Friday, September 10, 2010

Green Stock Offering

A “who is who” list of investment banks are on the front cover of PetroAlgae’s S-1 filing for a secondary offering of an unspecified number of shares of its common stock - Goldman Sachs, UBS and Citibank get top billing with Baird, Cowan and Piper Jaffray following below. Apparently it takes a highly populated village to bring a renewable energy company to the U.S. capital market.

Shares of renewable fuel technology developer PetroAlgae, Inc. (PALG: OTC/BB) has traded as high as $26.75 on the Over-the-Counter Bulletin Board over the last year, but is recently priced near $10.00. The S-1 was filed in early August 2010, giving that large group of investment bankers plenty of time for pricing talk as the review process unfolds. The company had been issuing securities through private placements leading up to this offering. Options priced at $15.00 were a part of the issuances, making that price level a likely starting point for pricing discussions.

As all license and royalty business models PetroAlgae’s strategy avoids the capital intensive requirements of a renewable fuel producer. The company has bundled its process knowledge and technology into a software-based platform that can be licensed to oil companies, refiners, power companies or even agriculture producers - anyone with a need for the biocrude or protein products that come out of PetroAlgae’s aquatic microorganisms. Licensees get a software application with special algorithms and a remote sensing system that help direct light, temperature, density and nutrition factors in the growing environment. Nine patent applications are pending related to the proprietary technologies.

The company believes it has built a better mousetrap than others in the algae-to-renewable fuel business. Its solution relies on multi-cellular aquatic micro-organisms that are indigenous to the licensee’s location. With more than one-cell in the little guy’s structure, the required pre-harvest drying process is expedited. Perhaps more importantly, the finely tuned cultivation process turns out harvestable algae four times faster than Mother Nature, making it possible to harvest multiple times per day.

PetroAlgae claims its pilot facility in Florida demonstrates that its approach produces as much as 225,000 metric tons of biocrude from a 5,000 hectare growing pond. The numbers look impressive, but the astute investor will probably wonder if there is a price for competing fossil fuel at which PetroAlgae biocrude is simply too expensive. Here is where is its is vital to add in the protein production - 90,000 metric tons of protein from that same growing pond.

One of the most important elements of PetroAlgae’s platform is the production of biocrude that is a so-called “drop-in” fuel - that is it can be fed into the existing refinery infrastructure. Indeed, PetroAlgae claims its biocrude is a substitute for “resid” or the heavy fraction remaining after distilling petroleum crudes at atmospheric pressure. PetroAlgae appears to be relying on this characteristic to make its process appealing to cokers who are having a tough time maintaining capacity utilization at profitable levels.

PetroAlgae claims its system is profitable for biofuel production down to $20 per barrel crude oil. Yet that apparently means simultaneous biocrude and protein production. We expect to see some strange marriages of refiners and agriculture producers as possible customers.

The company claims to have over 300 prospects of its target list and 5 memorandums of understanding from interested parties. As impressive as this might be, the sales cycle is long for this product and investors could have a long wait before license and royalty revenue begins to flow.

Even if investors are able to walk through the chemical engineering and biochemistry that underlies the technology, it will be necessary to swallow some bitter pills in the PetroAlgae deal. The company’s auditors have attached a going concern caution to the financial statements - no revenue, a history of operating losses, and little cash on the balance sheet. The last three years of financial statements were restated to fix accounting errors from prior years - inadequate financial controls and lack of sophistication in the executive suite. There is also $35.7 million in debt on the balance sheet, which is the primary use of proceeds from the offering. The company’s principal shareholder, PetroTech Holdings, which has declined to convert that debt to equity, probably since it already owns 94% of the company’s outstanding stock.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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