What Does Iogen's Fate Mean for Codexis?

By Maxxwell A.R. Chatsko - May 8, 2012 | Tickers: CDXS, MRK, RDS-A, SZYM | 0 Comments

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Last week Royal Dutch Shell (NYSE: RDS-A) and industrial enzyme producer Iogen Corporation announced that plans to build a 10 million gallon per year (MMgy) cellulosic ethanol facility in Manitoba, Canada would be suspended. Since 2004 Shell has invested an estimated $500 million into the joint-venture, named Iogen Energy. The most recent agreement began in mid-2010 and was due for reevaluation in 2012 after the proposed process (opens PDF) was tweaked in a 0.5 MMgy pilot facility. Needless to say, the process being developed by Iogen to create cellulosic ethanol from straw failed to persuade management at Shell to keep writing checks. The process was evaluated with enzymes from both Iogen and Codexis (NASDAQ: CDXS) up to 150,000 L.

The 500,000 gallon cellulosic ethanol facility in Manitoba, Canada may be forced to close its doors in another “face-in-palm” moment for next generation biofuels.

The news comes just months after Shell announced they had built a thermocatalytic facility for producing next generation biofuels using technology from partner Virent. The news also comes just months before a decision is made to extend or suspend a partnership to develop cellulase enzymes with Codexis. Unfortunately, the Codexis-Shell and Iogen-Shell relationships have several parallels. However, there are important distinctions that may help Codexis win another investment from its big partner.

Scenario 1: Partnership Ends

Not everyone was shocked by the Iogen-Shell decision. In fact, several industry experts had put little faith in anything other than a cancellation. The Canadian government’s obsession with the tar sands coupled with a mandate that requires only a 5% ethanol blend in gasoline pointed to an obvious conclusion some say. Furthermore, Shell has invested in nearly one dozen smaller companies with interesting technologies over the last 15 years only to drop them once commercial feasibility or economics were in doubt. When the technologies looked promising, however, Shell had no problem dishing out checks to develop them. This was demonstrated by Virent recently and Codexis and Iogen in the past.

Shell has invested an estimated $350-$400 million in Codexis over the last several years (sound familiar?) and accounted for 60% of the company’s 2011 revenue ($75 million out of $124 million), so a discontinuation of R&D with Shell would pose a major setback. A look at Codexis’ personnel allocation shows that the company is largely focusing its efforts on developing its cellulase enzymes and yeast strains for the Shell and Chemtex partnerships. Codexis would certainly not walk away from cellulase enzymes altogether, but may downsize their operations to reduce costs.

Luckily, Codexis has no debt (an oddity for a developmental sustainable chemicals company), a pharmaceutical enzyme business that has grown at a 42% clip the last three years, and a great opportunity to develop detergent alcohols (market value of $3,000 per MT) with partner Chemtex. In this scenario, Codexis would be free to partner its cellulase technology with whomever they choose, not just companies dictated by Shell. That’s how the company will spin it, anyway. Losing Shell would hurt (a lot), but it wouldn’t be a knockout blow. There are plenty of companies that are interested in cellulase enzymes for a multitude of industries including pulp and paper, textiles, animal feed, and sustainable chemicals.

Scenario 2: Partnership Gets Renewed

In this scenario, Shell sees Codexis as the more valuable enzyme partner than Iogen. Some see the Iogen decision as a foreshadowing of the ensuing Codexis decision, but perhaps Shell is focusing its efforts on the growing Brazilian market. Let’s be honest, Brazil has a formidable ethanol infrastructure in place that Canada cannot compete with. The Shell-Cosan joint-venture, named Raizen, is the largest producer of ethanol in Brazil with over 2 billion liters of annual ethanol production, 24 production facilities, and 4,500 fueling stations. Raizen is also the largest investor in Codexis because without the company, the road to ethanol from sugarcane bagasse will be much more difficult to travel.

This scenario would be much better for current investors (like myself), but has nothing to do with past developments. Sure, the research is over halfway completed, but Shell is deciding on putting future money into Codexis. The $400 million invested so far means little to Shell going forward and shouldn’t be factored into the equation for investors. Has Codexis proven that it is worth another couple hundred million dollars or more?

Assuming that the newly approved process for Merck’s (NYSE: MRK) Januvia keeps the company’s pharmaceutical enzyme business growing strong; let’s compare the two scenarios to 2011 revenue.

If Shell continues to go with Codexis, then the company should continue to grow near a 16% clip. Otherwise, the company will limp into 2013 without its big partner. Still Codexis would make more in-house revenue than investor favorite and rival Solazyme (NASDAQ: SZYM), which won’t come close to $70 million in 2012 revenue without accounting for R&D contracts.

Foolish bottom line

For now, I would hold off on any investment in Codexis until a decision has been made. If Shell walks away shares would certainly take a hit, but the company would be undervalued due to the overreaction. In fact, I believe a lot of the risk is already priced into shares, but that doesn’t mean shares won’t fall further. If Shell continues the R&D agreement then a lot of risk would be taken out of the equation, also a win-win for investors. The big question for the industry is whether or not Shell is dumping biocatalytic processes altogether. Will the research agreement be renewed? The simple answer to this complicated question: I don’t know.

Did you enjoy this article? Follow me on Twitter to keep up with my future posts on energy, sustainable chemicals, and biopharmaceuticals @BlacknGoldFool.

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