Clean technology stocks don’t exactly have a great reputation, and the Solyndra debacle certainly has not helped. The term “financial parasites” has been applied to companies in the space, many of which are pre-revenue (an exception is Solazyme (NASDAQ:SZYM)). What is exciting to investors and what these companies pitch is a technology with the potential to be industry-changing. Many people think they are betting on the idea itself, but really they are betting on the execution of that idea. A company that we have been following is Texas-based clean technology company, KiOR (NASDAQ: KIOR), that uses its propriety biomass fluid catalytic cracking technology to convert non-food biomass to renewable crude oil, which can then be converted into gasoline. The process uses non-food feedstock i.e., plant oils/sugars/grains and can use existing refineries and transportation infrastructure without any modifications. The company will initially use “woody biomass” aka wood chips as its input. Biomass fluid catalytic cracking is expected to be competitive on cost and with the Renewable Fuel Standard (RFS2) mandate of 36 billion gallons by 2022, pricing should hold up. KIOR has been successful in steadily improving yield over the last few years from 17 gallons per ton to 67 gallons per ton. Notably, it has the backing of large industrial companies like Chevron (NYSE: CVX) and Weyerhauser (NYSE: HYH), providing reassurance to some investors.
With development stage companies, we look for positive updates on its timeline for plant build-out, take-off agreements, and any potential delays or cost overruns. The company reported fourth quarter earnings on Tuesday and though it did not recognize any revenue, it reported significant progress on its first commercial facility (Columbus, Mississippi), which is approximately 75% complete. The Columbus facility is on schedule to begin production in the second half of this year with an annual production capacity of approximately 13 million gallons of biocrude. We cannot overemphasize how important a positive outcome at Columbus is. Investors will be scrutinizing the build-out and final product and will heavily impact KIOR’s future ability to raise additional capital and maintain its growth timelines. Though the capex estimate stayed at $222 million, we think this plant is susceptible to future cost overruns. The good news if true, is it that the facility is expected to be economically viable without government subsidies. Columbus also already has a supply for the woody biomass from Catchlight, the joint venture between CVX and HYH.
KIOR’s second plant and hydrotreater will be located in Natchez, Mississippi. We find KIOR’s estimate for construction to commence in the second half of 2014 to be aggressive in light of the permitting, financing, and construction that still needs to take place. Here again, we are concerned that the capex estimate of $460 million may not be enough, even given expected cost savings. Natchez has access to the river, which will made input and product shipments easy, and there is already a natural gas pipeline and electric power on site, making it a great location for a hydrotreater. There have also been indications of local government incentives.
Overall, we think that the company’s build-out timeline is pretty aggressive considering the requirements for land-use planning and permitting in addition to public opposition like the “Not In My Backyard” sentiment. KIOR projects that its first cluster of commercial plants will be up and running by the first half of 2015.The creation of jobs and infrastructure investment in rural areas of the county may facilitate acceptance—KIOR received a $74 million loan from the Mississippi Development Authority. We suspect KIOR may have to return to the equity markets in the next year to secure more capital for either cost overruns and/or expansion.
With these types of ventures, it is always important to honestly evaluate your own risk appetite. To date, KiOR has not commercialized its technology platform and is still constructing its first commercial-scale facility in Columbus. If KIOR is unable to successfully transition its technology while maintaining yields and keeping costs in line it could delay its time to market and damage investor confidence. And with only three announced off-take agreements, we think that this lack of signed contracts to match capacity expansion will impact KIOR’s ability to get financing for the next phase of its strategy. Another wrinkle to the story is that Vinod Khosla’s Khosla Ventures has significant control over shareholder decisions. Khosla was a pre-IPO investor and owns all of the Class B Common stock (The Class B Common stock shares voting rights with the Class A stock). Stuart Peterson’s Artis Capital is also a large shareholder with nearly 14% of the company. Adage Capital, Millennium Management, and Coghill Capital also had tiny positions in the stock at the end of December. Unfortunately, we don’t like speculating on this $1.4 billion company and our recommendation is “Avoid” at this moment. We would be more comfortable buying the stock once the Columbus plant comes on-line as scheduled and meets initial production projections. Moreover, the securing of additional feedstock agreements and off-take agreements will reassure the market about the company’s long-term viability.