Solazyme (NASDAQ: SZYM) uses microalgae in an industrial fermentation process to extract renewable oils from plant-based sugars. SZYM manufactures and distributes these oils for an array of applications in fuel, industrial, personal care, and food products. While the company has an exciting technology platform and broad product pipeline, SZYM has not demonstrated a sustainable and effective alignment between its business and operating models. This ineffectiveness has been driven by external issues (i.e., oil prices), but also by a repeated inability to convert R&D efforts into marketable products with scalable distribution partnerships. Figure 1 shows the cumulative effect of these issues, as stock has lost ~80% of its value since its mid-2011 IPO.
Figure 1, SZYM stock price through November 2015 (1)
Failed attempts at commercialization
Solazyme’s first commercial product was an algae-based biofuel for naval and aviation applications, with the US Navy and United Airlines as pioneer customers in 2011. Due to cost and regulatory pressures, many transportation companies were piloting biofuels as an emission-friendly alternative to traditional fuels. After a successful 2011 pilot with United, the airline committed to buying >600K MT of biofuel annually from SZYM at the market price of jet fuel (2). At the time of SZYM’s IPO in May 2011, the price of oil was >$110/barrel. By 2015, this price had dropped to <$40/barrel (3). This price drop rendered the United Airlines contract unfeasible, as the lower market price would not cover SZYM’s production costs for the biofuel. Furthermore, even at a profitable unit price, the volume required by the United contract was an order of magnitude greater than the projected capacity of its existing production facilities in Clinton, IA and Peoria, IL (4). The United experience demonstrates a successful R&D partnership that failed to reach commercial viability due to a misalignment between SZYM’s business and operating models. Similar partnerships with Chevron, Dow Chemical, and Ecopetrol also floundered.
In early-2014 SZYM released “Encapso”, a premium drilling lubricant used in oil and gas extraction targeting the growing US shale market (5). Encapso delivered excellent results, including a 50% reduction in non-productive time in North Dakota fields (6). Furthermore, by selling a “medium-volume” product at ~10x the price of biofuel, Encapso helped solve for the capacity constraints noted above. However given the subsequent collapse of oil prices, demand for Encapso was muted as it was far more expensive than traditional oil-based lubricants. Encapso demonstrates a diversification of SZYM’s business model, as they now produced a complement to the traditional oil business (and not just a substitute). Moreover the product demonstrated SZYM’s first step away from the high-volume, low-margin biofuels that were difficult to produce at scale.
Given Solazyme’s capacity limitations and prevailing market conditions, prospective customers did not respond positively to SZYM’s forays into higher-volume industrial products. SZYM was slow to fully pivot its business model to low-volume, high-margin products to bring it in line with the reality of its operating model, namely that its facilities performed better when producing small batches of compounds and struggled consistently producing large batches with consistent quality. Instead, in late-2014 SZYM looked to expand production capacity by adding another factory to its footprint, a giant 100,000 MT facility in Moema, Brazil (4). Moema signaled a “doubling down” attempt to achieve the operating scale to deliver high-volume products at a competitive price. Unfortunately the production ramp at Moema was slow and costly, eliminating the prospect of lower prices for Encapso and biofuels.
Looking forward: lessons learned?
The company’s Q3 2015 Earnings Report demonstrated a wholesale pivot in business model in an effort to meet its operating reality – an inability to produce algal oil at industrial scale. The company announced it would prioritize its food and cosmetic products, unveiling partnerships with Bunge, Mondelez, and Unilever (7). These new products include high-end olive oil substitutes and face cream, demonstrating a dramatic shift from the high-volume industrial products the company first attempted to commercialize. While Solazyme is sacrificing the high-volume opportunity of industrials, they charge higher unit prices on these new lines of business, thus requiring a lower level of capacity utilization to achieve profitability. Given its troubled operating performance (success with smaller batch sizes and quality/stoppage issues as batch size increases), focusing on higher-margin products may help SZYM stem its operating losses (they have been unprofitable since IPO and have ~1 year of cash runway left). Solazyme also announced that it would close its Clinton facility to focus on operational efficiency at a lower production scale across the company. The Clinton closure signifies a full-circle retreat from targeting high-volume products after market pressures rendered high capacity operations unfeasible.
- Yahoo! Finance: SZYM stock quote; 11/30/2015
- SFgate: “Continental Jet Uses Solazyme algae based biofuel”. http://www.sfgate.com/business/article/Continental-jet-uses-Solazyme-algae-based-biofuel-2323742.php
- Federal Reserve Bank of St. Louis, Crude Oil Prices: WTI. 11/30/2015
- Gigaom: “Huge news for Solazyme. Algae oil company starts up commercial factory in Brazil”. https://gigaom.com/2014/05/29/huge-news-for-solazyme-algae-oil-company-starts-up-commercial-factory-in-brazil/
- Solazyme company website: “Solazyme launches new product line Encapso”. http://solazyme.com/blog/2014/03/25/solazyme-launches-new-product-line-encapso/?lang=en
- Encapso product brochure. http://www.encapso.com/assets/files/1114-Solazyme-Encapso-Eprint.pdf
- Solazyme Q3 2015 Earnings Report. October 30, 2015.