Year End #6: SZYM, Where did I go so wrong?

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Year End #6: SZYM, Where did I go so wrong?

Solazyme was a disaster. I knew better than to buy a development company which was losing money, but they promised that they were close, VERY close, to large-scale production and profitability.

I started buying SZYM in Jan of 2013 at $7.30 in very small amounts and added gradually at $8, at $9, at $10, at $11 and even, heaven forgive me, at over $12 as the story got better and better. They promised their US plant would open in the first quarter of 2014, and that their huge, many times larger plant in Brazil would not only be open, but actually pretty close to running full bore by the end of the second quarter. They announced Encapso, which made drilling more efficient. This all would change them from a small money-losing development company, to a large scale, commercial production company, no longer money-losing and soon profitable, and even very profitable. This was going to become a huge, multiproduct company with products from the food industry to cosmetics, to industrial oils!

The time line I’m giving you is just from memory, but the US plant opened on schedule and started producing on a small-scale basis. Just a teaser, though. What mattered was the huge Brazil plant. The first warnings of trouble were when they didn’t get it opened on time. They assured everyone that they were having no technical problems with their process. Just a problem in getting consistent electricity from their partner. And the problem continued and continued.

The price started dropping, and with all their reassurances it looked like a bargain at $8 when it had recently been at $12. On October 17 of this year I decided to cut my risk at $6.40 and sold half my position, and foolishly kept the rest, not wanting to give up. On Nov 5, after the close, they announced their 3rd quarter results – AND an entire reformulation of their business:

In the broader commodity markets, pricing is challenged for the semi-commodity oils that most of our first-generation oil products compete with, such as enhanced palm kernel oil. So, to cite a specific example, palm kernel oil was selling for about $907 per metric ton as of last week versus about $2,000 just a few years ago, and our overall input costs have not dropped commensurately over this period.

Consideration of these factors has led us to make some adjustments in our strategies to drive capital efficiency and commercial success. We will narrow our production focus to smaller volumes of higher-value products at both Moema and Clinton/Galva. We will prioritize cash management and product margin over a rapid capacity ramp. We, therefore, no longer plan to produce at nameplate capacity within 12 to 18 months.

We believe this is economically prudent in the short term while better positioning us for long-term opportunities. This will enable us to better manage our capital as we ramp production at the plants, descend the cost curve and continue commercializing and driving increased demand for high-margin products such as Encapso and specialty food oils.

Basically they were abandoning any hope of large-scale commercialization at least for 18 months, and with no time line after that. They were going to remain a small money-losing development company, which was going to try to cut its losses by firing workforce, cutting salaries, focusing on small scale high margin products. They were going to be carrying their two plants half or more empty, which would greatly increase their cost of goods sold, and reduce margins. They’d obviously need more money raises, if they could find buyers, which would dilute the shares further.

This wasn’t the hypothesis that I, or many others signed on for. The next morning they opened at about $3.75, and I sold out the other half of my position there. It closed that day at $3.14, and closed today at $2.58. (It’s been as low as $2.16).

They started Jan 1st of 2014 at $11.19. I got out at an average price of about $5.00, so this was a significant loss for my portfolio for the year. Where did I go wrong? It’s easy. This was still a development company, which hadn’t got a real business going yet when I bought in. I never should have done that. I should have waited until Moema was up and running, and the company was profitable, even if I paid a lot more. The message is clear: Avoid development companies that are just starting out, no matter how good the story! Nuf said.

Saul

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The message is clear: Avoid development companies that are just starting out, no matter how good the story! Nuf said.

Wow, Saul

Even with that tough story, I’m amazed at your discipline in buying and selling. I love your system.

Meanwhile I started buying into SZYM at around $10; recommended to a friend of 60 years he do the same and he got in on a interim pullback at $9.02. I was jealous but quite sure I had done him a good deed, felt good about leading him to the trough which, after a few months, became filled with abattoir runoff.

I sold out all my stock (except the IRA where I intend to wait a few quarters to see if it rises as it should…and then dump it at a lesser loss) at I guess an 80% loss and incurred further losses in options (though I have a decent one still open that if SZYM can do ANYTHING in the right direction and keep the stock where it is, I’ll make a bit of money back. It just has to stay above $2.

All in all, this was a great learning experience in position size (I did the right thing), in option usage (I did the right and a wrong things), and in understanding how a stock’s price can twist and turn. It is the first time I have participated in a story like this and now I am forewarned and armed.

I also learned to listen to my inner mind with SZYM. I was originally concerned about their marketing strategy and thought it was either arrogant or brilliant but it did make me uneasy. Now that I see my concerns were real, I sold all the KNDI stock I had bought a few months ago due to the same management concerns. With both, I was overwhelmed by the potential and didn’t pay enough attention to how that potential (and by whom) it was going to be reached.

There’s my confession for 2014 and I hope I will be blessed out of those bad habits. :slight_smile:

Have a prosperous New Year and don’t drink too much.

Mykie

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Saul,

Your refreshing honesty regarding SZYM is exactly the reason this board is easily the best. Thank you!!!

Sergeant Friday on Dragnet used to say: “Just the facts, ma-am.” Well, management did not give us the facts. And the story was oh so good. We were all fooled.

I always learn more from my mistakes than my wins.

We are all huge winners benefiting from your wisdom and honesty.

Happy New Year to all!

Jim

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Year End #6: SZYM, Where did I go so wrong?

I’ve been interested in alternative fuels for over seven years. The high hopes for making fuel from waste, algae and other feed-stocks mostly failed, it simply was not cost effective. I sold RTK in 2011 when they switched from fuel to nitrogen fertilizer. I watched Syntroleum and Tyson Foods build the bio-refinery in Geismar, LA. and figured correctly that Syntroleum would not benefit from it. The Geismar plant was acquired by Renewable Energy Group (REGI) last year. I also watched Solazyme but stayed away for two reasons: by 2011 I was disappointed with alternative fuels and I don’t invest in Latin America – too much socialism. Back then Brazil was very much in the news but their oil industry fizzled, too much chauvinism.

Last year I renewed my interest in biodiesel and bought REGI. The reason is that REGI is a profitable low cost producer of biodiesel. All the previous players had a hard time making a profit. REGI is setting up a competitor to Solazyme, REG Life Sciences, but instead of buying feed stock they will use the byproducts from their biodiesel plants. This is a commodity business and what counts is being the low cost producer.

There are some posts at the REGI board that you might find interesting:

Fool: Why REGI bought Dynamic Fuels
http://discussion.fool.com/Message.aspx?mid=31297871

Why was Dynamic Fuels not in operation?
http://discussion.fool.com/why-was-dynamic-fuels-not-in-operatio…

Learning about REGI from Solazyme
http://discussion.fool.com/Message.aspx?mid=31298022

Why so many biodiesel makers went broke
http://discussion.fool.com/why-so-many-biodiesel-makers-went-bro…

Denny Schlesinger

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I also watched Solazyme but stayed away for two reasons: by 2011 I was disappointed with alternative fuels

Ah, but Denny, the big appeal of SZYM is that they weren’t going to be manufacturing alternative fuels. It was cosmetics (already running), food oils (also already running), high margin industrial oils, etc. I never would have bought in either if it was “Let’s turn corn into bio-fuel!”

Saul

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I still like and own Solazyme.

I initially bought around $7, held through various pops and drops up to around $14 and I continue to hold today, down at around $2. I haven’t bought or sold a single share in the entire period of time except to harvest tax losses, although I did short some puts down around $3. It’s a little miserable to look at, but I’m not hugely bothered because I made an appropriate allocation given the nature of the company and the risk involved. I bought small and my portfiolio is not hideously impacted as a result.

I think allocation is the real lesson to learn here.

Solazyme was and still is an early developmental-stage company and the risk is huge. Even if they were producing oils or fuels or puppies or hats at nameplate capacity, that would still be the case, so I don’t know that nameplate capacity is really as important as the market wants to believe. Proving capacity is really just one of the mountain of hurdles they need to overcome in order to be successful - producing tons of something nobody wants to pay for is silly regardless of what it may prove. It seems that the technology is fundamentally sound and Solazyme’s ability to tailor it to produce all sorts of output is both demonstrated and encouraging.

I wouldn’t fault an oil or gas producer for shutting in production when that production becomes a money-losing endeavor so I won’t fault Solazyme either when marginal production of commodity oils stops making sense. It makes sense to batten down the hatches and cut costs rather than increase production and lose even more. Now, I use the example of oil producers because it’s topical given the crash in oil prices, not because Solazyme is a synthetic fuel producer… Although the same oil price crash does in fact also impact Solazyme. It sucks that their answer to falling palm kernel oil prices was to focus on higher-margin products like Encapso because that’s going to fall off a cliff now too. I doubt the next CC will be a happy one.

So what’s left to like? A company constantly adjusting production to make whatever’s about to crash next?

I like to think of it in the longer term. Solazyme is a synthetic biology company, and I think synthetic biology is going to be the decade’s next significant emerging industry. That doesn’t necessarily mean Solazyme will survive or that it will succeed even if it does survive, but the opportunities ahead of the company are immense. Specifically, I am interested in Solazyme’s ability to manufacture tailored food products and nutritional supplements like AlgaVia. Possible health benefits may sell it initially, but the simple fact is the people need to eat protein and producing it using cows, pigs and chicken is hideously inefficient. The feedstock that these animals consume could feed billions of people. Producing it directly from crops like soy or whatever is simply the best current alternative. Solazyme’s algal production stands to be hugely more efficient and opens up a whole new universe of manufactured food production.

Solazyme’s products have enormous and diverse applications. Being able to capitalize on any given application is certainly still a question mark but there are just so many paths the company could take. It’s a flyer and it always was.

I bought because I saw interesting, almost science fiction-like possibilities for the future. In my mind, the interim production of commodity oils was just to build a foundation that would support that future. Now things are in jeopardy and the plan for that foundation is threatened. Like I say, I think it makes sense to become defensive in the interim and I’m OK with it.

Solazyme may yet survive this perfect storm. I think it’s probable that they do. What happens next is just more questions marks, but the light at the end of the tunnel is oh so bright.

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I found this nice comment on the SZYM board by Rich (ChanceEldrDancer). The unbolded part is what he’s referring to. I bolded his own comments to help distinguish between the two.

Saul

. . . no new timeline given for when Moema might reach nameplate capacity. I found this to be a bit of a thesis changer, although Seth seems to be saying he finds it refreshing that they won’t make new promises if they are unsure they can keep them. . . ultimately, I still believe SZYM has the goods to be a game changer. It just might take an additional year, two or more.

I think we have had a very significant thesis change, in the sense that the thesis for buying SZYM when we did has turned out to be essentially 100% wrong. And I am less impressed than Seth by the “refreshing” fact that management cannot articulate a path to anything more than, possibly, survival.

I remember FMD – recommended the first week I was an HG member… Almost immediately, the thesis behind that investment was blown completely out of the water, and advisors and community members squirmed and wriggled and found new ways to justify holding – under very different these than the original one. With hindsight, I realize that the emotional pressure to avoid admitting a “mistake” (not really a fair word – not every loss is the result of a mistake – here it just did not work out; such is life) allows thesis creep, where a thesis that would have been laughed out of the analyst room had it been advanced in support of an initial buy is now given credence.

Honestly, if you were coming fresh and new to this potential investment, would you even look at it twice? I sure would not. So I am staying far, far away from SZYM.

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I sent the following to Goldberg, the “unofficial Ticker Guide” for SZYM on the SZYM board. I’ll let you know what answer I get.

Saul

Gouldberg,

I wonder how much people are taking into account that SZYM’s main future plant (Moema) is outside the country, subject to politics and vagaries of Brazil, and apparently on the land of, and under the control of, another company, which is huge, and has other compelling interests, and can’t, or doesn’t seem willing, or doesn’t care enough, to even get a stable electricity supply to this factory which is SZYM’s life blood. That seems to me to be a major negative, but I’ve never seen it even mentioned anywhere as a factor.

Saul

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I asked Gouldberg, the “unofficial Ticker Guide” for SZYM on the SZYM board, the following question:

Gouldberg,
I wonder how much people are taking into account that SZYM’s main future plant (Moema) is outside the country, subject to politics and vagaries of Brazil, and apparently on the land of, and under the control of, another company, which is huge, and has other compelling interests, and can’t, or doesn’t seem willing, or doesn’t care enough, to even get a stable electricity supply to this factory which is SZYM’s life blood. That seems to me to be a major negative, but I’ve never seen it even mentioned anywhere as a factor.
Saul

Here’s his answer:

Hi, Saul.
I would think it’s definitely a factor because it simply puts some things outside the company’s control. I’m sure most never imagined that getting a stable, permanent source of electricity would become the major problem that it has. It certainly seems to have taken management by surprise and thrown a big wrench into their plans. But you’d have to imagine that risk was considered by Solazyme before agreeing to the joint venture with Bunge in the first place. I also don’t think Brazil contains the same political risk or uncertainties of a country like say, Venezuela, but your point is well-taken.

Management has said Moema should have a permanent link to the electrical grid in early 2015, which should eliminate any intermittent outages they are experiencing.

The other risk to consider is what Maxx Chatsko has been saying for a while now: that he suspects they are running into technical hurdles as well with the fermentation process. If he is correct, that is a much larger problem than a plant delay.

The way I think about it, SZYM needs to do three things to succeed in the long-term.
1. Find new, disruptive uses for their core technology where SZYM algae products can create a competitive advantage.
2. Show they can produce those products in sufficient quantity to be commercially viable.
3. Sign major customers who want to include SZYM ingredients in their end products, which will ensure SZYM’s products are accepted by the mass market.

While Solazyme has made good progress on the first area, obviously the second and third areas are full of risk and not at all certain. The fact that their largest plant is in a country with very different infrastructure standards is, as you say, an additional headwind to say the least.

Gouldberg

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The message is clear: Avoid development companies that are just starting out, no matter how good the story! Nuf said.

Hi Saul,

I only comment here for discussion since your position on SZYM is unassailable. I also haven’t been posting here much due to domestic duties holding sway, so even if this is too long, please do applaud no matter the content :slight_smile:

SZYM:
What’s important here is I am a new investor so much of the errors I made with SZYM have been great learning experiences. I carry forward way more knowledge and don’t expect to get into a over position problem again.

With SZYM buy ins, I did something similar and ended up with a BE price of $10.38. I also had some options that I had to get rid off, option calls that I bought when the stock was around $9, thinking it was going to bounce right back up. It didn’t and that generated a just under $400 loss.

My position size with SZYM went from 1.5% when I bought in, (I now conclude that was really my only mistake) to .3% now due to the price drop of around 80% and an increase in my IRA total value. That’s the good news, I mean I knew 1.5% was too much but like you, couldn’t resist the potential and now, even if it goes to ZERO, it won’t affect me.

But I hate losing so last month when the stock price was laboring to stay above $2.00, I sold $1 Puts and received $1175 cash to use between now and January 2016, expiration date.

If the stock is over $1 on the expiration date, I get to keep all that cash and any money I may have earned during that one year.

If the stock is below that $1…well, the last time the stock was $1 was…never.

Anything could happen but my new trading premise was that during 2015 this company should be able to land some contracts for their other high margin products, even though they won’t generate a big profit. This alone should bump that stock up some and at that point if I want out, I can take it and not suffer such a big loss and that on a stock with still…lots of potential. And they should have some millions of cash at the end of the year so I doubt they will go out of business by expiration date.

So any excess profits from that $1175 (deduct $375 I lost with the purchased $9 calls) I can mentally deduct from my cost basis on this stock. I still hold too many shares but since the value is waaay down, it hardly makes sense to sell now. I might as well sell when/if the stock does in fact bounce up a bit due to their making progress on their new strategy. And after reading and pondering and making hard decisions on this stock, I was reluctant to toss it over board and forget about it. I want to leverage that intimate knowledge and put it to good use, whereas a new stock, I would have to start over again.

I offer here only a different view of the same events (and knowing you do not use options) for consideration and discussion.
Mykie

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So what’s left to like? A company constantly adjusting production to make whatever’s about to crash next?

Nothing inept about that, Inept.
Mykie
Still long some SZYM and short some puts

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Thanks for your ideas, Mykie. What you’ve done certainly seems to make sense as an alternate way of handling a difficult situation.

Saul