Known and unknown, black swans, yellow cranes, and advanced biofuels

July 18, 2012 |

As advanced biofuels companies hit their milestones and watch their stocks get crushed, we look at investor uncertainty, yellow cranes, black swans, and striking announcements from Codexis and Aemetis.

A best-seller we have been working through this summer here in Digestville is Donald Rumsfeld’s memoir, “Known and Unknown”. His known-unknown paradigm makes for a good investment lens with which to examine the prospects and fates of companies in advanced biofuels and biobased products.

Rumsfeld said: “There are known knowns; there are things we know that we know. There are known unknowns; that is to say there are things that, we now know we don’t know. But there are also unknown unknowns – there are things we do not know, we don’t know.”

Among the known knowns are the price of oil and biofuels, their current costs, alternative fuel mandates to the extent that they stay in place, (and to a great extent ) production capacities over the next 5 years; even advances in the speed and cost of genetic manipulation.

Among the known unknowns, the demand scenarios, the weather and its affect on crop supply, the pace of cost reductions in advanced biofuels, the political climate over the next 2-3 years, and the fate of the Euro.

Among the unknown unknowns that were revealed over the past five years: the impact of the indirect land use change and fuel vs food debates; the sea change in natural gas production and pricing; the failure of E85 ethanol as a blend-wall workaround; the depth and severity of the de-leveraging that has been taking place over the past five years in the OECD countries, sparked initially by the housing crisis and the Great Recession; and the virtual snuff-out of progress on climate change.

It is, generally speaking, not the known knowns or the known unknowns that have sparked a flight from risk in the trading of advanced biofuels stocks and the closing of the 2010-11 IPO window; it is the pile up of the unknown unknowns – which explains to some extent why, in advanced biofuels that, no matter whether you hit milestones or not, the stock gets crushed.

Solazyme, for example, has done nothing but hit or exceed virtually every milestone it set out in its IPO roadshow and thereafter: crushed from a post IPO high of $27.61 to a low of $7.68, before a recent rally which has brought the stock up to $13.39.

Gevo – while beset by headwinds in terms of an ongoing IP lawsuit with Butamax, has been proceeding to scale on its indicated timeline, mechanically completing its Minnesota project, completed the equity raise for its South Dakota project: crushed from a post IPO high north of $25 to a low of $4.10, before recovering in recent weeks to 4.47 (went over $8 before a costly financing effort).

A tale of two equities: Aemetis and Codexis

This past week at Aemetis (the mash-up between AE Biofuels and Zymetis that was completed last year), the company announced that it had completed its acquisition of the 60 million gallon Cilion ethanol plant in California. The stock rose from $0.64 to $0.80 on the news and AMTX market cap rose to $72M.

Let’s look at the data.

The Cilion plant and assets were bank appraised at $80 million value -  Aemetis paid $20 million cash and converted the remainder into 20 million Aemetis common shares at a price of $3.00 per share. This represents 11.2 percent of Aemetis fully diluted shares outstanding, and among the new AMTX shareholders:  Richard Branson, Vinod Khosla, CalPERS/Yucaipa, Western Milling and Jeff Skoll. The transaction values the Aemetis as a company (180 million shares in all, post-transaction) at around $540 million.

What holds back AMX share prices – the known unknowns of crush spread, weather, the future of the Renewable Fuel Standard? We suspect not – these were equally factors back in the boom ethanol years of 2006-2008. We suspect it is the unknown unknowns.

At Codexis, the company has been generating strong business in its non-fuel sector – including work for heavy-hitting pharma customers like Merck and Pfizer and a landmark renewable chemicals deal for its cellulase enzymes with Chemtex – but has been beset by questions about Shell’s intentions and timelines in advanced biofuels, given that it has had an exclusive Shell relationship in the fuel arena. Result? Stock crushed from a post IPO high nearing $14 to a low of $2.96 before recovering in recent weeks.

This week, Codexis and Shell announced the beginning of what will be major changes in their relationship later this year. Some aspects are certain, some are uncertain.

The Codexis news

Codexis announced that the company has signed an Exclusive Negotiation Agreement with Shell. Under this agreement, Shell has agreed to negotiate exclusively with Codexis through September 1, 2012 the terms of a new agreement under which Shell would grant to the company certain rights and licenses in the biofuels field to develop and sell cellulase enzymes to third parties on a worldwide basis, except Brazil. Codexis has exclusive rights to commercialize its cellulase enzyme technology in all other fields.

The known knowns

Under the Shell-Codexis agreement, beginning on August 31, 2012, Shell can elect to reduce between 13 and 48 full-time employee equivalents on one day notice. Previously, the required notice period for this type of FTE reduction was 90 days.

The known unknowns

Codexis is determined – but we are not yet quite sure the extent to which it will succeed – to win virtually a global freedom to operate in selling its cellulase enzymes into fuel markets. The exception, it appears, will be Brazil.

“If we finalize a new agreement with Shell as we currently anticipate, the rest of the world’s second generation biofuels producers will now also be available as target customers for our cost effective cellulase enzyme technology,” said Codexis CEO John Nicols.

Analyst reaction

Over at Piper Jaffray, senior analyst Mike Ritzenthaler wrote:

“We believe the most likely outcome of these negotiations is for Shell to allow Codexis to open up its marketing efforts, make a healthy cut to the number of FTEs on September 1 (a maximum of 48), and trim the number of FTEs further in October.

“But Codexis is facing a saturated market. Major second-gen projects that utilize cellulosic enzymes are already spoken for…Codexis will be starting their sales cycle in a global marketplace in both a displacement effort to unseat the incumbents (which we expect to be difficult) or bidding on new meaningful projects as they arise (of which we know of none currently). We believe that the next slate of major projects will follow the projects we’ve highlighted above, which indicate a 2015-2016 timeframe.

“Maintain Underweight rating and $3 price target. A major tenet in our Underweight thesis on shares of CDXS is a structural shift in the Codexis/Shell relationship. We expect more clarity on the relationship and the implications for Codexis by September.”

The Codexis challenge

If CDXS wins its freedom – it will have to move nimbly to snap up cellulosic biofuels customers.  As Piper Jaffray’s Ritzenthaler rightly points, out, there’s a second wave coming in cellulosic biofuels in 2015-16, but those opportunities are unlikely to have a major impact on share prices any time soon.

But we suspect, here in Digestville, that there may be more opportunity in the 2012-14 deployment cycle for CDXS if it gets a move on.

Here are the known knowns – the sure-thing lock-outs. Dupont, BP, POET-DSM and Mascoma – using their own enzymes — and Petrobras, which will be locked out by virtue of its Brazilian location.

But terms under which Fiberight and COFCO are locked into Novozymes – and the terms that Inbicon has in its relationships with DSM, Novozymes and Genencor. Those are known unknowns – and may well present an opportunity. And, to the extent that Abengoa is producing its own enzymes off the Dyadic C1 platform – well, we see that as a CDXS opportunity – replicating the Dyadic-Codexis relationship currently enjoyed within the Shell arrangements.

And, CDXS has to be focused on Beta Renewables – where it is the incumbent on the renewable chemicals side, while Novozymes is the incumbent on the fuels side.

Those are the known unknowns.

We suspect that the CDXS share price future, though, will continue to be dictated by the overall flight from risk and this cycle of global de-leveraging.

Black Swans and Yellow Cranes

But keep this in mind. There’s a lot of cash on the sidelines – and fund managers are unlikely to win renewals from their institutional customers based on a steady diet of historically low T-Bill yields. Looking, for example, at the New York construction market – you see signs of renewed risk appetite, as the competition between financial managers starts to play a role in investment decisions.

The yellow cranes are a sign of investor spring, after a long winter of the black swans. It is a metaphor for investment as a whole – when desire for the yellow cranes outweighs fear of the black swans – like a mouse emerging from the shadows in search of the cookie – then, and perhaps only then, will something resembling common sense return to the markets.

Are there signs of a wave of renewed investor confidence, when the forces of flight-from-risk are overwhelmed by the forces of flight-from-do-nothing? We think there are – though not yet reaching the advanced biofuels sector, for sure.

Investment, ultimately, is spurred by a determination to discount the  fact that there are, ever and always, a pile up of unknown unknowns.

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