Tuesday, June 21, 2011

Dressed Up Microbes

A little over a year ago in April 2010, Maxygen, Inc. (MAXY:  Nasdaq) spun out its Codexis-branded biocatalyst business amid great expectations for getting a better valuation for both Maxygen’s remaining biotech business and Codexis (CDXS:  Nasdaq).  Shares of the “newco” started out at $13.00 and ran within days to $14.50  -  an impressive run up in a choppy market.  Then the stock went into a free fall, dashing all expectations against the rocks.

Codexis biocatalysts  -  a fancy word to dress up very ordinary enzymes and microbes  -  initiate and accelerate chemical reactions of one kind or another.  As opposed to inorganic catalysts, biocatalysts have a number of advantages.  They operate at room temperatures and require less complex manufacturing equipment.  They are also environmentally friendly, producing less lower volumes of waste than conventional chemistries. 

The problem with biocatalysts is that when thrown into an industrial environment, their natural processes can be challenged.  Furthermore, it is sometimes difficult to scale up these processes to the quantities required for a final product.  Then there is the most vexing problem of all  -  product inhibition  -  that describes how the very chemical products that result from a biocatalysts natural processes can in the end cause harm to the microbe or enzyme. 

This is where Codexis scientists get to shine.  The company’s strategy is to enhance the commercial viability of its microbes and enzymes using a variety of advanced genomic techniques to address their short-comings.  Codexis uses its own proprietary bioinformatic software tools, to rev up the stability and tolerance its biocatalysts thereby increasing stability and product yield.

Codexis has customers, including a prized research and development collaboration with Royal Dutch Shell plc for applications in renewable fuels.  The company is not limited to energy partners.  In the pharmaceutical industry, Dr. Reddy’s Laboratories (RDY:  NYSE), Merck and Co. (MRK:  NYSE), and Pfizer, Inc. (PFE:  NYSE) are customers.  Codexis would also like to get a crack at air, water and chemical applications.

Those pharmaceutical industry relationships pumped revenue up to $107.1 million in 2010.  Unfortunately, Codexis reported a net loss of $8.5 million and used $16.4 million in cash to support operations during the year.  Including the March 2011 quarter, sales in the trailing twelve months inched up to $112.4 million, but the net loss widened to $10.6 million.  Investors can take some encouragement from a switch to positive cash flow in the trailing twelve months.  Favorable changes in working capital accounts provided much of the cash flow.

The majority ownership of Codexis was held by Royal Dutch Shell.  However, Shell recently transferred those 5.6 million shares to Raizen Energia Participacoes S.A., a Brazil-based biofuels joint venture between Shell and Cosan Limited.  Raizen now owns 17% of Codexis.

The relationship with Raizen could be more meaningful that one with Royal Dutch Shell.  Raizen is a $12 billion joint venture with annual production capacity of over 2 billion liters of ethanol, making it the third-largest fuels company in Brazil. It has a retail network of 4,500 fuel stations, 24 sugar mills and an installed capacity of 900MW of electric energy from sugar cane bagasse.  Raizen would make an excellent customer that could use Codexis biocatalysts to tweak ethanol processes.

Although financial reports suggest in improving situation for Codexis, it appears investors are not impressed.  The stock has move up from historic lows, but remains depressed.  It has not helped that financial press has made something of insider sales.  CEO Alan Shaw exercised options in recent weeks, triggering commentary that suggests he has lost confidence in the company.  Shaw’s total position is largely unaffected.  Furthermore, it appears he was simply monetizing a stock bonus, a trade that has to be expected when stock awards are a significant portion of total compensation.  Codexis has no better cheer leader than Shaw, is a chemist by training and has been at the helm of the company since inceptin. 

Codexis shares look undervalued against the long-term potential in its biocatalysts.  It is a stock worth accumulating for a stake in the high tech end of the spectrum of renewable energy investments.

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.  Codexis is included in Crystal Equity Research’s Beach Boys Index in the Alternative Chemicals Group.

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