be turned on when the plant was growing.
- Jonathan Wolfson, CEO of Solazyme
In essence, as he would further describe, another one of the company's advantages in regards to its core technology is the ability to manipulate oil profiles in ways that are not currently possible for plant-based oil production. The reason for this is relatively simple. By utilizing algae cells, the company is able to break the development cycles into two parts: 1) Growth 2) Oil production.
- Growth. In the growth phase, Solazyme provides the right conditions for the algae to divide in a manner of "logarithmic growth" (ie. 1, 2, 4, 8, etc). Throughout this phase, the cells are utilizing the carbon (sugar) in order to develop their structures (cell walls, membranes, etc). During this time period you're looking at a relatively low oil output with about a 5% - 15% oil yield but a high amount of biomass creation. This phase allows for the cells to become viable and functional cell factories through the creation of their essential structures.
- Oil Production. Now by merely changing the conditions at this point, the company is able to bring the cells into a "lipid production phase." In this phase, all the carbon (sugar) that the microalgae cell eats goes toward oil production. As a result, the amount of outputted oil is increased to a yield in excess of 80% per cell. Much of this is due to the parent algal strain that Solazyme had optimized to result in such a high yield. In essence, by switching the conditions of the algae, the output leads to a higher oil production yield instead of biomass volume witnessed in the growth phase. Its also during this phase in which the company can change the conditions to produce non-standard oils in the cells (by which, I presume involves some genetic modifications).
The importance of this two-step process allows for something that distinguishes the company in a very important manner. By being able to grow the cells so that they become viable entities first, the company then appears to be able to switch what it is the cells are able to produce once the cell's essential structures have been created. This allows for the very unique output of oil profiles that company can produce when it comes to a wide range of chain lengths and saturations. This is simply not possible for plants.
With genetically modified plants, all of the tampering with the end product happens at the seed level. As a result of this, genetically modified seed companies like Monsanto and Syngenta can only make changes to the seeds that will not affect the viable growth of the plant. For instance it might be easy to tailor a certain output, but if the seed doesn't even grow its essential structures because of the odd genetic make-up, the output obviously doesn't occur. Essentially by being unable to separate the two phases of growth and production in their manipulations, such plant-oriented companies are constrained by their variety of outputs.
Solazyme is therefore able to create significantly unique outputs of tailored oils in ways that the modified seed producers such as the Monsanto's, DuPont's, and Syngenta's of the world are simply unable to do. Combined with the exponentially quicker development time that is also unique to Solazyme's microalgae, the company retains a one-two punch combination that allows for an overwhelming advantage in the field of unexplored intellectual property.
It's for these two reasons that investors may be missing the real value proposition offered by Solazyme. As analysts and shareholders focus on the biofuels along with a casual reference to the cosmetic and nutritional outputs, what seems to really be under appreciated about this company is its innate research and development advantage that its core technology allows. This process appears to be yielding some immense advantages when it comes to the realm of discovering unique intellectual property. As previously mentioned in my prior article, such advantages are what allowed for these modified seed giants to corner their respective markets just as Monsanto did to the corn & soybean markets.
Is it therefore possible for Solazyme to corner the industries that may become reliant on its perfected tailored oils for its products through its established intellectual property portfolio? Perhaps time will tell. However, I must note the irony that Dow Chemicals stands as an active partner for Solazyme in the pursuit for the perfect dielectric fluid. This is especially ironic given its own interests in pursuing modified seed technologies. Perhaps it too recognizes how far ahead of the pack Solazyme really is in this untapped market for genetically tailored oils. It remains advisable that investors should focus on what the company is saying in regards to this matter in the future. I have a strong feeling there's a lot more going on with this company than many appear to currently understand.
Disclosure: I am long SZYM.