Verenium (VRNM) - A Small Promising Company with a Bright Future
1) Its enzyme products primarily target the poultry, swine, beef, dairy, aquaculture and companion animals markets. Enzymes are used in the animal health and nutrition market to allow livestock, poultry, aquaculture and companion animals to more readily digest and absorb the nutrients naturally occurring in grains and protein meals. Global sales of animal feed enzymes are estimated to have reached $520 million in 2010, and are projected to reach $720 million by 2015. Their largest product line is related with the animal health and nutrition and their main product is Phyzyme phytase. Phyzyme phytase was developed in collaboration with Danisco Animal Nutrition to improve the digestibility of phosphorus and other nutrients naturally contained in animal feed.
2) Its second-largest product line is related to the grain processing. Their primary products are Fuelzyme and Deltazyme. Fuelzyme alpha-amylase is a highly evolved, high performance, thermostable enzyme that is effective over an exceptionally wide temperature and pH range allowing ethanol producers greater operational flexibility. Fuelzyme alpha-amylase provides superior reduction in mash viscosity, at a much lower dose compared to competitive products. Deltazyme is used in the fuel ethanol production to saccharify liquefied mash from various substrates including corn, wheat, milo, barley and cassava.
3) Its Pyrolase cellulase enzyme is an alternative to chemical guar breakers used in hydraulic fracturing or fracking operations. Well Pyrolase is a good product for use in situations with down hold temperatures up to 180 degrees Fahrenheit. The Pyrolase cellulase product operates at higher pHs and temperatures than conventional enzymes of this class.
4) Its VEREFLOW alpha-amylase is a unique enzyme for the removal of filter cake in drilling operations. This product has been shown to remove filter cake from lengthy sections of a horizontal reservoir by a non-aggressive chemical reaction. This performance contrasts sharply with conventional approaches, such as the use of hydrochloric acid (HCl), which reacts aggressively with calcium carbonate (CaCo3) reservoirs and is suspected of creating wormholes that lead to formation damage and blockage of formation pores. This in turn, can restrict the flow of hydrocarbons to the wellbore and limit well productivity. Effective over a wide temperature and pH range and with a safer environmental footprint compared to traditional chemicals often used in the process, Vereflow alpha-amylase provides the oilfield services industry greater operational flexibility. Verenium estimates the addressable global market for Vereflow to be approximately $20 million annually.
5) In the textile mill, wet processing, or preparation, removes the natural and man-made impurities from cotton yarn or fabric. The adequate removal or scouring of impurities before dyeing, printing or finishing is essential in producing quality products, since more than half the faults generated, such as streaking, color matching or colorfastness, can be traced back to ineffective preparation. Traditionally, cotton scouring has required the use of harsh alkaline chemicals (caustic), extreme temperatures and large volumes of water. Expenses include not only the cost of the caustic and energy, but also the cost of treating waste water to remove residual caustic and by-products. Today, textile producers have a new, effective alternative to chemical scouring with the advent of the Cottonase enzyme. This novel enzyme not only cleans better than chemical scouring, but also greatly reduces the need for extensive waste water treatment and energy consumption. The Cottonase enzyme is a versatile, economically viable and environmentally friendly alternative to chemical scouring in cotton preparation.
6) In the past, the pulp and paper industry has had only moderate success using previous generation xylanases because of their ineffectiveness in the harsh processing conditions of the pulp mill. Luminase PB-100 enzyme not only substantially reduces the need for bleaching chemicals, the enzyme remains active over a wider range of temperature and alkalinity (pH) than previous enzymes so it can be utilized by more mills. Luminase enzyme also provides greater operational efficiencies, as it works faster than previous enzymes, thus requiring less retention time. In addition, Luminase enzyme is effective for most types of pulp, thereby expanding the utility and benefit to the mill.
VRNM trades below its book value with PBV of 0.8. The company has a consistent revenue growth year over year which is around 10% to 15%. However, the bottom line is not consistently positive but it fluctuates from earnings to losses during the last four quarters. The quarterly cash flows have also been in the negative territory since fourth quarter 2011.
Based on my estimates, the revenue will be around $65 million for 2012 and thus the current market cap is 0.5x the annual revenue.
The gross margin ranges from 35% to 55% but the operating margin has gone negative during the latest two out of four quarters.
The current ratio is as high as 2.7 and the corporate cash is 0.5x the current market cap.
I cannot project the annual earnings and thus the P/E ratio with safety as the company has not provided any specific guidance for 2012. This lack of guidance also makes difficult any annual cash flow projection. In addition, I have to point out that the earnings in first quarter 2012 can not be used as basis for an annual earnings projection as these earnings were the result of an asset sale to DSM. More details about this sale are mentioned at the next paragraph.
From the debt end, the company got a $10 million bank loan in October 2012, so the long-term debt is just 0.25x the stockholder equity.
Latest Corporate Developments
1) In February 2012, Verenium and Tate & Lyle have signed an agreement for the use of one of Verenium's proprietary enzyme products in the development of novel food ingredients. Under the terms of the agreement, Tate & Lyle receives a technology license with exclusivity assurances in the field of development. Verenium receives $1.5 million in near-term milestone payments, revenues from enzyme product sales and a royalty on Tate & Lyle’s future sales.
2) In March 2012, Verenium sold to DSM its Oilseed Processing business, including Purifine Plc and licensed granted DSM exclusive licenses to its alpha-amylase and xylanase enzyme products for use in the food and beverage markets. The two companies also entered into a supply agreement for Verenium to manufacture the Purifine Plc, alpha-amylase and xylanase products for DSM, and agreed that Verenium will develop new gene libraries for use by DSM. The products acquired by DSM represented approximately $7.5 million in revenue to Verenium in 2011, and Verenium received $37 million in total consideration. Given that Verenium had a market cap of $40 million before the announcement, it is welcome news that a line of business representing 12.2% of the company’s revenues is worth $37 million. Applying that 5x revenue model to the entire business would value the remainder of Verenium at $268.5 million, a huge premium over its current market cap of $30 million. That’s not a simplistic approach, but emphasizes that the investors have not realized the company's value yet.
3) In July 2012 Verenium Corporation celebrated the grand opening for Verenium's new office and laboratory facility in the Torrey Pines area of San Diego, Calif.
"The completion of our new facility is an important milestone for the future growth of our business, and we thank everyone involved in helping us with this achievement," said James Levine, president and chief executive officer of Verenium. "Through enhanced design and functionality, our new facility promotes innovation and collaboration throughout the organization, and positions us for continued advancement in the industrial biotechnology industry."
Verenium's new 60,000-square-foot building includes state-of-the-art laboratories, office space designed to support employee creativity and a high-tech fermentation pilot plant for use in bioprocess development and optimization, enzyme product development and manufacturing scale-up. As part of the Nautilus campus, owned and operated by Alexandria Real Estate Equities Inc., Verenium's new building is designed to achieve LEED Gold certification through the use of a number of sustainable initiatives including energy efficiency and reduced water consumption.
4) In July 2012, Verenium received regulatory authorization from the Environmental Protection Agency (EPA) to market its next-generation cellulase enzyme for non-food applications, including use as a biocatalyst to break down the guar-based gel used in hydraulic fracturing. This highly thermo-stable enzyme was developed by Verenium scientists using proprietary DirectEvolution® technology, and is designed to function under higher temperatures and extreme pH conditions, such as those in gas shale and deeper oil and gas wells.
"While our Pyrolase® cellulase product currently used for breaking guar during hydraulic fracturing is effective in fracturing jobs at temperatures under 180 degrees F, our work with the industry enabled us to define the characteristics of a more robust enzyme breaker. Our next-generation product has been tested in the labs of several oilfield services companies demonstrating that it functions well in more extreme temperature ranges and higher pH conditions," said Levine.
Verenium estimates the addressable market in the U.S. for guar breakers in hydraulic fracturing is $250 million. Verenium's next-generation enzyme breaker represents an advancement in performance properties that the company believes can expand the share of this market addressable by enzymes well beyond the current 10 percent. The company expects to launch this next-generation product in the second half of 2012.
In my opinion, this is a major milestone for Verenium which believes its enzymes can replace the corrosive acids currently used in the fracking process to extract natural gas deposits. As all know, the fracking process is damaging to the environment with highly corrosive acids getting into groundwater channels. The oil and gas companies didn’t give a damn as long as the profits continued to flow, but as the impact of this destructive behavior comes to light they are feeling the heat to come up with cleaner alternatives. That’s where Verenium comes into play, as their biodegradable enzymes can replace the acids, breaking down guar without all the safety issues.
If Verenium has success with this new product in the fracking game, the natural gas drillers can continue to develop their gas fields with one less problem to deal with. As natural gas production increases, more business comes to gas pipelines and storage facilities. The whole industry would grow and create jobs, tax revenue and profits without the stigma of "dangerous" fracking fluids. It could also make Verenium be an acquisition target for majors like Haliburton (HAL) and Baker Hughes (BHI) which have developed their own "safe" fracking fluids.
5) In August 2012 the company said during a press conference that they had product candidates under active discussion and planning with potential collaborative partners or screening for opportunities in their enzyme collection. The company was in active discussions with more than a dozen companies about product development collaborations, most of these companies have deep expense with industrial enzymes and use enzymes to make products commonly found in our home. The markets they were discussing with the companies include not only expansion in their current areas of animal health, grain processing and oil field services, but also enzymes for food processing applications such as baking, for producing sweeteners and syrups, for personal care products and for detergents and cleaners. As the company also said, it was a long list with multiple potential collaborations with many of the global leaders in their field.
The last time the management bought shares of the company was in May 2012 when the CEO bought 4,994 shares at $3.65. The management holds approximately 3% of the company as of today. The management team has very good credentials as:
The CEO Mr. Levine has held various positions focused on the energy and healthcare industries with the global investment banking and securities firm, Goldman Sachs & Co., where he most recently served as a managing firector in the Power and Utilities Group in New York. Before that he served as a managing director in the Goldman Sachs Energy Group in London and held positions in the Goldman Sachs Healthcare Group in London and New York focused on biotechnology companies. Prior to Goldman Sachs, Levine held positions with Lehman Brothers Inc. in New York.
The vice president and COO Ms. Roemer has held several positions with BP Group, one of the world's largest oil and gas companies. She was chief of staff to the CEO of Innovene, a $24 billion petrochemical and refining business within BP Group. Prior to that, Roemer held executive-level roles including chief executive of a $1.7 billion North American chemical business, vice president of Digital Business and general manager of a $700 million global chemical business. Roemer also held various positions at Amoco Corporation between 1983 and 1999, in sales and marketing management, product management, production planning and logistics, and strategic planning.
Prior to joining Verenium, the vice president and chief of the business development and strategy Mr. Barrett has been a co-founder and managing director of Trident Partners LLC, a private equity and management firm focused on small- and medium-sized businesses which differentiated itself by direct involvement in operations and strategy development of its acquisitions. Before that, Barrett served as a consultant at Bain & Company developing and applying analytical frameworks and generating insights and results for client businesses. He began his career at Mitsubishi Motors Corporation in 1989 in Japan.
Mr. Bracken, the vice president and chief of manufacturing of Verenium, has been vice president of manufacturing at Vical Inc., a developer of biopharmaceutical products, where he was responsible for all manufacturing activities, served on numerous product development, validation and technical teams for new product candidates, and supervised all scale-up and optimization operations for the company. Before that Bracken was vice president of process engineering and manufacturing at Universal Preservation Technologies Inc., and was director of engineering for molecular biosystems. Prior to that, he held positions of increasing responsibility in process engineering with Gilead Sciences and Baxter International. Bracken began his career as an engineer with DuPont.
The company has not provided any guidance for 2012 thus far. So an investor has to project the revenue and earnings by himself getting some help from the latest conference call when the directors pointed out the followings:
1) In terms of their primary product line, sales of finished product by their partner Danisco Animal Nutrition, a unit of DuPont strengthened in the second quarter of 2012 and they are expected to remain strong for the remainder of the year. Poultry and pork which are the major markets for Phyzyme phytase are favorably priced relative to beef and this will continue to be the case as the year progresses. An important ruling in Europe revoked a Novozymes patent, which related to manufacturing animal feed containing coded demonstrable enzyme granules. This removed uncertainty in the marketplace and clarified Danisco’s ability to sell the thermal stable version of Phyzyme phytase in Europe. For a while it had been halted in Denmark under a preliminary injunction. This represents an important victory for customer choice and for Phyzyme phytase.
2) Regarding their second-largest product line, the revenues decreased in the second quarter of 2012. Their results reflect a very challenging industry-wide condition which has compelled ethanol producers to reduce operating rate and in some cases shut down and response to weak margins, in both the Europe and the U.S. The outlook for the ethanol industry is cautious as they see the challenges of over capacity and high feedstock prices persisting. In addition, the decline in their grain processing revenue reflects the absence of revenue from Veretase, their food-grade alpha-amylase which was transferred to DSM at the end of the first quarter.
In the positive side, they have a solid book of trial activities for their lead products Deltazyme and Fuelzyme in the third quarter and are targeting adding new customers as a result.
In concluding on grain processing, the company says that it is well positioned to capitalize on emerging opportunities with new enzyme products in their pipeline as the corn ethanol industry evolves in terms of revenue diversification and innovated process improvements.
The main risks are associated with the performance of the company's two main product lines along with the amount of new orders from the oil industry and the oilfield sector. The outlook of the ethanol industry is cautious, but the outlook of the animal market looks far more promising. The outlook of the oilfield sector is also very bright and the demand for safe and environmentally friendly hydraulic fracturing procedures will always remain one of the top priorities for North America.
I believe VRNM is a buying opportunity at the current levels of $2.49 (yesterday's close) and it is an acquisition target, especially if its oilfield products have market success. However, this is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell stocks has to do his/her own analysis at his/her own risk.