Three hot biofuels stocks down 44 pct since June: What up?

Biofuels Digest Index stocks bathed in red ink, on the big board at Digest HQ

A sea of red ink, since June, on shares in Solazyme, Amyris, and Gevo, has investors fidgety and short sellers on the prowl. What will reignite investor interest?

Investors in Solazyme, Gevo, and Amyris have had a rough three months – with the averaged share price of the three synth bio stocks dropping 44 percent since June 13. The IPOs did well, initially, with all three soaring in the immediate post-IPO environment. But the aftermarket, these past few months, has been unkind.

Time to hit the panic button on GEVO, AMRS, or SZYM?

Amyris (AMRS) chart since June 13, 2011

Gevo (GEVO) chart since June 13, 2011

Solazyme (SZYM) chart since June 13, 2011

Panic time? Not yet, grasshopper. The basic premise of the three companies is unchanged. They are ready for commercial scale production on their initial product lines, and raised capital through their IPOs to finance the equity side of their expansion.

Their quarterly results were generally in line with expectations.

Oil prices – which they are competing against – remain high, though with recessionary fears they have retreated from $100 to $87 (for WTO crude).

Generally, the companies are not coming out with initial products aimed at the fuel markets – that is for later, when capital is more affordable and they have saturated their high-value, small-market product sectors, to some extent, and made some money. So they are to some extent not catastrophically affected by the debate over, say, ethanol subsidies, and the future of the Renewable Fuel Standard.

So what gives?

Back in June, Pavel Molchanov opined on the subject of Gevo’s 23 percent decline in share value: “The sharpest portion of the selloff came [June 21],” writes Raymond James analyst Pavel Molchanov, “with the stock down 9% amid a strong broader market and calm oil prices. We see absolutely no fundamental reason for this 9% decline. Rather, the reason behind the unusual volatility appears to be a single block of over 900,000 shares sold near midday.”

Expiration of post IPO share lockups? Molchanov warned back in June, gains with Gevo: “Keep in mind, Gevo’s float remains limited (8.2 million shares) given that the post-IPO lockup doesn’t expire until August.”

Short shares? Gevo has 1.13 million short shares, up 33.3 percent, or 14.6 percent of its float. Solazyme has 1.12 million shares shorted, up 9.93 percent, or 3.86 percent of its float. Amyris has 2,55 million short shares, up 13.43 percent, or 11.31 percent of its float.

How much is that? Well, the NASDAQ average is 2.73 days of trading volume, at present.  Solazyme is at 2.96 days, Amyris has 8.73 days, Gevo has 9.26 days. So there’s some sign of excessive lack of enthusiasm for the stocks, despite all three keeping on track in terms of their commercialization timelines. Interestingly, KIOR, whose price has held up, has seen short selling increase 80 percent since last report date, and short stocks represent more than 18 days trading volume (based on share trading over the past two weeks).

New institutions buying, selling? Well, here’s a tale we’ll understand on the September 30 closing date. How much the institutions have held onto shares from the IPO is a good question – there was a lot of interest, we know, when the stocks were flying very high right after their IPOs, in profit taking.

Sophisticated stories? Biotech stocks have always had complex stories – the complexity of fuels and chemicals and the attack that these three companies make on the entire barrel of oil (and a lot more, in Solazyme’s case, as they substitute for food oils as well) – that surely is a tough proposition to convey to the retail investor.

Commercialization pace slowdown? Let’s look at Molchanov’s notes from Gevo’s analyst presentation:

“Production ramp on pace.  The retrofit of Gevo’s first commercial plant in Luverne remains on track for a 1H12 start-up.  Construction is expected to progress quickly once the footings for the isobutanol recovery unit (based on the Gevo Integrated Fermentation Technology – GIFT) are placed in the ground this month.  Meanwhile, the Redfield plant, Gevo’s first JV, is in the early stages of engineering and design, with start-up slated for early 2013.  The 500,000 liter/year plant at the South Hampton facility should come online by year-end, initially producing jet fuel, and later, gasoline and paraxylene (for PET applications) to support certification processes.  Gevo expects to receive ASTM certification for its jet fuel in 2013.  Management affirmed the target of 350 million gallons in 2015, unchanged from the IPO.

“Second offtake agreement secured.  Having recently secured a definitive take-or-pay offtake agreement with Sasol (SSL) for specialty chemicals, Gevo has signed its first fuels offtake agreement with Mansfield Oil – a large, privately held fuels distributor.  Though volumes have not been specified, the five-year contract allows Mansfield to blend and distribute Gevo’s isobutanol.”

Overall, nothing but affirmative news there. The Gevo/Butamax patent dispute?  “We view this patent dispute – a bit of a “David vs. Goliath” situation,” says Molchanov, “as basically a distraction, though there is no denying that it’s weighed on Gevo’s share price.  Despite the impact on the stock, it has not been a hindrance in discussions with prospective JV partners or potential customers – a sentiment that was reinforced by representatives from Lanxess.

The Digest’s Take

The stocks are receiving tepid support in the aftermarket, suggesting that investors don’t generally buy into the valuations. At 20 times earnings (the current S&P average – but keep in mind that these stocks trade on NASDAQ), the current valuations support forward earnings in the $10M range for GEVO, $33M for SZYM, and $41M for Amyris.

Those are low, considering that each is expected to reach capacity in the 300 million gallon range by 2015 or so. That’s a profit of around 3 cents per gallon for GEVO – crazy low margins for isobutanol, based on the existing market valuations.

So, some of this is mood, general equity pessimism, policy uncertainty, and so on. But we also surmise that the market is betting that these companies will have to raise a lot more capital (and dilute the equity pool) to build out the capacity they have in mind.

Given the state of project finance, that’s not entirely an irrational assumption. Highly leveraged capacity building may not be in the cards for these projects in the near term.

Accordingly, we suspect that the secret to unlocking share value will not be some great rise in oil prices, but rather the unlocking of project finance. The more debt, the less equity, the higher values for equity holders. Simple math, but worth looking at.

To that end, securing a position among the companies landing part of the government’s proposed $510 million injection of capital into advanced biofuels for military use may well be just the ticket for these stocks.

The intrepid investor who thinks that one of these three may just get over the top, may conclude that they are massively undervalued.

Takeover candidates?

Jonathan Yates writes: “As a result of these industry woes, small cap investors should look for takeover activity in the biofuel sector.”

Now, that’s something to watch. One of the majors could well decide that buying up, say, GEVO – could represent a very nice option for its own investors. But keep in mind that the public float for these stocks is low – takeovers will require scooping up a whole lotta equity tied up with early-stage investors who are generally not in a mood to exit their holdings at “everyday low prices”. For the VCs, particularly, low exit prices make the next round of capital raising for their own investment funds awfully tough. So, takeovers there well may be, but look for sharp premiums to current share prices.