The Future Is Fermented: Amyris

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About: Amyris, Inc. (AMRS)
by: Dave Schneider
Summary

AMRS is only followed by 2 sell-side analysts and is off the radar screen of institutions.

Balance sheet fears are misplaced.

Uncertainty in forward financial metrics creates the opportunity.

Stock is in the hands of daytraders but will migrate towards more institutional ownership as the year progresses.

Preface: During the course of editing/proofreading my report, Amyris announced a major partnership which changes things significantly. Rather than rework the entire report to reflect how the cannabinoid deal affects everything, in the interest of providing people a good primer on the company, I have left the original report intact with an update at the end to reflect what the cannabinoid deal means. I have been working on this report for a month, and in fact, gave followers of mine a heads-up on my LinkedIn profile in January with a simple phrase.

When investing in individual stocks, the most outsized returns can be made by finding a company that is unloved before it turns into a stock market darling. If that stock is also off the radar screens of most institutions due to it being very small capitalization and having a checkered history with a reputation of missing guidance, then the potential is there for even greater reward... and so the story begins.

Amyris went public in September of 2010 via investment banks Morgan Stanley, Goldman Sachs, JPMorgan, Banco Itau, and Stifel Nicolaus Weisel. The IPO price was $16 giving the company a market cap of roughly $700 million.

The premise at the time was to use Brazilian sugarcane turned into syrup as a feedstock for genetically precise strains of Brewer's yeast, which would metabolize the sugar and produce as by-products via fermentation, what the customers wanted. Started by PhDs from UC Berkley with a grant from the Bill and Melinda Gates Foundation to develop an improved treatment for malaria - Amyris built on that success to move into biofuels. They intended to disrupt the market for petroleum-based fuels by having the yeast produce molecules that could become the basis for diesel, jet fuel, and gasoline substitutes. With inexpensive and renewable sugarcane and manufacturing in Brazil, the idea made conceptual sense. Subsequent to success with the malaria product via yeast, the initial molecule of focus became Farnesene. It can best be described as a parent molecule which can serve as the scaffold to build many larger molecules within a wide range of categories. Amyris' take on it is here.

Jumping off the farnesene website page is the fact that the areas where farnesene can serve as a chemical building block are varied. They are areas where Amyris excels and are fragrances and vitamin precursors. Although current revenues are in the cosmetics and vitamin arena, Amyris and energy giant Chevron announced in May of 2018 an expansion of their joint venture to introduce "renewable base oil technologies". Although currently only a footnote to the story, Novvi is expected to begin to contribute to the AMRS bottom line at the end of 2019, or early 2020.

At the time of the IPO, with Amyris eager to disrupt the petroleum-based fuels business, the shale oil boom in the US was pickup up steam. That was the light at the end of Amyris's tunnel and the shale boom was an oncoming train. Years of losses followed, and the balance sheet was destroyed. With the company in tatters, even accounting got sloppy. In order to stay alive, Amyris resorted to doing financings that firms in better financial shape would not dream of. During this dark period, the science progressed. With little institutional sponsorship on either the buy or sell side, shares primarily fell into the hands of short-term traders and institutions who participated in the toxic financings. My reading of SEC filings from those dark days left me wanting Dramamine.

About Fermentation

People have been using fermentation since the stone age, which for those who are not history buffs means before Netflix. It was Louis Pasteur who figured out that fermentation is caused by living organisms. Examples of products created through fermentation include alcoholic drinks, sauerkraut, sourdough bread, cheese, kimchi, kombucha, and more. Coffee beans even often go through a fermentation process.

Fast forward to the present day and Amyris has developed a line of skincare (Biossance) that is being sold through Sephora stores and directly through their own website. Their work with farnesene led them to develop an alternative sustainable source for squalane - which has turned out to be an incredible emollient (softens the skin - a moisturizer). As the availability of Biossance squalane becomes better known, we may see it used OTC for people with disorders such as eczema. Alternative sources for squalene are shark liver or olives. It is also found in the peels of apples, lime and oranges, nutmeg, and basil. Olive oil is preferred to be used for cooking or eating and sharks prefer not being organ donors, making the Amyris way ecologically sustainable and by the way, less expensive than prior methods of extraction.

Sharks are happy, and Italian chefs are happy since based on the growth of their Biossance line in Sephora, we might be running a bit short on olive oil had Amyris not come up with their solution. Amyris has announced that they will be expanding their Biossance product offerings into the categories of baby products, hair care, and men's. The reception should be especially good in the area of baby care since Biossance products go way beyond even European requirements on ingredients regarding what is considered safe. (Standards in the USA are quite lax compared to Europe.) In fact, there are foods that are not sold in Europe for safety reasons that are sold in the US.

So, about Sephora - how many stores do they have? Sephora is part of the luxury brand LVMH Group. Sephora has over 2,300 stores globally with roughly 430 in the US. Biossance is only sold in a fraction of the 2,300 stores and Amyris has said that Biossance will be expanding to Asia and Europe in 2019. In addition, in the stores where Biossance has major displays, they are the leading brand in those Sephora stores. They do not have the same amount of display space in each store. In 2019, I expect to see Sephora increase display space allocated to Biossance. That, on top of expanding into new categories, should maintain the high growth rate of Biossance.

The other part of their "beauty" business is selling ingredients to other companies. They supply such global giants as L'Oreal, Shisedo, and others. This part of the business is called Apprinova, which is a 50/50 joint venture between Amyris and large Japanese company Nikkol Group.

CBD Potential

The market for CBD-infused skincare products is growing and these plus edibles & beverages may overtake smoking in terms of the biggest slice of the legal cannabis economy. The highest margins with the cannabis economy are the extracts. On the website, there is a section called "Our Process". One sentence should be of interest to investors in the Cannabis sector - "It replaces compounds typically derived from plant sources that can't be extracted reliably". Although cannabis companies use expensive extraction technology to get compounds from the marijuana plant, what if you could get yeast to simply eat sugar syrup and spit out cannabinoids? It can be done and Amyris did this 3 years ago but there was no legal market. Currently, they are simply waiting for the right opportunity.

The largest cannabis companies have maybe a hundred stores and market capitalizations in the billions. Amyris has a market cap of about $350 million and current distribution via Sephora within the U.S., Canada, and Brazil. As more cosmetics companies want to put CBD into their products, they can get it from marijuana growers or even hemp farms but I suspect that a less costly alternative can be found with Amyris.

What can Amyris do besides put CBD into their skincare line? Currently, marijuana companies are spending millions on equipment to extract the molecules of interest from marijuana. The extracts are then put into a myriad of different products including beverages, foods, medications, and pet supplements. But the cost of the equipment is just the beginning. Running this equipment is not child's play. You need trained personnel. You need square footage. And when your highest margin products depend on the reliable extraction of valuable products, you want the equipment running to perfection. Could a cannabis company save that money and transform fixed costs from their extraction business to variable costs by calling up Amyris and asking them to ship 20 kilos of CBD? Yes. A company doing that would have more room to grow more plants. It works for everybody. And none of this potential is in the stock price.

https://i.imgflip.com/26ovz8.jpg

That is Jackie Gleason leading us to the product area that investors are currently most excited about. A sugar replacement. Sugar has been associated with numerous diseases ranging from cancer to Alzheimer's. Some people even call a major portion of Alzheimer's "Diabetes type 3". Most of the public is only aware of diabetes as being the sugar focused disease when the fact is that its inflammatory properties contribute to a wide range of disease.

Over the past few years, stevia has emerged as a leading contender for people who want less sugar in their diets. But stevia leaves contain more than one compound that is sweet. Going back to the original thesis - that Amyris gets yeast to make molecules that are found in plants or animals - they have gotten yeast to make one of the molecules within Stevia. Fortunately for Amyris, this particular stevia extract has emerged to be the leading contender for the next generation of sugar substitutes. This product called Reb-M is essentially the best part of stevia without the downside of other molecules within stevia that has a taste profile that food and beverage companies don't want.

The Problem That Isn't a Problem

It's been no secret that global healthcare authorities have declared war on sugar. In many nations, sugar is about to be taxed in order to change consumer behavior. The costs of obesity, diabetes, and sugar related illness are astronomical. In addition, food and beverage labeling laws are changing in the U.S. which will require consumer products companies to show the amount of added sugar. Yes, Agave syrup is sugar and don't give me your tree hugging honey story. Food and beverage companies have reviewed all the sugar substitutes in their scramble to find an alternative. Reb-M is the favorite for now. The issue that Amyris has is that of capacity. The global market for sweeteners is around $90 billion. The demand is there and Amyris is pretty much sold out through 2020. So, others are deciding that they want to make it also. Because it is a natural product, it cannot be patented. However, there is I.P. around the way to get the yeast to make it, and it is there where the years of pain and losses have given Amyris a lead compared to anyone on the planet to expand manufacturing capacity. In addition, Amyris has its manufacturing sitting in the middle of sugar fields in Brazil, with an endless supply of raw material for the yeast to feed on. If no other companies wanted to make the stuff, Amyris investors should be worried. But everyone wants to make it. The fermentation process is easier using sugar as the base vs. corn or other crops, and the cost of operating a fermentation plant in Brazil is much less than it is in the USA. Skeptics can call it a commodity, but whatever you want to call it, having the lowest cost in making any product is a good thing. Their motto contains the words "No compromise". That refers to quality and consistency, and if I am going to put something in my food or beverage, that is what I want, and I believe that is what the mass market will want. And inevitably, others will make Reb-M. But based on how many years Amyris has been training yeast like puppets on a string, it will be very tough for others to compete on price. Read the labels of every bottled or canned or bottled product in your kitchen. Then, after seeing how much sugar seems to be in everything and saying to yourself, "Holy S___", you will know what I mean. So, Cargill and DSM can go ahead and make the product for a lot more money and it will create some jobs in Nebraska which is a good thing. But it won't stop Amyris.

Partners for Growth

On December 4, 2018, Amyris announced partnerships with several companies. Among them was Raizen. Raizen is the largest grower of sugar cane in Brazil. With the world trying to cut down on sugar consumption, Raizen needs to find new markets. Since Amyris feeds the yeast sugar syrup, Amyris is a natural customer for Raizen. With Amyris intending to grow its own production capacity beyond the opening of the "Brotas-2" manufacturing plant later this year, Raizen will be an integral part of that. Raizen has a guaranteed customer for its crop and Amyris has a guaranteed source of raw material. At this point, nothing is known about potential CAPEX sharing or timing of the first joint facility.

That September Quarter

The most recently reported quarter was a big disappointment to investors. Both revenue and earnings were well short of analyst expectations. Currently, only two sell-side analysts follow the company, and Amyris missed both sets of estimates. The problem was the global price of Vitamin E. In December of 2017, AMRS sold the plant which is responsible for Vitamin E to Royal DSM and in turn agreed to a royalty deal where they receive 35% of all dollars when vitamin E is above $8.40 per kilogram. The street and insiders at AMRS had missed the fact that the price of Vitamin E had dropped below the threshold price. Insiders actually bought stock in the open market during the quarter. The price drop on Vitamin E was due to BASF bringing online a new plant. Since the new BASF capacity will not go away, some may assume that AMRS will never see any more royalties from vitamin E sales through the end of time. However, vitamin E is used far beyond human nutrition and the need for it continues to grow. In addition, the royalty rate actually expands from 35% over the $8.40 magic price to 45% over the next year and a half. Could there be a catalyst beyond the forecasted (Reuters) 5% forward growth rate for vitamin E demand? I might have found one and I started taking vitamin E as a result. It is known that in general, we lose about 1% of muscle mass per year after age 40. Some of largest selling supplements are muscle building supplements (creatine, etc.).

A randomized, double-blind study at the University of Washington shows that a supplement enhanced regimen that includes Vitamin E, astaxanthin, and zinc significantly helped elderly subjects with muscle strength, treadmill test, and muscle size. To me, that is a breakthrough. The study has not been well disseminated, and I doubt that companies making vitamin E are even aware of it. But, with this article on Amyris, I suspect they will hear about it. For those who are interested, the astaxanthin that I take is zanthosyn which is more bio-available than other formulations. (you don't have to take as much to get the same effect).

As someone who is a gym rat, showing up 5-6 times a week for 1.5-2 hours per session, I want every edge I can get. And vitamin E, astaxanthin, zinc - all safe and no drug testing organization for professional sports will give a damn about it.

The Clean Beauty Line (Biossance) was not beautiful in the quarter either. Although AMRS reported about $6 million in Biossance sales during the quarter, this includes the effect of Hurricane Florence which delayed $12 million in shipments. Their facility in North Carolina emerged in great shape after the Hurricane, but shipping was a mess. So as much as the September quarter was a mess, the December quarter should be better and investors will pay attention since AMRS still has more coming in the area of geographic and product line extensions. Black Friday saw the internet sales for Biossance go a little crazy, and there were thousands of people who could not get their orders in time. That is good since it means people are starting to love Biossance, but Amyris was not ready to handle the volume. So, they gave $10 credits to people whose orders got messed up. That will show up in the December quarter.

The Basic Business Model is that the gross profit in selling a product that is made in Brazil will have roughly a 10% markup on cost. The rest of the profit is royalties on end sales. Amyris can get up front fees upon signing deals or work out a deal which front loads a portion of the royalty stream. Historically, royalties could come in as long as a year after products were manufactured since the manufacturing process was done in batches to produce a year's worth of supply at once. Then, the factory would switch to making something else. That time lag is one reason why their new plant should help the cash collection cycle - the plant is more flexible and will do shorter runs of product, so instead of producing a year's worth of product to say, a fragrance customer - they can make one quarter's requirement, then essentially flip the switch and make a different product. In addition, the cost to develop a new product is paid for by the client. This goes back to the fact that Amyris is not inventing new products - they are figuring out how to make existing products at less cost and with less environmental impact.

The Microsoft Connection

It is serendipitous that the company got its start with a grant from the Bill and Melinda Gates Foundation. The success of Microsoft got its fuel from the creation of Windows which became the parent operating system that enabled the creation of the numerous applications that changed the world. The platform of windows enabled Microsoft Word, Excel, Publisher, etc. Metaphorically, Amyris has replicated the business model from its initial investor. The technology platform of Amyris is essentially an OS that enables the creation of products ranging from skincare to an ingredient used in winter tires. And they do not need a dozen factories to make a wide variety of products. If this were a traditional petrochemical manufacturing situation, the CAPEX would have a lot more zeros on the right. For new products, Amyris does not need new PP&E. They just use a different yeast. And as that OS gets more and more optimized, the cost to develop new products drops and the speed of new product introductions increases. Although CEO John Melo has stated that he would like Amyris to be the "Intel Inside" more and more products, I prefer the OS concept.

Global Warming, BASF, and China

In an interesting development, BASF recently declared Force Majeure on acrylate esters production. Acrylate esters are used in a wide variety of consumer products. If the lack of water is a result of climate change, then the ability of AMRS to step in and fill the gap of production could be a major near and long term positive. We do know that China is taking major steps to shut down polluters in the chemical industry, and AMRS has good relations globally. At this point, all we know for sure is that this is an unexpected positive, with an unknown knowledge of just how big a positive. But it is right in AMRS's wheelhouse.

The December 31, 2018, news release - Who is Xinfu and what does it mean?

On 12/31/18, Amyris announced the third deal with China-based Xinfu. Xinfu is Yifan Pharmaceutical. They are also listed on the Shenzen Stock Exchange under the name Yifan Pharm, code 002019. With a market cap as of 1/1/19 of $1.9 billion US, they are a substantial company, with a presence in drugs, polymers and they are the #1 vitamin company in China. Coincidentally, they are the world's largest vitamin B-5 manufacturer and all the B vitamins can be made via Amyris fermentation. Essentially, Amyris transferred the vitamin E deal that they had with DSM to Xinfu. In return for that, Amyris got $50 million up front and 45% of the annual royalties from DSM that exceed $10 million per year. Recall that in the September 2018 earnings call Amyris told people that for conservatism to remove Vitamin E royalties from their models - since pricing is volatile. The Xinfu announcement failed to excite anyone but given that the price of vitamin E is not something that AMRS can control, there is no guarantee that the price will rise, especially in a world where commodity prices are dropping. So, the deal brought in $50 million quickly which is needed for the completion of their plant Brotas-2. Xinfu's first product deal with Amyris was announced in September of 2018. The second was Nov. 8, 2018. Worth noting in the press release of September 27 is this: "The combination of Amyris's technology position and Yifan's market position is expected to result in the product being commercialized within the Chinese market by 2021 with the first product revenue achieved the same year. Assuming successful commercialization of the first target, the companies expect to bring to market 3-5 additional products in the coming years." We know the first product is a nutritional product. The November 8 announcement said that the second product is a vitamin. Amyris has the technology to produce several vitamins at costs that are nearly impossible for others to replicate. Investors should keep in mind that vitamins are sold outside of the human supplement market. There is a large and growing market for use in companion and farm animals. The unusual rapid addition of a second product within weeks of the first product is a sign that the relationship is off to a great start. So, we have built in growth for 2020 and 2021 from Yifan Pharma. Is that too far away to care about? Biotech companies that hope to have drugs for the human market can have market caps in the billions and lose money through 2022 and investors are willing to pay up for them. Amyris has never spent a dime trying to invent a new drug. What they do is take what is already being used by millions of people or in many cases billions of people - and work out processes to produce the products in an eco-friendly manner, with sustainable sugar cane as the feedstock at costs that disrupt the status quo. Therefore, AMRS business model is dramatically lower risk than the biotech stocks that investors are used to hearing about.

Frienemies - Royal DSM and Amyris

Royal DSM is one of the world's leaders in nutritional supplement ingredients. Their ADR's trade as RDSMY. DSM got a great deal when they invested at the beginning of 2017. Over time, they accumulated what is up to a 25% stake of the fully diluted shares. There is a standstill agreement in place which prevents DSM from owning more. At the end of 2017, Amyris still was looking for money. They had a plant in Brazil that had been designed for very long runs of farnesene. Originally, the farnesene from this plant called Brotas 1 was slated to be turned into fuels - renewable jet fuels, diesel, etc. When oil prices dropped as a result of the fracking revolution, the flowchart of the company and plant was transitioned to make farnesene subtly tweaked so that it could be essentially turned into vitamin E as the end product. Call it the "Vitamin E" plant even though it does not make vitamin E. It makes farnesene that is shipped to a Chinese company called Nenter and gets converted to vitamin E in China. Nenter is a subsidiary of a large company called GuanFu (stock code 002102) which is publicly traded. GuanFu had actually invested in Amyris some years back. They have what is likely the lowest cost vitamin E in the world.

With the expansion of its product portfolio, Amyris needed manufacturing that is more flexible than that farnesene plant. With DSM being a world leader in nutrition ingredients, they struck a deal where AMRS sold the plant to DSM in return for royalties. (referred to earlier) The cash gave AMRS breathing room with participation in profits from vitamin E sales. But the interest of DSM is beyond vitamin E. At a May 6, 2017 investor meeting, the President of DSM Biologics Andre Bos said that after reviewing Amyris' science, people, and technology - that DSM's top scientist came back home and was "flabbergasted". This was before DSM invested in Amyris & got a board seat. They also have first rights on nutritional ingredients developed by Amyris. My view of DSM as regards Amyris is that of a "frienemy". DSM is excited about what Amyris can do for them while at the same time paranoid about getting parts of their business disrupted by new technology. I think that had the standstill not been in place, that Amyris would now be part of DSM. In fact, at that same May 16, 2017 meeting when asked about a possible acquisition of Amyris by DSM, Andre Bos and John Melo responded similarly - Melo saying "Not at this price" and Andre Bos saying, 'Not at this price but…" So I view the involvement of DSM with mixed feelings. They (and many other firms) are a backstop in case Amyris makes a major mistake and needs a rescue. DSM only needs to buy 75% of Amyris since they already own close to 25% of the fully diluted shares.

Most people are misinformed on another part of the DSM relationship - with DSM owning so much and having a seat on the board, how free is AMRS to engage with firms outside of DSM for the sale of their products? The "view from 30,000 feet" is that DSM has first right of refusal for any nutritional products. If that were true, then DSM would be able to squeeze AMRS on pricing and handcuff them from engaging with other companies. The truth is that AMRS can make a deal with anyone, but DSM has the right to meet or beat the terms that other companies propose to AMRS. So, with all the markets that AMRS products play in, that explains why the CEO is constantly engaging with firms globally. Most people think that AMRS has deals with Xinfu because DSM said no thanks. I think the widespread misunderstanding of the DSM relationship is partially responsible for where the stock price is. It also means that the company will likely have more partners coming than people realize.

What to expect in 2019-2021

Consider Biossance, one of the fastest growing skincare brands in the nation - also growing outside the USA. Biossance will expand the product line this year while increasing retail shelf space per store. AMRS is on record as saying that they get 40-45% of the revenue of the final retail purchase which means Sephora and obviously they get 100% of the revenue when people buy online from Biossance. It is tough to predict where the ratio of online to retail will be from one year to the next for Biossance. What we do know is that when AMRS sells products for its own account, the gross margins average around 70%. But, they are also on record saying that when they sell Biossance directly, the gross margin approaches 90%. Conclusion: 100% online sales = 90% GM. Sales at Sephora should create 40-45% of that since that is their portion of the revenue. If we assume a 50/50 split in end user sales between retail an online, the blended Biossance margin coincidentally would be (.5x 90%) + (.5x40%) = 65% blended. If more sales shifted to direct, gross margins and pure gross profit dollar's rise. That should occur as Biossance users become repeat consumers - the ease of point and click shopping. So to calculate annual gross profit for Biossance, apply your guesstimate for annual Biossance revenue and the ratio of direct sales to Sephora sales. My Biossance guesstimate for 2019 is 60 million and for 2020 it is 110 million. The quarterly run rate entering 2019 was about $12 million. At a 65% gross margin, Biossance gross profit = $39 million for 2019 and $71.5 million for 2010. That may seem high, but in their November 2018 conference call, they said that Biossance gross margin is running at over 70%. So, that indicates customer strength in direct online purchasing which is a very good sign. Also, 2019 is when Biossance enters the Asia-Pacific market.

Sweetener: Revenue estimate of $60 million in 2019 as the product ramps with $100 million in 2020. Keep in mind that demand for AMRS's new sweetener is quite high. For 2019, manufacturing is outsourced. Gross margin for the sweetener for 2019 and 2020? For conservatism, 55% in 2019 and 65% in 2020.

Gross profit in 2019 = 55% x $60 million = $33 million for sweetener

Gross Profit in 2020 = 65% x $100 million = $65 million

Subtotal Gross Profit Clean Beauty + Sweetener: $72 million and $136.5 million for 2019 and 2020

The tricky part is handling the ramp up of the new plant that comes online at the back end of this year. When the switch is flipped to the "on" position, depreciation starts and if for the first quarter it is on, it is running at 10% capacity utilization the financial optics would not be pretty. But as capacity utilization increases the numbers will improve. That is why I view 2019 as the transition year to consistent GAAP positive earnings and free cash flow. I suspect that the new plant will be running at full capacity within one quarter of opening. And any half decent analyst or portfolio manager will be looking at 2020-21 estimates to value stocks by the middle of 2019.

Brotas-2 and -3 Plant Dynamics

Brotas-2 is designed for flexibility, meaning the ability to make many products in varying amounts. For conservatism, it is best to visualize capacity utilization of Brotas-2 ramping up over the course of a few quarters. So, margins would start out dull and ramp up sequentially. But… my work on the demand for Amyris products suggests that Brotas-2's utilization will have as the limiting factor the engineers ability to get the plant humming to perfection rather than sitting around waiting for new orders. In fact, based on what in my opinion the demand looks like for the non Reb-M products of Amyris, the deal with Raizen makes perfect sense - they are already planning "Brotas -3". That plant I believe is likely to be dedicated to Reb-M. The market for Reb-M alone is in the billions of dollars per year so why not optimize a plant for it? And with the partners that Amyris already has… ASR Group which includes Domino Sugar & C&H Sugar, Shaklee, Givaudan, Camil Alimentos)… Amyris will have a buyer for every gram of Reb-M that they produce from a dedicated plant. Obviously, margins from their own plant should dwarf whatever the margins are for RebM for 2019 and 2020 since RebM manufacturing is outsourced for the next 24 months.

HMOs are more than Health Maintenance Organizations

Amyris on the average should introduce 2-3 new molecules/products per year. They are on record as saying that they are going to do something with HMOs. This refers to human milk oligosaccharides. We know that the best nutrition for a baby is natural mother's milk, and one reason for that happens to be the HMOs. They are the 3rd most abundant solid component of breast milk and support the health of the infant through the gut in areas of digestion, immune system, and even cognitive growth. Even though infant formulas have dramatically advanced with the addition of omega 3 oils, the presence of HMOs in infant formula is just getting started. In addition, there are more than 130 of them in natural milk. Here again, a global market. Here again, an expensive ingredient to include in baby formula in the quantities that matter. Amyris should be able to produce the HMOs for a cost that makes them the first call for anyone who wants them. With 130 million babies born each year, is that enough of a market? Well, science is finding that HMOs are useful all the way into adulthood. HMOs act against E. Coli bacteria, influenza A and the norovirus (give every passenger on a cruise ship some Amyris HMOs.) HMOs help restore the balance of the microbiome in the gut. People with diseases such as inflammatory bowel syndrome, obesity, and diabetes could benefit from the addition of HMOs in their routine. I would not be surprised to see HMOs added to probiotic-rich foods - example - yoghurt.

Having a healthy gut may even help with milk allergies.

The above journal article mentions that traditional infant formula can be detrimental due to altered intestinal bacteria. A good part of that is likely due to the lack of proper HMOs. This is potentially an enormous market for Amyris.

The gut microbiome is also linked to depression and schizophrenia.

So, if they start selling HMOs this year, I have no clue as to how much or when it will happen. But, for 2020 it should be meaningful. There is a good chance that the market for HMOs could rival the market for Reb-M in terms of size of the opportunity. Again, being the low-cost producer - it will be up to Amyris's execution as to how big this business becomes for them.

Aside from HMOs just getting introduced this year, they should be due to introduce another molecule which I assume would be another fragrance or flavor. Many people think they will introduce vanilla flavoring. That makes sense - Vanilla plants are grown in Madagascar and Indonesia and the supply is finite and subject to all the risks of traditional agriculture. Production in Madagascar is volatile and customers need reliable supply.

Balance Sheet

Historically, the balance sheet of Amyris was a red flag to most investors. With the move from sustainable fuels made via fermentation to using fermentation to create molecules and products that are in high demand, the balance sheet has also transformed. A big overhang that no doubt has kept institutions away from the stock was convertible debt that had been slated to mature in the middle of this year. Those converts were replaced with a convert with a longer maturity. Given the terrible September quarter, worries of solvency again were raised. Although such fear was misplaced, it did not make any difference to the stock price. One reason why such fears are misplaced are the warrants that when exercised, would bring in $150 million to the company.

But with the Vitamin E fiasco on top of a stock market that was getting increasingly nervous about geopolitical risk and higher interest rates, the potential cash inflows seem to have been ignored by the market. The first set of warrants expire on 7/12/2019 with a $7 strike price. Exercise of these would bring in $25 million.

There is enough cash that can be generated from warrant exercise to pay off every cent of long term debt/converts, build a new plant and put the company in a net cash position. An added boost to the balance sheet will come from their tax loss carryforward. My guesstimate is that at the point when they become profitable, they will have about $250 million in carryforwards. This will accelerate the balance sheet improvement. Aside from being important to the conceptual case, it is important since many institutions rely on mathematical screens that include balance sheet strength. Amyris today would not pass the screen so most portfolio managers even if they thought this was the best idea since sliced bread would not be allowed to buy it for clients. But, the number of institutions who will be allowed to buy it should dramatically increase as the balance sheets morph into respectability. More eyes looking at it, more buyers of the stock = larger market cap which brings in more potential institutions looking at it, and it feeds on itself. Talking heads on CNBC will like it more at $10 than $4. That is just how the world works.

Free Cash Flow - Cash Collection Cycle

Backward-looking, FCF is ugly. Long production runs and getting paid after a very long time. Going forward you will have shorter production runs with a greater variety of products and a shorter days sales outstanding figure. (DSO) The ability to do shorter production runs should also help days inventory outstanding for products made for Amyris' own account. Changes in DPO's I have nothing to say about right now. Overall, the cash collection cycle should improve significantly once the new plant comes online later this year. Capital Expenditures - A good aspect of the business model is that one physical plant can make many different products. I suspect that ROA (return on assets) calculations will show dramatic improvement for several years. The CAPEX situation is also helped by their tie-up with the largest sugar cane grower in Brazil, where they agree to buy the sugar and the grower helps build plants beyond Brotas-2. My guess is for some shared CAPEX. An additional positive to increasing the breadth of product offerings is a reduction in the volatility of earnings. Multiples of earnings, EBITDA etc. should rise as the volatility of earnings drops. - (Investing 101)

Potential Risks:

- Brazilian currency dramatically rises

- Tariffs against Brazil

- Products ramp slower than desired

- Intellectual Property Compromised

- Sugar Costs Rise

Blue Sky Teaser: Fermentation as a drug factory. The world wants drug prices to drop. What if fermentation could produce drugs including cancer drugs for costs below what is currently available?

Years ago, Amyris got its start with a malaria drug - is more on the drug side on their "list of things to do?" AMRS happened to recently announced receipt of a grant from the National Institute of Health.

This is not material to their numbers for the near to intermediate term, but depending on how successful they are with the vaccine research, it could be nice for the numbers in a few years. In my evaluation of the company, it just is more evidence that this company is in the process of layering on multiple recurring revenue streams and as they continue to do so, the story is becoming more open-ended.

Likely Stock Price Movement in 2019

Investors who are focused on quarterly earnings reports that meet or beat sell-side analyst forecasts should not own this stock. With few people writing about it, and with the company ramping up the sugar substitute as well as their own production capacity - forecasting quarterly numbers are a waste of time for now. In addition, investors have no idea when or how HMOs will be introduced this year. In my mind, what matters is just disrupting the sweetener and HMO market and readying the platform for a big splash in 2020.

As I see nothing in the December quarter that itself would get new investors excited, I see the stock not doing much until late spring. What could change that are more deals which could come randomly and put more meat on the bones of the story? With the March quarter results, investors will have a more stable balance sheet to look at and be given a more tangible potential ramp for the sugar substitute. The implications of the new Brotas-2 plant should get more attention on the March quarter conference call. Odds are good that we would have more of a discussion of HMOs on the call. It is possible that partner((s)) for the HMOs could be announced before March results are released. That could boost the market cap by $100-$200 million. News on the HMOs could include mention of some up-front payments or the deal((s)) could be heavier on the royalty side. Either way, being short the stock in front of that would be painful. Still, with company, in my opinion, still not profitable in the March quarter, most institutions will not be involved. At that point, the market cap might be $500-600 million.

June quarter results and the conference call would make investors realize that the new Brotas-2 plant completion is visible - enabling a transformation of the cash collection cycle and reducing the need to outsource production. Sugar substitute would be gaining traction by the June quarter. Institutions have more to work with and start to realize that multiple products that all have recurring revenue are going to be ramping over the next few years. The products and growth for 2020 will be tangible with 2020 revenues and growth viewed as "locked and loaded". At that point, value managers will be flummoxed, wondering why they did not see the opportunity at lower prices. GARP portfolio managers will be assigning their analysts the task of figuring it all out. Momentum investors will begin to hear about the company but generally not be involved. Market cap $600-700 million? Since the company introduces 1-3 new products per year, it is likely that we will have another product announcement by the time the June quarter is released for likely introduction in 2021-22. Odds of increasing sell-side analyst coverage close to 100%.

September quarter results

The enormous ramp in all financial metrics for 2020 and 2021 is staring investors in the face. Aside from the enormous revenue growth, the gross margin expansion from the switch to their new Brotas-2 plant becomes something analysts start discussing. Their JV with energy giants Total and Chevron receives attention since reaching critical mass. The JV is about to switch from losing money to making money. Investors starting penciling out the gross margin jump and staggering potential of their dedicated RebM plant jointly done with sugar cane grower Raizen. Value managers will think they are too late and GARP managers will be significant buyers. Momentum investors are starting to nibble. Since 85% of the volume traded in our markets is either passive, ETF, or algo-based, the increased market cap of the company brings more of these groups in. At this point, the balance sheet does not keep anyone away since warrant exercise has brought additional funds to the company. The larger company also attracts more clients, since it is possible that potential clients of the Amyris had shied away from getting tied up in 2018-early 2019 due to concerns about the longevity of the company. Market cap = $700 million - $800 million.

In a world of slowing growth, companies that can grow quickly are harder to find. As such, they should get a premium valuation. In 2018, finding companies with high eps growth was easy due to the tax cut. Those days are gone. Amyris should show unusually high growth for 3-5 years once the inflection point is made in the 2nd half of 2019 or beginning of 2020.

Valuation a Year From Now

One year from now it will be valued on 2020 and 2021 estimates. In presentations during 2018, the company said they thought they could do $200 million in EBITDA in 2020. That is not necessary for the stock to be an absurd buy. If they do half of that in 2020 and hit $200 million in 2021 and the market assigns a 15-20 multiple on the 2021 number by mid-2020, that creates a market cap of $3-4 billion in 18 months. On a fully diluted share count of 135 million, the stock would be $22 - $30. Apologies for suggesting the stock could rise. However, even cutting that in half still results is a compelling situation.

FAQ:

I previewed my report to some friends who are HNW and institutional investors and these were the most common points (names deleted or changed for anonymity)

Institutional Investor Questions

Q: Amyris is an interesting microcap/small cap story. But we can only invest in mid-cap stocks with a track record of positive earnings. What can we do to invest in the same theme within our investment mandate? A: Put AMRS on your screen, wait 2 years. It will be large enough to fit your criteria.

Q: We run a quant fund. You didn't even mention its beta or do a factor analysis on how the stock will respond to changes in currencies, energy prices and other things. We are not sure how to categorize it - with skincare products, a joint venture with major energy firms and other stuff. Any suggestions as to how to deal with it in a quant portfolio? A: Not my problem

Q: Amyris has invested so much and we are an ROIC driven firm and it just isn't there. This makes no sense to us, so we don't understand why you like it. And what's the beta on this thing? A: You are right, you don't understand it.

Q: Amyris has a checkered past of missing their forward guidance, so why should I invest in such a company? A: If you invest in a company that has normally met or exceeded guidance, wouldn't you be paying a very high multiple of… everything for that? And setting yourself up for disappointment for the smallest miss? At this point, the amount of negativity embedded in the valuation of AMRS almost discounts the heat death of the universe.

HNW friend:

Q: I subscribe to Motley Fool and they have had some seriously negative articles about AMRS saying to avoid the stock. What do you think? A: Stop smoking your belly button lint.

Management Incentives:

CEO John Melo receives a bonus of 750,000 shares for 2019 performance IF the average stock price during a 180 day period is >=$15.00 Also, the average price for the last 30 days of that 180 day period has to be >= $15. Given where the stock is now if he wants the bonus, we would need to see a steep ramp in the stock price.

Most people who try to model revenues and earnings will try to do quarters for 2019. I will not since there is too much uncertainty. The good news for 2020 is that Brotas-2 should be done this year so 2020 should be something to be very happy about. A different approach to approximate earnings is to look at each plant, put a 67% gross margin on that capacity, and then you have potential gross profit for each site. So if each new facility in Brazil can crank out $350 million of revenue - an extremely rough estimate would be $235 million in incremental gross profit for each new facility.

The Game Changer

On Feb 5 before the market opened, Amyris announced a $255 million Cannabinoid Development, Licensing, and Commercialization agreement.

Amyris' CEO John Melo made good on his comments at the Jefferies Industrial Conference last year that were reiterated at other venues. They could make cannabinoids with one hand tied behind their back and were waiting for the right opportunity. And it looks like they found it. Aside from adding another recurring revenue stream in 18-24 months, what does it all mean? A nice review of the deal is here: This bud's for you: Amyris's $255M cannabinoids project is dope

My thoughts on the future:

  1. Cash needed for building out the Brotas-2 plant is not a worry. Milestone potential and the upfront payment from the CBD deal = $255 million. That is 2/3 of the company's market cap prior to the announcement. I figure Brotas-2 cost is around $70 million. They have a partner for building plants with Raizen, more partnerships likely before year end which means more cash coming in. Add $25 million likely from warrant exercise this summer with the ability to borrow more if need be, and the plant will be built.
  2. Any worries that other potential partners had about doing business with Amyris should be in the rear view mirror, therefore I believe more deals for unannounced products are on the way.
  3. Brotas-2 capacity utilization will be very quick which explains why AMRS is already working with Raizen on additional plants.
  4. Longevity of the hyper-growth period for revenue and earnings is extended from (guesstimate) 4 years to 7 years. As a result, multiples of EBITDA, earnings, etc. that I had in mind are likely too low. This is an important point. Many companies have a fast growth phase and then fade to a growth rate of GDP+. At the NY Sweetener launch event, I spoke to a managing partner from an investment firm who said to me "If they can do half of what they think they can do, this could be insane" - I agree.
  5. A reading of the press release suggests they are NOT working with a cannabis company. Given the purity and consistency of the production process (discussed earlier in my report), this is bigger. Major consumer brands are looking to put CBDs in drinks and foods. Recently, website consumerlab.com has published reviews of products that contain CBDs. They have found significant variability from what is on the label to what is actually contained in some products. This is exactly why Amyris should be the "go-to" supplier for any multinational wanting quality and consistency.
  6. Craigs List will be reborn in order to sell used CBD extraction equipment when AMRS grows production to the point where they are the world's lowest cost producer of the highest quality CBDs.
  7. Short Sellers in the stock have already published nonsensical garbage since the CBD news. Most likely, they will point out that the company is not making any money and has never made money. Yawn.
  8. This fall, Amyris CEO will be interviewed by Jim Cramer on Mad Money. With the stock at $13, Cramer will suggest to viewers that they should watch for any pullback in the share price for an entry point. He will also use the phrase "The Future is Fermented."

Disclosure: I am/we are long AMRS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: primary symbol is amrs but your system picked up only the S, so hope you can fix that.