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Amyris, Inc.: A Sweet Future Brought To You By John Doerr – Amyris, Inc. (NASDAQ:AMRS)

Billionaire investor John Doerr holds 19.99% of Amyris, Inc. (NASDAQ:AMRS) common equity and is actively trying to gather as much of the company’s warrants and debt as possible. Why would an investor with the track record of Mr. Doerr buy up every piece of paper possible from a company that on the surface appears to be going bankrupt? While at first glance AMRS looks in deep trouble, we at 1035 Capital have found a few reasons why Mr. Doerr has repeatedly opened his wallet to this struggling company, and in our opinion, is likely to continue to do so. In short, AMRS science and IP could be a game-changer for many large markets. Additionally, AMRS appears to be transitioning to a much-improved business model focused on higher-priced, higher margin, and faster-growing products which should translate to a bright future for AMRS shareholders, especially Mr. Doerr.

However, in order to reap the rewards from this transition, the company first needed to regain compliance with their SEC filings and NASDAQ listing rules. AMRS recently overcame this hurdle, removing a significant headwind for the company. Upon filing, there was a brief 10% pop in AMRS shares followed by a 25% drop. This reaction was a result of a combination of factors including a “sell the news event,” disappointing margins due to investments to grow capacity, a disclosure of technical default on a loan with CVI, and conversion of $34.5M of debt into equity held by Foris Ventures. This article will examine each of these issues in more detail, but first, let’s touch on the CVI default.

A default of any type is rarely good news, as is the case with AMRS. However, the company obtained waivers from all of its debt holders, who are primarily insiders, to waive the right to accelerate payments on outstanding debts per the respective cross-default clauses. AMRS’s financial struggles could have easily ended in bankruptcy if not for passionate and well-heeled insiders. The company’s debt and warrants have largely been moved into the hands of a small group of investors with significant equity holdings in the company and a long-term horizon. This is helpful as AMRS cleans up the one bond in technical default. Our research indicates that the recent strategic shift, ongoing financial restructuring, and the support from large wealthy insiders are finally positioning AMRS to be successful going forward.

Background

AMRS is an industrial biotechnology company that uses sugar, water, and yeast to ferment and create rare, sustainably-sourced and high purity molecules from hydrocarbons to CBD and many things in between. Its business was initially focused on biofuels but then switched to the vitamin and fragrance industries through several partnerships with major companies. However, these were primarily relatively low margin ingredient supply deals.

Cue the recent financial restatements. As a part of these partnerships, AMRS entered into several significant related-party transactions that were accounted for incorrectly. The company was forced to restate their financials earlier in 2019. At a high level, the restatements were primarily around revenue recognition policies on these complex related-party deals but they were all non-cash charges.

Since its founding, AMRS has invested considerable cash to prove its technology works and then to build out capacity for various opportunities such as the current sweetener, PureCane, as well as squalane production used in their clean beauty brands, Biossance and Pipette. The considerable costs associated with scaling fermentation production cause the company to continue to operate at a loss muddying the waters of product profitability through 1H2019. Now that the near term investments are behind them, this problem should clear up in the second half of the year.

As a result, the company may finally be near consistent EBITDA profitability with the success of its first branded product, Biossance, and the launch of two new brands: Pipette and PureCane. Additionally, the company has a large CBD opportunity on the horizon with royalties on sales potentially beginning as soon as 1H 2020.

Compliance – The Good and The Bad

AMRS announced the need to restate financials on April 11th, 2019. According to MarketWatch, AMRS needed to “cut fiscal 2018 revenue by $12 million to $16 million and net income by $7 million to $11 million. The errors were the result of the way the company handled revenue from royalty payments.” This led to a significant and deserved drop in the share price. The negative effect of the restatement was amplified by the company needing to refinance significant debt around the same time, resulting in a perfect storm. With the help of John Doerr, AMRS was able to manage their way through this dire scenario mostly unscathed. The final obstacle is to renegotiate terms on one remaining loan referred to as the “CVI loan” which has an outstanding balance of roughly ~$68M. This issue is discussed further in the next section.

After many headaches by investors and company insiders alike, AMRS re-filed its 2017 and 2018 restated financials on October 1, 2019. This, unfortunately, didn’t occur until after the company dismissed KPMG as its auditor. Management and the board lost confidence in KPMG’s ability to fulfill its commitment assisting the company in timely re-filing by September 30, 2019. As a result, AMRS brought in BDO and MGO to finish the 2017 and 2018 full-year audits as well as get the 1H19 filings up to date. Due to changing auditors mid-restatement, the shares again were rightfully punished after this announcement, driving the stock down from around $4 to the mid-$2 range.

As of October 7th, 2019, AMRS returned to compliance and is expecting to resume a normal earnings release schedule going forward. Now compliant, the company can re-enter more traditional financing markets to reduce the debt costs it endured while refiling their statements. Luckily for AMRS and their shareholders, they have a significant and committed backer in John Doerr.

Mr. Doerr has been instrumental in funding AMRS’s operations as well as refinancing some of its worst debt on the balance sheet. He didn’t do this purely out of the goodness of his heart, he was rewarded with warrants to purchase millions of AMRS shares at around $2.87/share. For existing AMRS shareholders, this dilution is a better option than outright bankruptcy because the company sits at the precipice of several significant growth opportunities that could translate into much higher share prices, despite the anticipated dilution.

The downside to regaining compliance was the conversion of $34.5M of short-term loans held by Foris Ventures, AKA John Doerr, into equity. When AMRS was at the Jefferies conference on August 6th, management disclosed in the presentation slide below that the company expected to have $150M of debt outstanding once they got back on file.

(Source: Jefferies Industrials Conference)

It is difficult to figure out exactly how many shares the $34.5M of short-term loans was worth in equity, but given that most of Mr. Doerr’s warrants have been re-priced to about $2.87/share, we will use that price as the basis of conversion. Using this method implies AMRS shareholders have seen about 12M shares of dilution since regaining compliance. Based on the most recently updated 103M shares outstanding, shareholders are receiving 12% dilution in exchange for removing almost 20% of the company’s outstanding debt as of July 2019.

Debt, Default and the lack of Bankruptcy (Thanks again Mr. Doerr)

AMRS started 2019 with significant debt coming due, a difficult situation further complicated by the financial restatements mentioned above. Unfortunately, AMRS had to turn to several increasingly more expensive sources of short-term cash to fund operations and short-term debt re-financing. One of the loans was owed to a company called CVI which is currently in technical default. This was first announced via an 8-K on 07/19/19. When the company finally became current with its filings in October, some investors – apparently for the first time – saw the disclosure of the default on the CVI loan because since then, they have been making a lot of noise about the issue and what it means for the company. They claim bankruptcy and delisting, but our research indicates it seems very unlikely.

First, the CVI disclosure should not have been a surprise to investors. It was originally disclosed in July via an 8-K. Second, at the B. Riley conference on Oct 4th, John Melo was directly asked about the CVI loan and whether the company was going to file for bankruptcy. His response was:

we have actually paid off quite a bit of debt this year, if we were going to go bankrupt, we would have done so with the debt wall we faced in April. We didn’t. We have no plans to go bankrupt. We have large shareholders who own a significant amount of the company and have been aggressively funding the company this year and have the intention and plan to continue to do so.

We have complete intention to service and pay the [CVI] debt – it will get paid in due time as we work through the terms. There is a fallback that allows us to settle in equity. We haven’t wanted to do that because we don’t want to use the equity for that purpose and believe there are better alternatives.

The better alternatives are: a couple of long-term investors are interested in refinancing that debt. They would then take out the old debt and provide the company with a note and holder they know and like. We believe the company is worth a lot more than the current market cap so using our equity to repay that much debt is not something we want to do.” – John Melo

When pressed on the issue, John went on to say:

“we are in the process of resolving this very quickly. If we are not resolved by year end something has gone horribly wrong. We expect to take care of this very quickly.” – John Melo

Management plans to fund future operations through the current warrants outstanding which would provide up to $200M in cash to AMRS. They believe this is the best source of new cash for the company, but admit that realistically only about $100M is likely to convert at these prices, primarily due to the recently renegotiated strike prices.

While it is likely shareholders will see more dilution ahead via John Doerr’s massive pile of warrants and convertible debt, the company found a strategic and long-term holder for these financial instruments. Mr. Doerr was willing to financially back the company during its darkest hour and now has a vehicle to keep supplying cash to AMRS. We view his involvement as a good thing because it provides some clarity of funding for AMRS shareholders.

Once the noise settles from the CVI loan technical default, filing issues, dilution, and getting back into compliance, we believe AMRS will begin to see the fruits of the company’s recent strategic shift pay dividends as their brand sales continue to grow at impressive rates. We are especially excited to see the 4Q 2019 numbers which we expect to begin to lay bare the significant transformation at AMRS as this is when 50% of the brand sales for the year occur.

PureCane: The Future for AMRS is Sweet

AMRS has positioned itself to become the leading supplier of Reb M, which is similar to Reb A, the molecule many people are familiar with that makes stevia sweet. Reb M is generally considered the more sugar-like molecule from a taste and purity standpoint, but due to its rarity in naturally occurring plants, most manufacturers have historically used Reb A. AMRS’s solution to this problem was to use low-cost sugar cane water and add yeast that is modified to convert the sugar water directly into Reb M. The process is similar to how yeast is used to ferment beer.

By using fermentation to produce Reb M, AMRS makes a much purer, better tasting product that costs less and is sustainably sourced from sugarcane. At production scale, AMRS believes it can produce Reb M at cost parity with raw table sugar. This implies its manufacturing costs are multiples lower than current stevia production costs. By disrupting the production cost of Reb M using fermentation, we believe AMRS is well-positioned to take meaningful share of the stevia market. It is also likely AMRS will take share from other high intensity sweeteners and even traditional sugar as consumers look to reduce their overall sugar intake.

Deriving sweetener from the stevia rebaudiana plant is a costly and time-consuming process. While the entire stevia plant is sweet, the leaves are the sweetest but only up to 5% of the dry weight can be converted into sweetener extract. According to Burpee, a single stevia plant can produce up to ½ lb. of dried leaves.

Given this information, we can infer that one plant can produce approximately (1/2 lb is roughly equal to 226 grams) 226 grams of dried leaf of which 5% can be converted to stevia extract for sweetener or just over 11 grams per plant. Currently, average yields of stevia per acre are reported to range from 5500-8000 lbs of biomass. Given that only about 5% of this biomass is converted to stevia extract, an acre would produce 275 lbs – 400 lbs of product. AMRS’s short-term goal is to produce 100 tons (200,000 lbs) of Reb M and make it available to sell in 2020. Comparing this to a traditional producer of stevia, they would need 500-725 acres of land just to match AMRS short term production goals.

According to John Melo at the Jefferies global industrial conference, it takes 20x less farmland to produce PureCane than any other natural sweetener. Management believes their 100 tons of capacity is enough to get through 2020. AMRS plans to significantly improve capacity in the next 18-24 months but beyond 2020, their capacity, specifically downstream purification capacity, will become severely constrained. To this end, management anticipates undergoing debottlenecking processes in purification to improve capacity while they make an investment decision with Raizen on a second production facility.

In April, AMRS announced:

a long-term strategic supply agreement for the plant with Raizen, the world’s largest sugar producer, which will reduce our costs and ensure the highest quality of non-GMO feedstock. And finally, Raizen and Amyris will evaluate production opportunities [a second plant] related to the zero-calorie sweetener. Such considerations are separate from the current specialty plant mentioned before.” John Melo Q219 Earnings call.

AMRS has a long-stated goal of reaching 30% of the stevia sweetener market by 2022. According to the company, the stevia market is currently worth ~$1.4B and growing as shown in the slide below. If the company is successful in converting 30% of the stevia market by 2022, this one product would be producing $400M or more in sales for the company, compared to today’s total market cap today of ~$375M.

(Source: AMRS BioDisrupt 2019)

Due to the recent financial restatement issues that bogged the company down this year, we believe the size of the PureCane opportunity is being severely discounted by investors currently. Our confidence in the product is elevated by the fact that more than 100 brands have begun formulary work using AMRS’s sweetener. Generally, progress has been good with this sweetener opportunity despite a small production stumble that delayed first sales by about a month at the beginning of the year. However, AMRS is now a full year ahead of its technology roadmap for PureCane fermentation.

On the last conference call, John Melo stated:

we are on track to be the lowest cost producer of the world’s leading natural zero calorie sweetener. This is similar to what we’ve achieved across the rest of our ingredient portfolio. In less than a year, we have over 100 food and beverage companies actively formulating their products using Purecane inside. Companies in every category are looking to convert to our sweetener beverage, baking, dairy, confectionery and nutrition products. We are selling our full 2019 production and have started taking orders for our 2020 capacity. We have a blockbuster ingredient for sugar reduction. The world is demanding and we are ramping up production quickly.”

AMRS breaks their sweetener opportunity into five segments: 1) Innovators 2) Small & Mid-size enterprises 3) Formulators 4) Global Brands 5) Consumer – PureCane. Below are short descriptions of each segment.

Innovators: AMRS considers innovators to be small local companies that can reformulate products quickly. John Melo mentioned at the recent B. Riley conference that “every innovator that has tried the product has adopted it.” Typically, innovators provide the fastest time to revenue and on average convert their formulas within 90 days.

Small & mid-size enterprises: Small & mid-size enterprises are typically more regional type businesses that require more volume. This group of customers are also reformulating products quickly but typically take up to 6 months to translate to revenue. AMRS is converting the majority of these customers currently and expects them to be the biggest revenue driver over the next 6-9 months for the sweetener business.

Formulators: AMRS has a long history of working with the leading global formulators such as Givaudan. AMRS now has excellent success in this market with its sweetener product. The company expects formulators to become a large contributor of revenue for this business over time, but not as the early driver of the product. The company expects to add another 2-3 large global formulators in this business soon.

Global brands: Global brands take the longest to convert into revenue but they also require the highest volumes. On average, it takes one of the global brands about 18 months from formulary acceptance to revenue. At the B. Riley conference in August 2019, John Melo made this comment:

“Currently, one of the three leading beverage companies (Pepsi, Coke, Dr. Pepper/Keurig) has already approved a reformulation with AMRS’s new sweetener.”

This implies AMRS will be supplying a major beverage customer by 1H21 at the latest. AMRS quoted the beverage company executives saying AMRS’s sweetener is the “best tasting sweetener they have ever tasted.” By our calculations, the first major beverage customer isn’t likely until 1H21. However, AMRS management expects this segment to be the largest volume source of sweetener sales by YE 2020. The 6-month difference could be because they are planning to build inventory for a large global beverage launch in 1H21.

Consumer: PureCane is the brand name of the company’s direct to consumer tabletop and cooking ingredient sweetener. PureCane is already on sale in Brazil and has received glowing reviews from customers. AMRS is expected to launch PureCane in the US by YE 2019 and China shortly thereafter. As mentioned above, the company’s fermentation technology is at least one year ahead of schedule which is creating the happy problem of needing to debottleneck the downstream purification process faster to increase total capacity in the near term.

Over the next 18-24 months, AMRS expects to become the market-leading supplier of zero-calorie natural sweetener in the US and Latin America. Management expects to become the market leader in the Brazilian stevia market in 2020 which is growing at 40% per year. Additionally, at the recent Jefferies conference, Mr. Melo stated that US consumers will be able to purchase PureCane online by the end of the year. Given the recent launch of another AMRS product, Pipette, on Amazon.com, we think John may be foreshadowing a PureCane launch with Amazon by year end.

Clean Beauty: Biossance & Pipette – Watch out J & J

Biossance

AMRS’s wholly-owned skin care brand, Biossance, is the largest revenue generator for the company currently. AMRS owns the formulations of the product line and believes the key differentiator of Biossance is the amount of squalane used compared to the other brands AMRS sells to. Squalane is the “secret ingredient” of the beauty world because it is naturally produced by the human body. AMRS’s sugarcane-derived squalane mimics the body’s naturally produced squalane helping skin to maintain its moisture.

According to Mr. Melo at the Jefferies Global Industrials Conference:

Squalene as an emollient, is the world’s leading moisturizer and the world’s leading carrier of active ingredient to penetrate the skin deeper and faster than any other carrier used for actives.”

Squalane was originally found in sharks which is how it was gathered until people began using olives to derive the product. As is generally the case for AMRS’s products, its squalane is lowest cost, highest purity and cruelty-free compared to other traditional sources of squalane.

AMRS sells its squalene ingredient to 3,500+ beauty and skin care brands around the world through the Neossance brand. Management’s strategy is to disrupt markets using science, then make the molecules available to the industry to drive cash flow which they then re-invest to launch their own brands. Neossance and Biossance are the best examples of a company executing on this plan to date. AMRS appears to be replicating this strategy with the recent launch of PureCane which we discussed above as well as Pipette which we introduce shortly.

Biossance is currently in 247 of the 450+ Sephora stores in the Americas, but only 219 have the full product line. The brand is currently sold exclusively through Sephora and DTC on AMRS’s website, biossance.com. We anticipate Biossance will continue its strong growth as Sephora increases doors over the remaining exclusivity period. We also expect to see AMRS drive sales growth through its DTC website as a result of greater brand awareness and increased demand for clean beauty products in general.

At the B. Riley conference on October 03, 2019, John Melo shared remarkable stats on the Biossance brand within Sephora. Biossance posted impressive same-store comp growth of 103% YoY on a same door same SKU basis. Biossance’s revenue base is expected to be ~$60M this year and management expects similar growth next year. Meaning these impressive growth numbers are becoming a significant driver of the company’s financials. Additionally, Mr. Melo mentioned that he expects Biossance’s strong growth to continue for several years beyond next year based on what is in the pipeline today. Mr. Melo also noted that the top brands at Sephora do $100M+/year just in North America and he expects Biossance to achieve this level of sales within the Sephora footprint.

(Source: B. Riley Conference Oct 3, 2019)

Using the data above, we estimated the future revenue contribution of Biossance’s current and expected new online customers. Our assumptions are based on an average lifetime customer value of $1000, an average customer lifetime of 3.5 years and then we discounted the brand’s recent 29% per quarter CAGR by instead using a 10% and 15% CAGR respectively. Additionally, we assumed the new customers per quarter CAGR would remain constant through the time period as would total lifetime value. Using these inputs, the future revenue stream of Biossance’s current customers is shown in the table below.

(Source: Authors calculations)

The above tables show the explosive growth potential ahead for Biossance’s online business. Note that this doesn’t include Sephora sales and management is currently guiding for $60M+ in Biossance sales for 2019. This number is expected to roughly double again in 2020 and then continue this level of growth for the next several years based on what is currently in the pipeline.

Management’s expected growth rates are much faster than we assume above, but even with our conservative estimates, we show strong revenue growth potential for Biossance. If our estimates are accurate, AMRS could have a second $200-400M revenue-generating product over the next few years in addition to PureCane. These two brands alone could produce $600-800M in revenue in the intermediate term for AMRS compared to management’s guidance of $150M in sales for 2019.

Pipette

In September, AMRS launched a second clean brand for babies, called Pipette. According to the slide below, the global baby market is expected to reach over $100B by 2026 with masstige products growing at an impressive 17% CAGR. Acumen Research and Consulting estimates the baby cleaning products market to be a $5.3B business by 2026, growing at a 6.2% CAGR. Management notes that the majority of their Biossance customers are millennials looking for clean beauty products that are also good for them and the planet. There are roughly 75 million millennials, of which, 40 million have children. These families are also looking for clean products for their babies, especially in the wake of the product formulation and legal troubles Johnson & Johnson is having with its baby products.

AMRS’s management sees the Johnson & Johnson misstep as an opportunity to capitalize on a growing trend for their consumers who are now having children and demanding clean products for them. Pipette also uses squalane as the main ingredient in its products. At the most recent B. Riley conference, John Melo noted that Biossance’s average product has only $0.69 of squalane in it, but retails for ~$70. Given these numbers, you can imagine that Pipette has the potential to become another very profitable business for the company. The low COGS allows AMRS to price the product aggressively to gain market share. As a result, we believe Pipette is a formidable new entrant into the masstige baby care market.

Due to the Johnson & Johnson legal issues mentioned above, this is a great time for AMRS/Pipette to disrupt the 800 lbs. gorilla in the baby care market. Unlike in skin care, this market is dominated by Johnson & Johnson who as recently as 2013 had over 25% of the total baby care market. On the recent business update call, John Melo stated his belief that over the long-term Pipette could become the leader in the clean baby segment and that he expects the brand to achieve a much faster growth rate than Biossance.

Pipette’s first month numbers are better than Biossance when it was out during the first couple quarters.” John Melo – B. Riley Oct 03, 2019

(Source: B. Riley Conference Oct 3, 2019)

AMRS expects that the much broader distribution of Pipette versus Biossance will allow the product to ramp sales much quicker. As you can see in the image below, the product is available at Buybuy Baby, Amazon, The Dermstore, Walmart, 1800 Flowers, and Pipette.com. With an estimated baby cleaning market of over $5B, broad product distribution, and management’s goal of becoming a leader in the space, it likely won’t be long until Pipette becomes another significant revenue driver for AMRS.

(Source: B. Riley Conference Oct 3, 2019)

Finally, AMRS recently created a JV with Pipette brand partner, Rosie Huntington-Whiteley, called Rose Inc., to expand AMRS’s line of clean beauty products into colors. We believe this announcement marks the first step toward AMRS producing color cosmetics providing another large growth opportunity in the clean beauty market. According to the slide below, color cosmetics is an attractive ~$65B global market that the company is not yet participating in.

(Source: B. Riley Conference Oct 3, 2019)

Flavors & Fragrances

“Amyris, a publicly-traded company that grew out of my laboratory, is the world’s leading company for microbial terpene production,” according to Jay Keasling, a renowned researcher at UC Berkley.

Terpenes are natural products that are often very difficult to synthesize in the laboratory. They include, for example, many essential oils, steroids and clinically relevant substances such as the antimalarial drug artemisinin or the chemotherapy medication paclitaxel. And a whole bunch of candidate fuels. And much of what Evolva is up to with new compounds like nootkatone, and just about anything that has come out of the Amyris shop is grounded in terpene science. Amyris’ process makes farnesene at high yield. But generally, speaking, terpene production is a world of low-yields, and the process often requires numerous, not always selective synthesis steps, and the yields tend to be low.”

AMRS continues to see a strong demand for flavor and fragrance ingredients and after removing vitamin E royalty sales, expects to roughly double revenues from this segment in 2020. So far this year, the company has begun selling one new fragrance to Firmenich. On the first run, this new fragrance product exceeded their internal production targets by 80%, a strong start in this new market and an indication of the improved efficiency the company is seeing in new strain development. Additionally, on the last earnings call, Eduardo Alvarez stated:

“we remain on track to deliver our second new product of the year for Givaudan during the fourth quarter, which will be a leading natural flavor ingredient.”

The introduction of these two products meets AMRS’s goal of introducing 2-3 new products a year. On the last earnings call, management noted that the products in the F&F portfolio that have been for sale for more than a year continue to deliver growth rates of 50% or more. When the 2-3 product goal per year was initially stated, it was before the contemplation of CBD opportunities for the company, which we will discuss in the next section. As a result, we believe any CBD molecules launched would be in addition to the stated 2-3 molecules per year goal.

We have become the leading supplier of natural, sustainably sourced ingredients into the flavor and fragrances industry and are very pleased with the deeply strategic relationships we have with Firmenich and Givaudan, the two industry leaders and also our ongoing relationships with Takasago and IFF. Our strategy of partnering with industry leaders and delivering on their strategy to source natural and sustainable ingredients has resulted in us becoming the leading supplier of these ingredients in the world.” John Melo Q219 Earnings call.

In order to keep up with the strong demand growth, AMRS is experiencing across its portfolio of products, the company employs a third-party contract manufacturer in Spain. The company also broke ground during Q319 on a new specialty ingredients plant which they expect to be fully operational by the Q1 21. This is important because beyond 2020 AMRS’s supply capacity for its products becomes very tight so the addition of this plant will support the majority of the company’s growth plans through 2024.

Eduardo Alvarez commented that:

this facility will allow us to manufacture five products at once. This plant will be in Brazil, at the world’s second largest mill in Barra Bonita, which is a Raizen-owned property. This plant will be 100% owned by Amyris and has been designed to meet our future production growth and supports most of our revenue for the next three years.”

Given AMRS’s current financials, it is not in a position to finance a new plant without a partner. Originally this plant was intended to be funded by DSM but as a part of the renegotiated vitamin E deal, our understanding is DSM is no longer required to help fund this new capacity.

We think this fact puts an exclamation point on the company’s shift in strategy to move toward producing higher margin, branded products. The company is currently:

in discussions with a few of our flavor and fragrance partners that are interested in financing the plant, so they can ensure security of supply.” John Melo Q219 Earnings call.

LAVVAN and the CBD opportunity

AMRS is in an enviable position in CBD due to its long history and significant patent portfolio built around terpenes. “Terpenes and cannabinoids work together to develop a strain’s particular flavor and resulting high, a phenomenon known as the entourage effect.” AMRS’s proven ability to scale products and its strong patent portfolio around terpenes are significant competitive advantages over other players in the space. Competitor/customer Ginko Bioworks also signed a deal with Cronos Group in 2018 to produce cultured cannabis. We believe this partnership underscores the attractive benefits and interest in the market for producing biosynthetically derived cannabinoids.

(Source: Jefferies Industrials Conference)

Research done by Paradigm Capital and highlighted by AMRS at the HC Wainwright conference shows the three primary benefits of using biosynthesis to produce cannabinoids. These benefits are highlighted in the slide below and include more consistent production, lower capex, and lower COGS. We believe these factors will be very important in the large CBD market as many new entrants rush to fill demand. Therefore, being a low-cost producer will likely prove to be an important competitive advantage.

(Source: HC Wainwright Conference)

Using biosynthesis to produce these molecules allows AMRS to isolate some very difficult to produce cannabinoids that have many potential uses if they can be derived in large quantities. The inability to source these compounds effectively from naturally created biomass has limited the research conducted on these lesser-known cannabinoids. This is due to the difficulty of sourcing them and extremely high price points with some rare cannabinoids being worth more than $20,000/kg.

The market for CBD is large and growing rapidly with easing regulations allowing for legal sale in the US and globally. The slide below uses estimates from several different research organizations that AMRS grouped into one convenient graph. By 2025, Cowen and Company expects the US cannabinoids market to reach $16B and up to $66B globally, as seen in the second slide below.

(Source: HC Wainwright Conference)

(Source: B. Riley Conference Oct 3, 2019)

AMRS entered the CBD space through a development agreement with a newly formed company called LAVVAN. The two companies signed an R&D agreement with up to $300M in milestone payments plus a significant back end royalty rate which has not been publicly disclosed, but management has indicated will be a significant long term revenue stream for the company upon commercialization.

In an attempt to triangulate AMRS’s potential royalty rate on CBD sales, we turned to the healthcare biotechnology industry which is a good proxy as it often also uses similarly structured development deals consisting of up-front R&D milestones plus royalties on future sales. Since the exact details of the LAVVAN/AMRS agreement are unknown, this method should provide a good approximation of the appropriate royalty rate range for this deal. According to the LESI Global Life Sciences Royalty Rate and Deal Terms Survey from 2016, “the median fixed royalty rate for the earliest stage products was approximately 4%, increasing to 12.5 % post Proof of Concept.” Considering AMRS’s significant IP in the terpene space, the broad scope of the agreement, and proven ability to scale to commercial production, we believe AMRS should receive a royalty rate equivalent to a mid to high single digit percent of sales.

(Source: Authors Calculations)

The orange band highlighted in the table above is the revenue AMRS would receive given a 7-8% royalty rate on the CBD sales (represented in the top row) from the LAVVAN partnership. Given the global nature of the deal with LAVVAN, the size of the market, broad scope of the agreement, and the potential to be a low-cost leader this should allow annual sales to reach a billion dollars a year in the intermediate to long term.

At this level of sales, CBD royalties would become a $70-80m/year business for AMRS. Additionally, these are royalty payments, so we can assume they will come with very high margins for AMRS helping drive the overall profitability of the company going forward. AMRS is also able to use its CBD alongside/in its own brands providing a second CBD revenue stream for the company, similar to what they have done with Neossance/Biossance.

The agreement with LAVVAN covers the development of more than 20 cannabinoids. At the recent Jefferies industrial conference, John Melo announced they plan to commercialize their first product, CBDa, in the 1H 2020, pending regulatory clarity. Building on their successes in squalane, management plans to position itself as the leading supplier of high purity CBD to global brands as they have done with other molecules like Neossance. Additionally, the company aims to become the leader in OTC pain, anxiety, and sleep disorders as well as integrating the product into their clean beauty line.

According to John Melo on the conference call announcing the LAVVAN partnership:

The overall structure is for exclusivity. There are some triggers or performance criteria that are required to maintain exclusivity. As you can imagine, one of our lessons has been that we need a partner that performs to maintain exclusivity and when that happens, life is good. So, there are performance criteria and triggers for the exclusivity to be maintained between the two parties.”

A few final comments on the LAVVAN partnership – Due to the fact LAVVAN was created solely to be a leader in the CBD market and hadn’t existed long before it entered a partnership with AMRS, many investors have been skeptical of this agreement especially whether or not LAVVAN will be able to pay the significant milestones and royalties promised. Some of this concern was alleviated when LAVVAN appointed former MedRelief CEO, Niel Closner, as its new CEO on August 8th providing a well-respected leader in the cannabinoid space.

At their recent business update call and again at the B. Riley conference, AMRS management stated they are currently ahead of their development plan and now expect to commercialize two cannabinoids in 2020, up from one previously. This is a big announcement. Mr. Melo dropped several tidbits about this second cannabinoid to include that the molecule is rarely available but when it is, it is VERY expensive. Similar to the Reb-M vs. Reb-A market, he believes there is a major opportunity for cannabinoid 2 to displace CBD once it becomes more widely available via AMRS fermentation process.

As of today, the company is making both CBDa and cannabinoid 2 in the lab but noted they are almost 80% done development of cannabinoid 2 which is well ahead of the development of the CBDa molecule. This is an interesting tidbit of information that may provide an important clue as to the identity of cannabinoid 2. While some have speculated cannabinoid 2 is THC, we don’t believe this fits with the commentary made by the company so far. In our opinion, cannabinoid 2 is much more likely to be CBG or Cannabigerol.

Due to the rarity of CBG and its high cost, many people have not heard of it nor has there been much research on the molecule. However, it is believed that CBG “can support the brain, reduce inflammation and stimulate the appetite. CBG is also considered to kill or slow bacterial growth, reduce inflammation, inhibit cell growth in tumor/cancer cells, and promote bone growth and repair.”

Despite the demand and medical potential of CBG, there are only a handful of manufacturers who currently make the product and production costs remain quite high.

CBG is notoriously expensive to produce, so much so it’s been dubbed the ‘the Rolls Royce of cannabinoids.’ It takes thousands of pounds of biomass to create small amounts of CBG isolate. That’s because most hemp only contains minute percentages of CBG, whereas there are now hemp strains that contain 20% CBD in the crop. If the CBG content of the same crop is only 1%, that means you need to extract 20 times the amount of biomass to get the same amount of CBG out…” – James Rowland, CEO of Steve’s Goods.

Why do we think cannabinoid 2 is CBG? First, CBG is a rarely available cannabinoid that is very expensive which fits with the commentary made by John Melo at the B. Riley conference. Additionally, “CBG is the precursor from which all other cannabinoids are synthesized, which is why it’s often referred to as the “mother” or “stem cell” of cannabinoids.” We believe this description of CBG helps inform why, despite not expecting to commercialize CBG in 2020, its development is almost complete whereas the first cannabinoid planned for commercial development, CBDa, is still in an earlier stage of development, per John Melo at the B. Riley conference.

Furthermore, we listened to AMRS’s 2019 Biodisrupt presentation and wanted to specifically highlight the slide below on cannabinoids. Recall that this event was about AMRS R&D pipeline and that the deal signed with LAVVAN is for 20 or more cannabinoids molecules. The slide below contains 23 cannabinoid molecules that AMRS believes it can produce. The red circle (added by us) on the slide below is CBG. Given CBG’s position as the “mother” of the rest of the cannabinoid family, it is reasonable to conclude it would be among the first synthesized. The four other main rare and high value cannabinoids also show up on the list below – further highlighting the value of AMRS’s biosynthetic approach to producing these molecules.

(Source: AMRS BioDisrupt 2019)

We believe AMRS’s history in terpenes, its impressive patent portfolio, its proven ability to scale commercial production, and its ability to produce rare and expensive cannabinoids in a cost-effective manner are the key reasons LAVVAN chose to partner with AMRS versus any of their competitors.

A final thought on AMRS’s CBD opportunity – We think this is a great example of the company pivoting to higher value end markets which should improve asset efficiency, margins, and sales going forward. Also, AMRS retained rights to use its sugarcane derived cannabinoids to use with its own products. The company sees considerable branded opportunities for CBD in skincare applications as well as an add on with its PureCane sweetener product.

This cross-selling opportunity further underscores the strategic shift the company is embarking on to build a stronger higher margin, recurring revenue business. Additionally, instead of hiring new researchers for the CBD opportunity, AMRS pivoted the existing research headcount from other non-core projects onto this project allowing the company to undertake this large opportunity without additional operating costs.

Why do we like AMRS now?

We at 1035 Capital have followed AMRS for several years and always liked the technology but were unsure of its business model. While the model has not been fully de-risked, we do like the company’s recent strategic shift away from lower margin commodity markets toward higher revenue, higher margin products which in turn should improve asset efficiency. For example, Biossance is now a meaningful recurring revenue product for the company and has proven AMRS’s ability to commercially scale products. With management expecting two positive EBITDA Q’s in 2019 and EBITDA profitable for all of 2020, we believe this is a new era for AMRS shareholders. Thus, putting 1035 Capital in the familiar position of front running the black box, this time with AMRS.

We also like the recent changes in partnership deals and royalty agreements with DSM which remove the company from lower margin business freeing up capacity and research man-hours for higher margin, larger opportunities like CBD while meaningfully lowering the company’s quarterly cash burn rate.

The combination of the restructuring of these collaboration agreements with our long-term partners, reduction in one-time expenses that are connected to our financings and our accounting issues and the actions Eduardo and his team have taken to reduce our cost of goods is resulting in a total of over $40 million reduction to our cash burn, an improvement to our EBITDA at our current annual revenue level. In summary, this is $20 million annually in reduced cash burn from the restructuring of the HMO and Vitamin agreements, $12 million annually from the elimination of costs related to our one-time accounting and financing activity during 2019 and a $10 million improvement in cost of goods from the restructuring of our supply agreements with our Spanish facility and the DSM supply agreement for farnesene from the Brotas facility.” John Melo Q219 earnings call

Graham Tanaka, of Tanaka Capital Management, often asks great questions on the AMRS conference calls, but on the most recent call, we found the following line of questioning to be particularly astute. Below, we have excerpted a back and forth discussing the improved capital efficiency of the new portfolio:

Graham Tanaka – Q – “I do think it’s a great opportunity to talk about — mainly a little bit about capital efficiency and what kind of revenues you can generate for, say, for $50 million of capex or $60 million of capex. My understanding is you would go to the higher value, higher price per pound or per kilogram value products and I’m just wanting if that means your capex needs would be lower per dollar of sales. Thanks.”

John Melo – A – Yes, I mean, that’s all connected to the gross margin, and I can tell you that based on the mix we have right now and our current cost of goods for the products in the portfolio, the return on that $70 million investment is about 12 to 18 months. And that’s again, really simple. The way we look at it is dollars generated per kilo of production and then the revenue — the annual revenue from that plant and this is product revenue, not collaboration, a single plant, $70 million investment has capacity to generate about $300 million of product revenue. So, I think those are the two, key metrics. What’s the cash you generate? It’s about a 12 to 18-month return. And then, what is the revenue you generate? And revenue is about $300 million annual, if the plant is fully sold out.

Graham Tanaka – Q – Just the big picture, what was the comparison versus the vitamin business and some of the more [commodity] type business. What would that ratio have been?

John Melo – A – That’s a great question. It’s about a five to six-year payback, which is pretty much what a typical chemical plant is, right. So, call it five to six-year payback and revenue. If you think about revenue $10 million — about $20 million to $30 million, call it $30 million on the high-end annual revenue off of that same investment, right. $70 million of investment. Again, about $30 million could be higher if you include value share in that, it could be as high as $40 million annually and again, about a five to six-year payback on the plant.”

In our opinion, there is currently a misplaced fear of bankruptcy and this is likely the primary reason AMRS is priced so cheaply today despite the very large opportunities ahead. While the risk is real, we find it comforting that AMRS has very well-healed insiders that have been willing to support the company through its accounting struggles and the large debt wall it faced earlier this year. Yes, these insiders were rewarded handsomely for doing so, but we think it is a strong indicator that if they didn’t let the company go bankrupt then, they aren’t likely to now. Additionally, we see John Doerr’s involvement and significant holdings as a strong vote of confidence for the company’s science and technology despite a less than ideal current financial situation.

Valuation

(Note: AMRS debt in the table above is adjusted for the expected debt extinguishment of $34.5M upon regaining compliance)

(Share price – without any share dilution)

(Share price – with 22M shares dilution)

(Share price – with 47M shares dilution)

(Share price – with 73M shares dilution)

(Share price – with 97M shares dilution) (Source: Authors Calculations, Estimates from Koyfin.com, Actuals from Seeking Alpha)

The tables above compare AMRS to its closest public peers. The tables in the middle are target prices given various P/S and EV/S multiples as well as a range of shares outstanding. The chart below compares AMRS to their closest private peers. Since AMRS first presented the table below on October 3rd, its market cap has fallen by roughly 25% further exacerbating the valuation comparison. As you can see, relative to both public and private peers, AMRS is quite cheap. Historically, this discount has been disserved due to a need to restate financials, poor contracts, an unproven business plan, delisting issues, a large debt wall that needed to be refinanced as well as the real risk of bankruptcy.

Today, many of the most troublesome issues for the company are in the rearview mirror. As a result of restating their filings, selling their vitamin E royalty business, and getting current with listing standards on October 7th, the company has removed three significant overhangs on its share price. The remaining issue is the technical default on their CVI loan which management has stated publicly they expect to resolve before year-end through the support of significant inside parties, likely John Doerr.

(Source: B. Riley Conference Oct 3, 2019)

We believe the market will begin to reprice AMRS stock toward its peer valuations due to the increased visibility and reduced risk that comes with regular filings. AMRS is not a clean and risk-free story, but we do believe the worst is behind the company and it is very attractively valued today. As a result, we think shares will begin to reprice upward as visibility improves.

Looking at the peer comparisons above, the reevaluation opportunity in AMRS is significant. AMRS is currently trading at 1.45x 2020 sales versus competitors trading near 8.5-9.5x times 2020 sales. This is a significant 7-8 turn discount to peers based on 2020 P/S. Due to AMRS’s debt and cash issues, we encourage also looking at EV/S but even here, AMRS still trades at a ~6-turn discount to peers based on 2020 EV/S.

To balance the two primary competing narratives of AMRS’s growth and near-term cash/debt funding requirements (which we believe will be fulfilled through warrant conversions and growing EBITDA), we apply a reasonable 4-6x sales multiple range pending additional clarity on its path forward. This range is still well below competitors who typically trade in the 8+ range.

Using a conservative EV/S multiple of 5x 2020 sales, we arrive at a YE 2020 price target for AMRS of ~$9 assuming 125M shares outstanding. The same methodology on 2021 sales implies a YE 2021 target price ~$15 on the same 125M shares outstanding which highlights the significant growth the company is experiencing.

Our share count is informed by the footnotes in the slide below expecting ~20M warrants to convert to shares removing 64M of debt outstanding. Finally, we point out that even assuming every warrant outstanding converts, our price target would still be in the $5-6 range based on 2020 sales.

(Source: B. Riley Conference Oct 3, 2019)

In the chart below, we provide a summary of our estimate of the revenue contributors by product line for AMRS going forward. The comment boxes provide context for the basis of our assumptions which primarily come from various company conferences. As it shows, there are significant growth drivers that lay ahead for AMRS. We erred on the side of caution by using low end estimates for most assumptions except the 2020 CBD milestone which we expected AMRS would receive the midpoint of the guided $50-100M.

(Source: Company Calls, Conferences and author calculations, Food Navigator article)

Risks

  • Inability to refinance CVI loan could lead to a forced bankruptcy
  • Loss of John Doerr as a supportive insider
  • Competition erodes profit margins
  • New technologies displace AMRS fermentation technology
  • Failure to scale technology to meet anticipated cost curves
  • Failure to commercialize new molecules
  • Failure to enter new partnerships
  • Failure to appropriately manage its brands
  • Failure to achieve CBD/other collaboration milestones
  • In some cases, AMRS’s brands compete with its customers who use AMRS ingredients in their products which could lead to loss of sales for either branded products or ingredients

Conclusion

AMRS is not a stock for widows and orphans. It remains in a somewhat precarious position until the CVI loan default is resolved which should happen soon. Looking forward, the company finally seems to have the right strategy and products in place to put this chapter behind them for good. Again, we acknowledge AMRS is not yet out of the woods, but the company also has significant growth opportunities ahead that demand investor consideration. Additionally, AMRS is positioned exceptionally well to participate in numerous megatrends including an increasing focus on health and wellness, clean beauty, and legalization of cannabinoids.

We understand why AMRS is priced the way it is today, but the turnaround of the company appears to have begun and soon it should become an exciting growth stock sporting much higher multiples. This is an ideal opportunity for our investment style. We aim to understand what our investments will look like in 9-24 months rather than focusing on how they looked in the past (to learn more about our investment philosophy check out our recent interview with Seeking Alpha here).

Evidence of the turnaround at AMRS can be seen in the monetized DSM vitamin E royalty, the increased focus on brands, and significant operating cost reductions. In the next two years, we expect the company to have a much stronger balance sheet, higher margins, sales, increased product diversification, and increased asset efficiency. We believe investors will be rewarded by both multiple expansion and positive estimate revisions.

Getting the company up to date with filings on October 7th was the first step toward regaining investor confidence although it was somewhat tarnished by being a week behind management’s goal of September 30th. However, it is much more important than it was done correctly, rather than on time and incorrectly, so hopefully, that was their reason. Resolving the CVI loan in a timely manner is the next critical step for AMRS’s management to regain investor goodwill.

Positive sentiment is important if investors are to give credit for the large growth opportunities ahead via multiple expansion. As shown above, for the first time in quite a while, sell side estimates have been reset to a level that should be quite achievable for AMRS going forward allowing for potential beat and raise quarters ahead, further supporting confidence in the new direction of the company.

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Disclosure: I am/we are long AMRS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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