Petroalgae: $1.8 Billion Market Cap With No Revenues

| About: Parabel Inc. (PABL)

Petroalgae (PALG.PK) has a current market cap of $1.8B, net debt of $57M, total assets of only $4M, and last 12 months' net loss of -$38M. Petroalgae has not generated any revenues since inception in 2006.

Management is well compensated. The CEO's 2010 salary was $486k, and five other senior managers earned over $200k. Five senior officers also received an $11.4M accelerated stock vesting in the fourth quarter of 2010, although that was based on the current high stock valuation.

Petroalgae is developing a process to produce bio-fuels from algae and other micro-organisms. In open-pond bioreactors, the company or future licensees grow aquatic microorganisms at accelerated rates, enabling the production of two end-products: a fuel feedstock that can be used in refineries, and secondarily, a protein that can be added to animal or human food.

Biofuels have a lot of potential. It is a renewable energy source that is in ample supply. As fossil fuel supplies may diminish in the decades to come, biomass fuels (converting bio-waste to energy, or algae to energy) become more attractive.

Petroalgae's stock hit an all-time high of $33 back in 2009, when Exxon Mobil (NYSE:XOM) announced that it would spend $600 million to study the feasibility of algae-based fuels, although none of those funds have been directed towards Petroalgae. Since then, Petroalgae has announced some corporate partners, most notably Foster Wheeler (FWLT), although monetization of these agreements have not yet occurred. In fact, one recent licensee, requested a refund of its $2M escrowed license fee, which was refunded in January 2011.

The main issue is cost. Petroalgae process is still not cost competitive with current fossil fuels. It is a development stage company, which will require a number of years to have a cost-competitive product that can generate revenues. Furthermore, there are many biomass fuel projects around the world, and barriers to entry are likely to be low, even with proprietary technology.

Most comparable entities are government/oil company-funded and/or private. I came across one quoted comparable - Refill Energy (OTCPK:REFG), which converts biomass into gas. Like, Petroalgae, Refill has no revenues, an operating loss, and total assets of $3.3M. Unlike Petroalgae, Refill has a market cap of only $0.5M. Now Petroalgae may be a higher quality company; but is it 3500 times more attractive than Refill?

As is often the case in the OTC bulletin board and pink sheet world, the size of the backers can influence the market capitalization. Valens Capital Management, a large hedge fund manager led by David and Eugene Grin, effectively controls 98% of the float and has financed the majority of Petroalgae's accumulated loss of -$105M. In 2008, through Valens-controlled PetroTech Holdings, 100M shares were purchased for $350k; just afterward, a Valens hedge fund directly purchased an additional 3.2M shares for $10M. Most of Valens financing of Petroalgae since 2008, have been through debt. Petroalgae's total debt now stands at $57M. Valens most recent infusion was $5.4M in Q1 2011 according to SEC filings. The end result is a thinly-traded, current market price of $16.50, equating to a market cap of $1.8B.

The question is how much longer can Valens afford to finance Petroalgae? The answer is complicated, as we do not have public information on Valens. Part of the answer lies in how Valens values its Petroalgae investment. If Valens values Petroalgae anywhere near the quoted price of $16.50, then Valens Capital Management has a huge income stream of management fees (and possibly performance fees) given an equity cost base of about a dime per share. Thus, the opportunity cost to let Petroalgae sink would be quite high. On the other hand, if Valens uses methodology that values Petroalgae at a much lower price, then the time frame for the Petroalgae bubble to burst would be less. If the former is the case and Valens is valuing Petroalgae at $1.8B, one must wonder how much longer Valens hedge fund investors would tolerate such a valuation. Petroalgae's new COO recently stated his preference, forcing the company to buy-back his awarded 12,500 shares at $8 per share, roughly half of the current quoted market price.

Disclosure: I am short PALG.PK.

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