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Investor Fears Most Likely Overblown About Neste's Lawsuit Against Syntroleum

|Includes: Syntroleum Corporation (SYNM)

Syntroleum (NASDAQ:SYNM) has been sued by Neste (NES1V.HE) for patent infringement. Both these companies use a technology that converts animal fat into ultra low sulfer diesel fuel (ULSD). The important aspect is that the fat is used to create ULSD, not Fatty Acid Methyl Ester (OTCPK:FAME) biodiesel. The process in dispute in a "hydrogenation" process not a "transesterfication" process used in biodiesel.

Recently a judged granted SYNM a "stay."


For the foregoing reasons, the court believes that staying this litigation pending the PTO's reexamination of the '344 Patent will serve the interests of judicial efficiency, and the court therefore will grant the defendants' Motion to Stay (D.I. 21.)

While I am not a Lawyer, and I do not have access to the detailed technical aspects of this case or the SYNM process, I don't need to be because the markets have changed in a manner that makes this issue moot. When this lawsuit was issued, yellow grease was the feedstock of choice because it was the lowest cost feedstock. There was an economic and competitive reason for SYNM to use yellow grease, and because of this, if Neste's patent is valid, it would have value. That value would be easily quantifiable. Currently yellow grease trades at $0.35/lb. The competing feedstock, soy oil, trades at $0.53/lb. Assuming that 7.6lbs of each feedstock is required to make a gallon of fuel, that means that the value of the patent is about $0.18/lb of feedstock or $1.37/gallon. Considering that SYNM's Dynamic Fuel Plant has a nameplate capacity of 75 million gallons, that is a serious concern, and understandable why investors would be fearful.

Why I'm not concerned is that this issue is effectively moot. The patent is for turning animal fat into diesel fuel. SYNM no longer has to rely on animal fat as a feedstock. Inedible corn oil does just as good of a job, and sells for just about as much as yellow grease, and the processing is most likely a bit easier and it is easier to collect and transport. To get yellow grease you have to visit multiple restaurants and processing facilities, often by relatively expensive truck, to collect their waste oils. The logistics can be complicated. Inedible corn oil on the other hand is mostly produced by a relatively few and relatively large ethanol plants, where cheaper rail transportation is often available. Transportation costs vary from about $0.04/lb for rail to $0.08/lb for truck, so mode of delivery is a big deal to these firms and this process.

Inedible corn oil currently trades at $0.39/lb, or about $0.05 more than yellow grease. Depending on the transportation mode, this difference can essentially disappear. In fact, I would imagine an efficient market will always maintain a spread of about $0.05 to make the two cost equivalent substitutes. If corn oil is a viable substitute for yellow grease and there is no cost advantage of using one verse the other, there's basically is no commercial value to Neste's patent. Basically SYNM can switch to corn oil, avoid violating the Neste patent, and suffer no economic consequences for doing so. SYNM simply no longer needs to use yellow grease to make their business model work, they can switch to inedible corn oil.

That is the first issue that makes me think this lawsuit isn't going anywhere, and SYNM will ultimately prevail. The other issues are:

1) SYNM's claim that the Neste patent would be "obvious to one of ordinary skill in the art," is valid. The difference between fats and oils is the level to which the carbon chain is hydrogenated or "saturated." Food companies often highlight the saturation content of their fats and oils. It doesn't take a rocket scientists to look at the molecular models of biodiesel and diesel, recognize that one is comprised of unsaturated chains and the other saturated ones, and reach the conclusion that saturating unsaturated carbon chains you can turn biodiesel to diesel fuel. I'm pretty sure I learned about that process over 20 years ago in Organic Chemistry 301.

2) Diesel is a commodity. There is no way for SYNM to have harmed Neste or forced them to sell their product for less than the market. SYNM simply doesn't produce enough fuel to alter the market price. With or without SYNM, Neste always had an available market for their product, so every gallon they produced they could sell at market.

3) SYNM and Neste don't compete in the same market. SYNM sells its fuel in the US, Neste in Europe.

4) Previous attempts by Neste have failed, and this current attempt was granted a "stay.'

5) If you read the findings of the Judge that granted the "stay," it appears to me that he is leaning heavily towards SYNM's position, but will leave it up to the Patent Office to make the final decision.

In my opinion and this is pure speculation, the true motivation for the Neste lawsuit is to harass and hinder the progress of SYNM. While the two companies don't directly compete here in the United States, fuel from SYNM has been used by some on the largest airlines in Europe. What better way to undermine the competition than to file a lawsuit, create fear and uncertainty, drive their stock price down and prevent them from raising capital to build and expand. Would you approach SYNM about a joint venture or licensing agreement if there was a chance that the license or joint venture would be invalidated by a lawsuit? Would you build a $100 million + plant that has the chance of not being able to produce because of a lawsuit? I wouldn't, and that is why this lawsuit is so damaging to SYNM. It basically puts the company on ice until the Patent Office makes a determination, and that could be years. Because of that SYNM should simply switch to corn oil and make this issue a non-issue. By doing that, SYNM would also limit their liability if the Neste case is found in their favor. I would imagine the damages will be calculated off the number of gallons SYNM produced while violating the Neste patent. If they switch to corn oil today, that should put a cap on the number of gallons subject to the lawsuit.

Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

Disclosure: I am long SYNM.