Finding Value In The Solazyme Misconception: Industry Vs. Public Perception

| About: TerraVia Holdings, (TVIA)

Take a minute to consider the following. Imagine a technology company that has found active partners in Dow Chemicals (NYSE:DOW), Ecopetrol S.A. (NYSE:EC), United Continental (NYSE:UAL), Chevron (NYSE:CVX), Bunge (NYSE:BG), Whole Foods (NASDAQ:WFM), Unilever (NYSE:UL), GNC Holdings (NYSE:GNC), and Quantas Airways (OTCPK:QUBSF), and the US Navy to name a few.

Consider also that a world-renowned food manufacturer Roquette willingly paid for all the capital expenditures and working capital needed to launch your first commercial scale facility in order to secure a joint venture agreement with this company. Last of all, pretend that this company has met and exceeded all of its clearly-stated goals and expectations thus far as of May 6, 2012.

Would you expect this company to be trading at a share price 45% lower almost one year since its IPO?

Surprisingly, this is exactly what is happening to renewable oils maker Solazyme (SZYM). Yet no price shock comes without justification, even if it might be errant in itself. In the case of Solazyme, several key concepts and terms continue to weigh the company down in light of ongoing negative connotations. Many of these emphasized thoughts can be found in recent coverage by writers from Forbes and the Motley Fool.

While their thoughts are entirely accurate in themselves, I question their focus which I hope to explain a bit further in this article. Here are several key terms and the negative associations that are easily being applied to them, and ultimately to the company:

  1. Algae. Attempts to harness algae through photosynthetic means and large farm concepts have thus far proven to be far from cost-efficient or effective.
  2. Biofuels. The biofuel industry is suffering from two headaches: 1) First generation failed concepts that subsequently hurt world food prices 2) An advanced biofuel industry (2nd generation) that is having difficulty in scaling up its operations, and in a timely manner.
  3. "Sugar is food." The thought of using sugar to create oils brings reminiscent thoughts of the first generation biofuel failures, which ultimately brings about connotation with being unsustainable.
  4. Cost-per-gallon. Simple division of total costs with yielded results, have many current figures bringing up questions of whether the price tag an organization is willing to pay can ultimately be sustainable.

When we look at these concepts, a pretty bleak picture begins to emerge. Yet let us ponder the more curious question:

Why is it that multiple industries are pressing forward with Solazyme as if the company's technology has already been proven and remains to be promising?

Bunge offers one of its premier sugar crushing facilities and enters into a joint venture agreement to scale up the technology. Roquette paid all the costs associated in sustaining a joint venture with Solazyme after recognizing its inability to compete in the space. Unilever has entered into multiple development agreements and is beginning to pursue the fascinating field of tailored oils that Solazyme provides.

Dow Chemicals just recently announced its willingness to buy millions of gallons of oil that will provide them with a competitive advantage over the traditional dielectric fluids. Even Sephora and QVC continue to prominently display the company's cosmetic line as more and more products emerge under Solazyme's label of 'Algenist'.

Perhaps when we revisit the prior concepts we should be focusing on something else:

  1. Algae. Solazyme utilizes a heterotrophic process, which allows for algae to be grown in the dark in an environmentally controlled systems using standard fermentation equipment. The company's biotechnology, which has yielded a unique parent strain of algae, has allowed for optimal yields of greater than 80% oil content. This can be compared against the wild algae's natural ability to yield 5-10% oil content on average.

  2. Biofuels. Solazyme's current emphasis is far from being focused on fuels. Higher margin industries that are just as necessary to the running of society are being pursued. Chemicals, food, and cosmetics are the primary emphasis in order to establish a firm profitable foundation for the company. Fuels remain an active part of the company, but will struggle to become as vital until significantly increased production capacity comes online. Even then, the company will find greater use in specializing in fuel additives and higher quality fuels that prevent the company's products from properly being compared against traditional biofuels.
  3. "Sugar is Food." While a valid point, a larger concept being overlooked is the rise of a sustainable cellulosic sugar industry that can convert biomass into sugars. As technology progresses sugars that can be used by Solazyme should be perceived less as food materials and more as biomass materials. Additionally, when considering the food division, the company's current process is essentially converting sugars into higher-value food products and cheaper alternatives - a concept that is sure to disturb few people.
  4. Cost-per-gallon. While the Navy might be far from content from paying what is likely to be $15/gallon for Solazyme's oils, presuming this contract price is the actual manufacturing cost, is errant in itself. It also proves that there is limited competition that may be able to underbid Solazyme. Last of all, Solazyme's ability to tailor its output provides a distinct advantage that destroys a straight comparison with current fuel prices. Whether it be the fact that the company can create higher-valued cuts or jump away from the fuel market altogether, Solazyme should be far from hindered by cost basis fears. As it currently stands concerning fuels and chemicals market, the company expects gross profit margins to range in the 30-60% realm.

As of May 6, 2012, Solazyme trades with a market capitalization of $608 million. The company should continue to fail in having a positive earnings per share until late 2013 or early 2014. This is when production capacity begins to come online in a meaningful way. Until then, the company holds a comfortable current asset position with well over $200 million in cash and cash equivalents. The company also has limited long-term debt, with merely $15 million as of December 2011.

When we consider the corporate story that is truly developing behind Solazyme's promising technology, one should begin to wonder why it is that investors are failing to take a cue from the industry's lead. If such companies are willing to stick their necks out on the line, why are investors continuing to fail when it comes to seeing valid investment potential? Perhaps these misconceptions just need to be cleared up again and again.

Disclosure: I am long SZYM, BG.