How a Free Codexis Can Elbow its Way to the Top
Maxxwell A.R. is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
On July 16, industrial enzyme developer Codexis (NASDAQ: CDXS) announced that they had signed an Exclusive Negotiation Agreement with long-time financier Royal Dutch Shell (NYSE: RDS-A). Although terms of a new research agreement won’t be finalized until later this month, the announcement has given valuable insight into the future of both companies.
While everything won’t come up roses for Codexis the company will likely be granted freedom to market its CodeXyme Cellulase Enzyme technology to biofuel companies other than Shell (Codexis already owns exclusive rights to its other business segments). Let’s dissect the significance of different aspects of the announcement and what management needs to do to successfully navigate freedom.
Reduction in R&D funding: What does it mean?
The most obvious cost of freedom is a big reduction in R&D funding, which accounted for $75 million of Codexis’ $124 million of 2011 revenue. Investors won’t know the extent of the reduction until the agreement is finalized, but it will happen. Under the preliminary agreement Shell has the authority to instantly terminate up to 48 full-time employees (FTE) working on the Codexis-Shell research collaboration as early as Aug. 31. That represents almost a third of the scientists working on the company’s CodeXyme Cellulase Enzymes.
In the short term Codexis will almost certainly take a step backwards as they cope with the changes. However, the company has taken full advantage of Shell’s deep pockets over the last several years and is extremely close to having a market-leading product. Do they really need another blockbuster deal with Shell to get over the hump?
Look at it this way. The creator of the Codexis’ C1 platform for CodeXyme Cellulase Enzymes, Dyadic International, has created a new enzyme (CMAX 3) that outperforms market leader Novozymes’ latest enzyme (CTEC 3) without a $400 million R&D agreement or a payroll of 150 scientists. What can Codexis do?
Efficiency will be critical for moving forward without Shell. While scientists work feverishly to create the next generation of CodeXyme Cellulase Enzymes, management should be working around the clock marketing their platform to various cellulosic ethanol projects. The problem, as Piper Jaffray senior analyst Mike Ritzenthaler points out, is that Codexis has zero share (outside of its Raizen partnership) of an already saturated market.
Freedom from Shell (except Brazil): What does it mean?
Any new research agreement will allow Codexis to work freely outside of Brazil. That way Shell and Cosan’s (NYSE: CZZ) joint venture, Raizen – which operates the largest ethanol network in the country – won’t have to compete against their own investment dollars. That is good news for Codexis. The bad news is that it may take some time to gain traction elsewhere. Incumbents such as Novozymes have been quick to assert their dominance and expertise in the budding industry, but there are several reasons not to bet against party-crasher Codexis.
It won’t be easy to gain market share overnight, but there is a quickly growing international market for ethanol. With the United States and Brazil reaching their respective capacity for corn and sugarcane, cellulosics will have to fill much of the future demand. Source: Codexis Investor’s Day
Management’s plan should be…
Every major cellulosic ethanol project in development already has an enzyme supplier in place. On paper, anyway. Outside of several exclusive contracts all agreements between fuel producers and upstream suppliers are non-binding. That would seem to reward an aggressive Codexis management team that has science on their side. Owners of cellulosic ethanol plants currently being developed at a cost of $10-$15 per gallon of fuel have to be curious about a new enzyme crashing onto the scene. With the escalating cost of construction in Brazil leading up to the World Cup and Summer Olympics in 2016 already pushing biorefinery costs upward, producers would be crazy not to inquire about Codexis’ products.
Sound crazy? Management would have several persuasive selling points. Codexis’ C1 platform allows for on-site enzyme production, which eliminates the logistical problem of accommodating several truckloads of enzymes at your facility every day and is full of financial benefits. Whether or not the company goes this route is still unknown, but if their enzyme activity is close to that of the field the price advantage would heavily favor Codexis.
The second advantage of CodeXyme Cellulase Enzymes may be difficult to sell now, but cannot be understated. Nearly all cellulases on the market are derived from Trichoderma fungi strains. Dyadic’s C1 platform being used by Abengoa and Codexis utilize Chrysosporium strains, which gives them a healthy distance from patent lawsuits (must-read link) that have grabbed headlines in recent years. While Novozymes and Genencor are stepping on each other's toes in a $10 billion market (by 2020) Codexis can quietly pick up market share from producers seeking a drama-free production process.
The first elbow from Codexis goes to…
Chemtex is currently using Novozymes CTEC 2 enzymes for its cellulosic ethanol facility in Crescentino, Italy. As fate would have it, Codexis and Chemtex are deploying their CodeXol Detergent Alcohols at commercial scale at the very same facility. From a logistical standpoint it doesn’t make sense to employ two competing enzymes under one roof. Codexis, with exclusive rights to Chemtex’s PROESA pretreatment technology for detergent alcohols, needs to make an immediate push to boot Novozymes from Italy. Why? Chemtex is using the Italian facility as a stepping stone into the next fastest growing market for cellulosic ethanol: The United States.
Will management act swiftly on these important issues? Investors can only take a wait-and-see approach and should not create or add to a position in Codexis until further clarification. However, keep in mind that with a book value of $2.67 per share, a buying opportunity may present itself in the next few months – assuming growth forecasts aren’t suddenly slashed by any curveball in the new agreement with Shell.
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