The ethanol producer, Gevo (NASDAQ:GEVO), has failed in its attempts to create isobutanol. Therefore, all it is now is a small ethanol plant, which puts its intrinsic value at $13.2M, or about $0.20 per share. Later in the article, I explain how I got to this valuation.
When Gevo first became public, management said they're going to make a useful liquid called isobutanol, which can be produced using an existing ethanol plant infrastructure. At the time, back in 2011, ethanol prices and margins weren't very good so there were a lot of stranded ethanol plants. Gevo's idea was to help the ethanol plant owners to retrofit the plants with the isobutanol technology and create isobutanol. So Gevo bought a plant for $20.7M called Luverne that can produce 22 million gallons of ethanol per year. The hope was once they were successful at retrofitting their plant to produce isobutanol, they could then sell the technology to be used to retrofit other ethanol plants.
The following diagram is Gevo's presentation from 2011 on how it would retrofit its ethanol plant to produce isobutanol.
As shown above, to retrofit a 22 MGPY (million gallons per year) plant, Gevo projected the cost to be about $0.77/gallon. That comes out to a total cost of $0.77 x 22M = $16.94M.
However, Gevo has spent $65.7M to retrofit its Luverne plant, as of December 31st, 2013, as stated in its recent 10-K. That comes out to about $3/gal for the 22 MGPY plant. And there still is no sign of being close to finished. The $16.94M projection was a very poor calculation by management.
In the Q413 earnings call, Gevo's CEO Pat Gruber said:
We have made a lot of progress moving through the isobutanol commercial process learning curve. Fundamentally, our technology works its scale with corn mash, the feedstock. And we are in the midst of learning how to run the integrated full scale isobutanol process.
Three years and over $65.7M later, and management is still learning. How long will this learning stage last?
The answer is the learning stage will likely never end because management's approach is wrong. According to a scientist who specializes in biofuels:
The process of making ethanol is so much different than the process of making isobutanol, that you have to build the plant from the ground up to prepare it to make isobutanol, you can't just retrofit an ethanol plant. There are too many contamination problems.
Contamination problems have continued to plague management in this process. If Gevo stops trying to retrofit the plant, and just focuses on efficiently producing ethanol, the company will burn less cash.
Is Management Secretly Throwing In The Towel On Isobutanol?
In the Q413 earnings call, Mr. Gruber said:
Needless to say, the additional cash flow is a benefit as we work to maximize (inaudible) per dollar as we scale up the technology.
Therefore, we plan to arrange three of our fermenters to produce ethanol. We are (indiscernible) configuration side by side meaning both ethanol and isobutanol, we produce concurrently.
Huh??? The original purpose of Gevo's business plan was to find an alternative to ethanol. Now, it is going to focus on producing ethanol? Gevo's decision to sell ethanol is a matter of survival. Gevo is not going to last much longer. It needs the income from ethanol sales to halt the cash burn as it's on its last legs.
Gevo is still putting on a facade that it will one day be able to commercially produce isobutanol. That is what is causing Gevo to trade at a huge premium to its peers. However, Gevo should now be considered a pure play ethanol producer, and valued the same as its peers. This puts its value at $0.20 per share.
The only assets that Gevo has is one small ethanol plant that has production capacity of 22 million gallons. To see how much Gevo is overvalued, I compare it to the only two pure-play publicly traded ethanol producers: Pacific Ethanol (NASDAQ:PEIX) and Green Plains (NASDAQ:GPRE).
The above shows that GPRE and PEIX are trading at just under $2.00 EV/gallons produced. PEIX is trading at a slightly smaller EV/gallon than GPRE because it produces less ethanol and so doesn't have the economies of scale that GPRE does. GEVO produces considerably less than PEIX does, about a tenth, so it has even less economies of scale than PEIX. Therefore, fair value would have it trading at around $1.30 per gallon. That would put its EV at $1.30 x 22M = $28.6M. Adding cash and subtracting debt, that puts GEVO's market cap at $13.2M, which would value it at $0.20 per share.
Last month, Gevo announced that distressed investment firm Whitebox loaned it $25.9M. This loan contains a first priority lien on all of Gevo's assets, which is only the plant. This amount, $25.9M, shows that Whitebox values Gevo at roughly the same EV/gallons metric that PEIX and GPRE are valued at. It values the company at $25.9M/22MGPY = $1.18/gal.
Whitebox Isn't A White Knight, It's A Great White Shark
A Seeking Alpha article recently came out titled Gevo: A White Knight Emerges As Delays Don't Mean Disaster. Whitebox is clearly not a white knight. Whitebox is the equivalent of a loan shark, or a "vulture lender". Companies only borrow from Whitebox as a last resort, if they can't raise funds from anywhere else.
Whitebox knows how to value biofuel companies and has lent money to the sector. This article tells how Whitebox was a major creditor to a bankrupt Illinois plant.
The harsh terms of the loan to Gevo speaks for itself. Whitebox is charging Gevo a gouging 15% interest rate, and in the case of a default, Whitebox gets Gevo's ethanol plant. Whitebox isn't assigning any premium to Gevo's isobutanol research. It recognizes that Gevo's isobutanol project is probably not worth anything. However, it knows that the ethanol plant has value as an ethanol producer, nothing more.
Gevo should be valued at less dollars/gallon than PEIX and GPRE, because it has less economies of scale being a junior plant. Also, the management of Gevo are scientists that are trying to create isobutanol. They don't have experience running an ethanol plant efficiently like the managements of PEIX and GPRE do. Therefore, they are going to make mistakes and have ramp-up costs. On top of this, and I know Gevo investors don't want to hear this, the company is still going to waste money to develop isobutanol, when in reality it should just quit that and become a pureplay ethanol producer. However, if it does quit its isobutanol project, then overnight the stock will drop 50%-75% because the market will then value it like the other ethanol pure plays, PEIX and GPRE. So in order to sustain its current market cap, it needs to keep hope alive in investor's minds. In the end, this strategy will drive Gevo to bankruptcy.
Excessive Executive Compensation
Gevo not only has the matter of helping the company survive longer, but also Mr. Gruber and the other executives want to continue getting paid their enormous salaries. If and when Gevo goes down, and the plant gets taken over by Whitebox, then the executives will be unemployed. It's extremely unlikely that any of them will be able to find jobs that pay what they are getting paid at Gevo. From the latest 10-K, the following was the base salary for the officers:
A team that ran a failed project and shredded shareholder money the past three years are getting lavish salaries. And this is just their base salary, it doesn't even include their bonuses! These clowns lost shareholders -$60.7M in 2012 and -$66.8M in 2013. Gross profit was -$8M in 2012 and -$9.7M in 2013 and operating loss was -$71.4M in 2012 and -$55.5M in 2013. And unbelievably, they decided to take from investors even more and give themselves bonuses for 2013. The following was their 2013 bonuses:
Whitebox doesn't care that management is overpaid. Whitebox welcomes a bankruptcy because then they get the ethanol plant. But the shareholders should care. They should be up in arms because management is taking money out of shareholders' pockets and putting it into theirs.
Gevo's isobutanol project has failed. As I stated above, the process of making ethanol is so much different than the process of making isobutanol that you have to build the plant from the ground up, you can't just retrofit an ethanol plant. But Gevo management won't admit to this and just run a small ethanol plant because then the stock would tumble overnight, and they wouldn't be able to pay themselves the lavish salaries that they are getting now. Therefore, the company will continue taking losses, and eventually grind down their cash balance to nothing. At that point, the stock will be worth zero, and Whitebox will take over the ethanol plant and sell it to a big ethanol producer like Archer Daniels Midland, Andersons, Pacific Ethanol, and Green Plains.
Disclosure: I am short GEVO. 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.
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