random thoughts on Solazyme

  1. Moema problem. The management emphasized that it was not related to their core technology and it is more of equipment/operation related. It will take some time and effort to get them fixed. Some minor CapEx may be needed. Also they think it needs to hook up to the grid to have a stable power supply and said that it wouldn’t happen until 1h 2015.

While I felt somewhat disappointed, I learned that the other two plants Solazyme has were not built from scratch and they were operational facilities before Solazyme took over. But Moema was started from scratch and so there were more issues. If as the management claims that the problems are not related to the core technology or the scale capability of the platform, and are operational in nature, I am sure they could be fixed.

Being a development company for so long, Solazyme may not have a lot of experiences in running large scale industrial production. Its CFO is also the COO. I am not sure this is the way to go at this point of time when operational management is critically important in the company.

Further delay of the solution to these problems would certainly cause additional capital expenditure and loss of opportunity.

  1. The change of strategy. The management claims that some of the competing products such as crude oil and palm oil have a large price drop whereas Solazyme’s feed material does not see similar price drop. This makes some of its products not economical. They want to narrow their offerings and focus on high-value high-margin products such as Encapso and Algavia. This is something a surprise to me but I think the wiser investors might have expected this and pushed the stock price down relentlessly alongside the crude oil price slide. I am just a bit slow in this. But here is my question: I thought Solazme’s oils are more desirable not because they are cheaper but because they are tailor-made and have unique/special attributes/qualities that better meet the requirement of specific industries/customers. And I think this is a very important part of the investment thesis. Am I wrong here?

  2. The management will not focus on volume ramping and no longer expect 12-18 moth time frame for volumes to reach nameplate capacity. Is this because the refocus on high-value, high-margin products will result in much smaller volume or is it because the management do not think they can hit the target because of the Moema problems?

In their Q2 call, the management alluded to capacity expansion and talked about placing a plant near the customers and etc. Now just in 3-month time, they see surplus capacity? Were they too optimistic then or too pessimistic now? Or the Moema problem is bigger than what we know?

  1. Assuming the management is completely truthful about the Moema problems and their strategy shift is completely a reflection of macroeconomic changes they have no control of, then I applaud the management for their quick action and their courage to take the tough steps well aware of the almost certain massively negative reaction from the market. I just wish they saw this 3 – 6 month earlier.

  2. With some reflection, I think Solazyme’s new strategy is much more sensible. I wish it were their strategy from the beginning. For a company without experience in running large scale production, without deep pockets and without a stable customer base, it would be wise and sensible to start with a few products that have compelling value to the customers and have a large and stable market. They can build their customer base, market position, revenue stream and cash flow and operational experience in the process while slowly expand to other market segments. This would be more conservative and sensible.

  3. Like Solazyme, Westport has great technology. After many years of development efforts, it is trying to turn itself into a commercial production company. Over the years it has signed numerous development agreements with various partners and has numerous technology development programs. It is in Russia, Italy, India, China, the U.S. and Canada. It is in passenger cars, forklifts, light trucks, heavy duty trucks, off-load vehicles, locomotives, marines, power generators and etc., it spreads itself too thing and burns cash too much too fast. With all that massive effort, the only thing the Westport has to show really is the CWI 12L truck or maybe the iCE Pack. Now they want to shift the strategy and narrow down their focus. But it might just be a bit too late.

So it is wise for Solazyme to realize this now and to narrow down their focus now. Though I wish they started with this focus, but it is not too late.

Just some random thoughts after listening to the call.

-M

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I thought Solazme’s oils are more desirable not because they are cheaper but because they are tailor-made and have unique/special attributes/qualities that better meet the requirement of specific industries/customers. And I think this is a very important part of the investment thesis. Am I wrong here?

I think they would be cheaper at volume, but the company isn’t able to produce them at volume yet and therefor has higher unit costs. That might have been okay when commodity prices were double what they are today, but now I think the company has realized they don’t have the capital to get up to the volumes needed to make these oils competitive at today’s prices. That’s my take, anyway.

In their Q2 call, the management alluded to capacity expansion and talked about placing a plant near the customers and etc. Now just in 3-month time, they see surplus capacity? Were they too optimistic then or too pessimistic now? Or the Moema problem is bigger than what we know?

I think it’s because of the shift in strategy. Before, they were trying to maximize volumes to drive unit prices down, so it was all about more more more. Now, instead, they’re going to focus on higher-margin products sold in smaller volumes, and so there’s less need for factory capacity as a result. So they won’t need to run Moema at full capacity next year.

Neil

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Neil;

Do you think the strategy shift is simply a response to macro-economical changes or is it a reaction to their Moema problem? Or what is your assessment of the Moema problem?

-M

Do you think the strategy shift is simply a response to macro-economical changes or is it a reaction to their Moema problem? Or what is your assessment of the Moema problem?

I think that this change is prompted by cash burn. Because Moema is taking so long to get up and running, it’s costing the company a lot more money than they had expected, and I think management has realized it’s going to take a while (and perhaps require additional capital expenditure) before it’s actually running the way they expected.

Then, I think they’re looking at what kind of earnings they can actually generate once Moema is finally running at capacity – whenever that is – and it’s not looking so hot in light of current commodity prices. Which means they might need even larger volumes in order to continue reducing costs, which would mean more factory expansion and significant capital that the company simply doesn’t have.

So given that combination, I think management has realized that the only way they’re going to have a chance with the capital they’ve got is if they make the most of their existing capacity with whatever issues it’s got while they work towards fixing them. That naturally steers them towards higher-margin, lower-volume products, and it just so happens that – in addition to the few they have now – they have a few more in advanced development (if we take management at face value). And in total, it might be possible to make a business out of all of these instead.

That’s my current read. If it’s accurate, it means there’s some good news and some bad news. The good news is they have two working facilities already that they can use for these products – it doesn’t matter as much anymore that they’re low-volume facilities since only low volumes will be required. So that softens the impact of the Moema troubles somewhat (and there is some product coming out of Moema already), though it will still be drag until it’s operating efficiently.

The bad news is that I’m guessing management is banking on these new products in advanced development, and that introduces a lot of risk. What if they fail to get regulatory approval? What if the market is not as strong as they anticipate? What if they can’t get the average selling prices they are projecting? What if these new products present additional manufacturing challenges once they go into production? So there’s definitely risk there. If management’s back wasn’t to the wall, I would say that they’ve assessed all that risk and still found the strategy to be very favorable; but their back is to the wall, so it’s hard to know if it really is favorable or if it’s simply the only option realistically available to them at this point.

What are your thoughts?

Neil

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Neil;

They started Moema plant in May. So I would say they made the decision reasonably fast. It could be alot worse they drag on for another quarter.

I just hope they have had a good assessment of their business and the new strategy is a path forward. The key is how much would be the volume for the high-value, high-margin products. The need to be of reasonable volume to achieve some acceptable economics.

Algavie and Encapso just got started and and take time to develop the market. It is going to be several long quarters before we find out if the strategy is working.

Solazyme underscores the risk of invest in cutting edge technology firms.

-M

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Solazyme underscores the risk of invest in cutting edge technology firms.

While that certainly is part of the risk, I think the much larger risk – the one that ultimately bit this company, just as it did WPRT – is that the company that is transitioning to a business that management has no experience running.

I decided to close out our full position a few minutes ago. The business idea remains promising, but I’ve lost whatever remaining confidence I had in management. I hope that it works out well for everyone who stays onboard, but I just don’t trust this management to execute any longer.

I also have to own up to holding onto this company a lot longer than I should have. I don’t say that because things didn’t turn out as hoped, as there will always be investments where that’s the case; but because I recognized earlier that I really had no business being invested in this company (ironically, I even posted my thoughts on this board about a month ago after coming to that conclusion), but I stuck around anyway thinking there’d be a short-term bounce once they got Moema running smoothly. It’s a classic mistake – sometimes I have to repeat those on occasion.

The good news is that, despite heavy losses on this position, the portfolio lives on to fight another day. Today’s results will be rough, but it’ll just be a little noise given enough time.

Onwards.

Neil

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