Renewable oils and bioproducts producer, Solazyme (SZYM), is in the business of using biotechnology to solve some of society's largest problems with some of the world's smallest organisms. The heterotrophic algae producer uses a controlled fermentation process to transform the world's abundance of carbohydrates into large volumes of uniquely customized oil profiles. In doing so, the company's technology appears capable of alleviating our reliance on crude oil, of increasing the world's food supply, of providing alternatives to the factors leading to deforestation, and of improving the nutrition profile for the foods we eat.
In my last article, I wrote about how Solazyme has developed some of the most advanced high-oleic oils available to the market. With market-leading levels of oleic acid, Solazyme's new oils provide increased oxidative and thermal stability. In a fraction of the development time spent by larger competitors such as DuPont (DD) and Cargill, Solazyme has now introduced a new source of algal-derived oils capable of being scaled to comparable levels now seen in the vegetable oil industry.
On May 29, Solazyme continued to prove this fact as it announced the first successful production of commercially saleable product from its large-scale facility based in Brazil (Moema). The key announcement marked an important milestone for the company's joint venture with Bunge (NYSE:BG). The Moema facility's production capacity is five times that of Solazyme's Clinton facility based in Iowa. With the launch of the 100,000 MT facility, Solazyme now has approximately 122,000 MT of capacity now ramping to full-scale production. Prior to late January 2014, Solazyme had a mere 2,000 MT of capacity at its disposal.
Climbing The Ladder Of Proven Capabilities
The opening of the Moema facility marked the most anticipated event to date in the company's history as Solazyme further de-risks its company profile. While the recently-opened Clinton facility proved that Solazyme could run its process at a scale needed for commercial production, the launch of the Moema facility provided the largest leap into completing the transition away from being a development company. The additional supply capacity enables the company to rapidly increase its product sales.
Solazyme now faces the task of consistently producing at this large commercial level in order to attract additional partners capable of furthering its agenda. To date, the company's technology has proven capable of living up to the challenge. Solazyme was the first industrial biotechnology pure-play to scale up its technology to the 500,000-liter fermenters now operating at Clinton. With the 625,000-liter fermenters operating out of Moema, the company offers incremental confidence in the capabilities of its technology platform.
Inherent in this latest feat is the context that numerous other companies have faced difficulties while scaling their technologies. Amyris (NASDAQ:AMRS) and Gevo (GEVO) are two such companies that have previously faltered in their initial attempts to scale. For Solazyme, the increase from 500,000-liters tanks to 625,000-liter tanks represents a small victory. Overall, the company has seen a 89,000-fold increase from the 7-liter tanks used in the laboratory. Yet while the 25% increase in scale from Clinton to Moema should be viewed as miniscule, it does further validate the reliability of the technology at these levels.
More importantly, however, is the implication that larger tank sizes result in more efficient production. While the company's current vat sizes are more than suitable for bringing the costs down to become a profitable enterprise, every incremental step helps to decrease the cost of production. For Solazyme, this allows the company to address larger volume markets for products with lower average selling prices because it is able to produce at a lower cost of production.
A New Stage In The Company's Transition
Going forward, "reliability" will inevitably be the key term to focus on for the company's technology. Solazyme is now entering a phase in which it must reliably produce product in order to meet existing supply commitments. This is an essential step as buyers evaluate whether the company can handle a greater volume of their production volume. As such, the company will likely maintain a slow and steady rate of initial production for this coming quarter. As noted below, the company's production will require a ramping phase over the next 12 to 18 months.
One factor that has thus far proven to be a thorn in the company's side is the intermittent power and steam issues experienced at the Moema facility. This is the issue that prompted the delay for the initial production at the Brazilian plant. It is for this reason that CEO Jonathan Wolfson noted the following statement in the company's latest announcement:
"Continued progress at the recently completed adjoining co-gen facility has resulted in more reliable power and steam, enabling startup of commercial operations and production of our first commercially saleable product."
Investors should take into account that this issue may continue to affect production going forward, although near-term solutions have since been put into place. Utility issues on this level are not usually solved overnight, even if their effect can be mitigated in a prompt fashion. While such concerns should exist in the minds of investors, the fact remains that such issues are not fundamental to the underlying value being expressed by the company's technology.
My Take On The Company Now
The value of Solazyme's technology should now be the key focus of investors going forward. The company has significantly de-risked its profile by bringing online the two core facilities needed to sustain future business operations. These two locations should provide ample capacity which can be expanded in the future. More importantly, they provide the necessary capability for Solazyme to become profitable in its other target markets outside of its high-end cosmetics business.
Solazyme now trades with a market capitalization of $759 million based off the last price of $9.99 as of May 30. As of the end of April 2014, Solazyme had $310 million in cash and cash equivalents which provides the company with a more than ample supply of capital needed to ramp its production. For consideration, it is estimated that the Moema facility cost somewhere between $150-200 million to construct over the past two years.
Over the next 18 months, Solazyme will undergo a rapid phase of revenue growth. This is likely to be paired with increased costs and expenditures, although it will significantly increase the cash flow coming into the company. Over time, Solazyme's margins will continue to develop eventually bringing the company's target markets into profitability. Meeting these margins and expanding supply capacity will now be Solazyme's long-term objectives.
I believe that investors understand that earnings will continue to have little impact for evaluating the state of company now. A more accurate measure of the company lies in its ability to grow its revenue and sell its product. Indeed, this will be the measure of whether the market is accepting the company's algal oils and bioproducts going forward.
To date, Solazyme has averaged gross product margins of approximately 60%-70% due to sales of its high-end cosmetics line. While overall gross margins are anticipated to shrink as the company enters into higher-volume and lower-margin markets, the increase of sales should ultimately drive the company into positive earnings. Keeping an eye on whether the company is approaching its target margins for each business segment will be ideal going forward.
A Look At The Company's Stock
In regards to the company's stock, one additional factor that has come into play for Solazyme is the amount of skepticism shown by market traders. In recent months, the number of short sellers has significantly increased. Much of this is likely due to increasing losses, a capital raise, and the initial delay of the Moema facility.
From the middle of January to the middle of May, Solazyme continued to trade at a similar price range of approximately $10/share. Nevertheless, the company's short interest rose from 9.75 million shares to 16.38 million shares as of January 15 and May 15 respectively. This represents a 68% increase of those capitalizing off of the company's failures.
What is important to understand about this short interest is the fact that every one of these shares represents a position that has been borrowed and sold, thereby creating artificial selling pressure. Eventually, these shares must be repurchased again resulting in an increase of buying demand. At current short interest levels, approximately one out of every four shares in the company's float is now being shorted.
In April, Solazyme conducted a public offering that increased the share count by approximately 5.75 million shares at a dilutive price of $11 per share. This price suggests that the company added more capital at a premium to the current price. Considering the increase in short interest, we see that the number of short sellers has increased beyond the amount of shares offered through this capital raise.
Essentially, despite raising capital at a higher value than the current share price, the entire offering has also been offset by an increase in short sellers. All of this has been accounted for in the current share price. The inability for the market to push the price lower than where it was in January remains a positive sign for long-term investors. It suggests that the mainstream interest in the company continues to grow despite the increased presence of short-selling traders.
Going forward, this bodes well for increased price support. As a result of the borrowed shares, the company now trades lower than where it should be. Not only does this increase the risk of a short squeeze with a positive company catalyst, but it helps to offset the declines as short sellers buy to take profits and close out their positions. At the same time, Solazyme is now in a greater financial position having raised capital at a much higher level. This helps to further strengthen the price support should an unexpected issue arise.
The risks that Solazyme now faces are no longer heavily tied to the technological development and manufacturing challenges already endured. Indeed, the direction of the company is now reliant upon the Solazyme's ability to execute its business plan. The establishment of key partnerships, the expansion of existing supply commitments, and the increase of additional manufacturing capacity are all catalysts which could propel the company forward. They also serve as key milestones in which to evaluate whether the company is now succeeding.
The opening of the Moema facility serves as a critical de-risking event as it removes the restraints which held Solazyme from growing its sales. Investors should expect for losses to accrue in the near-term as the company begins to ramp up its commercial production. However, successful operation of the company's facilities should secure Solazyme a profitable future as long as the company progresses towards its target product margins.
I continue to believe that the current price level represents a long-term buying opportunity. Specifically considering the amount of capital that has gone into developing this technology, I believe the company is worth at least $1.01 billion in the present as previously stated in my article found here. This would suggest a personal price target of $13.27. This is especially the case in light of the company's differentiated technology, established manufacturing capability, and strong financial balance sheet.
Disclosure: I am long SZYM, BG. 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.