Don’t Let Solazyme’s Bright Future Blind You to Risk

By Maxxwell A.R. Chatsko - August 8, 2012 | Tickers: AMRS, ARCO, MAKO, SZYM, TRLG | 0 Comments

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What better way to come back from a two-month writing hiatus than to ruffle the feathers of a religious group of investors? The market has witnessed Solazyme (NASDAQ: SZYM) trek steadily upward recently, but I believe the stock currently offers more of a value trap than a growth opportunity.

Let’s set the record straight: Solazyme does offer some amazing growth potential. However, buying into a great growth story means nothing if you pay too much. As the bandwagon for any growth stock swells it becomes more and more difficult to justify lofty valuations. Optimism fades at the first sign of weakness – and share price is never far behind. Just ask investors of MAKO Surgical (NASDAQ: MAKO), Arcos Dorados (NYSE: ARCO), or True Religion Apparel (NASDAQ: TRLG) what they think about growth potential now. The story of the balloon that popped is much more common in investing than the rocket ship that left the atmosphere.

Unfortunately, it is easy for investors to get emotional after putting hard-earned money into a company. That makes it unlikely that anyone will heed my advice just by looking at history alone. Therefore, I have made a list of three popular myths about Solazyme and will use my background as a bioprocess engineer to dispel them.

Myth #1: Acidic pH makes contamination less likely.

Management made questionable comments about this issue during the 1Q12 conference call by assuring investors that the operating pH range of 5.5-6 was sufficient to kill native contaminants. The question was likely raised to see how Solazyme’s process compared to the contamination-prone process being developed at Amyris (NASDAQ: AMRS). While an acidic pH does inhibit the growth of certain microbes, a pH of 6 is only 10 times more acidic than water.

Take the simple example of making wine. If fermentation is not carefully controlled you may end up with more vinegar than wine. That’s because Acetobacter aceti can oxidize ethanol (alcohol) into acetic acid (vinegar). It turns out the microbe is comfortable in a pH of just 4, which is 1000 times more acidic than water.

The truth is that contamination is the result of poor design (dead space in pipes, faulting returns, pumps and valves with difficult-to-clean crevices, etc.).

Myth #2: Heterotrophic algae are superior to autotrophic algae.

While Solazyme offers an innovative platform by using heterotrophic algae, it doesn’t really mean much in terms of performance. Investors and writers that like to point to the current struggles of autotrophic algae platforms as a reason to invest in Solazyme shouldn’t get too comfortable with their lead.

Privately-held Joule Unlimited has created the Helioculture platform, which I believe is the best bioprocess platform. Its modular design should take many of the aches and pains out of scale-up (famous last words). Better yet, with product yields approaching 10,000-25,000 gallons per acre per year (depending on product) a relatively small and useless swath of land in the desert could easily contend with outputs from traditional biorefineries. Throw in free sunlight and waste CO2 as inputs and the margins could become quite impressive.

Remember, Solazyme’s founders made the decision to stray from open pond technology over 15 years ago - an eternity in bioprocess technology. Just think, that decision was made before the completion of the Human Genome Project in 2000 and at roughly the same time Kary Mullis won the Nobel Prize for polymerase chain reaction, which made biotechnology possible.

Myth #3: Scale-up is linear.

This is my favorite myth because of how strongly investors cling to it and how simple it is to disprove. Let’s model a bioreactor as a cylinder and say that at bench scale it has a radius and height of 1 foot. Simply doubling the reactor volume will increase the surface area by a factor of only 1.5. 

It may not seem like much, but crucial variables such as heat transfer and agitation speed will be greatly affected. In reality there are dozens of factors – mechanically and kinetically (growth of microbes) – that are related to each other in non-linear relationships. Knowing this, it would be extremely difficult to coax your microbes into linear yields across scale. Can the company reach full commercial scale without encountering deflating data from scale-up operations?

Foolish bottom line

Does Solazyme have very good growth potential? Absolutely. However, you may want to ask yourself how the current valuation affects your entry point into that potential. All too often when shares of a highly-touted growth stock rise significantly above their book value they collapse on the first sign of weakness (See MAKO, ARCO, TRLG, to name a few). Currently, Solazyme’s book value is just $3.80 per share and that will certainly fall after 2Q12 earnings are released this week.

Are you willing to roll the dice and bet that the company won’t encounter problems in an industry full of unknowns between now and January 1^st, 2016 (1,242 days away)? Investors and writers are already overlooking the escalating cost of construction in Brazil leading up to the World Cup and Summer Olympics in 2016 – roughly the same time the industry plans to be running on all cylinders. Solazyme has witnessed its Moema project increase from $110 million to $146 million (32.7%).

I am looking forward to watching Solazyme develop its platform into an industry leading technology, but for now I will have to do it from the sidelines. There is just too much risk that is not factored into an $800+ million market cap. Shares would need to drop considerably before I feel comfortable starting a position.

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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