Published April 08, 2015

The Biggest Mistake Tech Investors Make

Arguably the biggest and most often committed mistake we tech investors make is to get so caught up in the promise of a company’s technology that we become blinded to problems with the business model underneath… problems that eventually drive the stock price much lower and take our investment dollars with it.

Today, investors in Amyris, Inc. (AMRS) appear to be getting bit by this very bug.

It’s happened to all of us at one time or another. Whether it’s a sales growth projection that we should know is essentially unattainable, expenses spiraling out of control, too much debt, regular management snafus… all of these issues can be swept under the rug by an investor who has become too enamored with a technology, or explained away by “growth stage economics.”

And that seems to be the case with Amyris, whose technology is easy to fall in love with. The company has developed a “synthetic biology platform to design microbes, primarily yeast, and use them as living factories in established fermentation processes to convert plant-sourced sugars into renewable hydrocarbons.”

Yep, “living factories.” Cool, huh?

Synthetic biology is an extremely attractive field, because in the long run, the applications are practically limitless. This emerging science grew out of the old human desire to manipulate living systems and make them do useful things for us, and involves redesigning organisms for new purposes and creating entirely new living things. New diagnostics, new therapeutics, new sustainable ways of energy production, and pretty much any other biomolecular or chemical manufacturing.

That’s a big list. Bigger than, say, 3D printing.

Currently Amyris is focused on industrializing the process and developing renewable oils and other chemicals for several big markets: cosmetics, performance materials, lubricants, and transportation fuels. There’s a few trillion dollars locked up in those markets. So, the company’s long-term prospects are compelling. But there are some serious problems with the business today that could keep it from ever making it in the long term.

Amyris started out making ethanol. But in 2012, they took an about-face and transitioned out of that business almost entirely. Instead, they began targeting higher-margin, lower-volume markets like cosmetics, flavors, and fragrances. It was a smart strategic shift to start moving away from the ruthlessly competitive commodity fuel space, but revenue has suffered, declining significantly in 2012 and 2013 and remaining essentially flat in 2014.

Total Revenue ($ Millions)
2010
2011
2012
2013
2014
80.311
146.991
73.694
41.119
43.274
Growth
83.0%
-49.9%
-44.2%
5.2%

Behind those numbers is an even different story. Back in the ethanol days, the company also made a lot of money from government grants and collaborations with big oil. That’s really fallen off lately, and the flat revenue for last year actually includes a 48% increase in real product sales.

Certainly, product sales that might recur year after year are better than one-time grants, right? And the cost of those sales was down from 2013 too.

Unfortunately, the product gross margin was still deep in negative territory. In other words, it costs the company far more to make its products than it can sell them for. Or at least it still did this past year.

$ Millions 2010 2011 2012 2013 2014
Product Sales $68.664 $129.837 $49.638 $15.808 $23.439
COGS $70.515 $155.615 $77.314 $38.253 $33.202
Gross Profit ($1.851) ($25.778) ($27.676) ($22.445) ($9.763)
COGS % Product Rev 102.7% 119.9% 155.8% 242.0% 141.7%
Product Gross Margin -2.70% -19.85% -55.76% -141.99% -41.65%

How’s the old joke go? “We lose $100 a unit, but we’ll make it up on volume!”

Nor are production costs the only issue. Operating expenses are absolutely out of control.

Research and development (R&D) expenses and selling, general, and administrative (SG&A) expenses were both down slightly in 2014. But they still totaled $105 million—nearly 2.5 times total revenue.

Assuming the company didn’t have to spend a single dime more on materials and labor than it does today, Amyris would have to grow its revenue by about 230% just to break even on an operations basis.

$ Millions 2010 2011 2012 2013 2014
Total Revenue $80.311 $146.991 $73.694 $41.119 $43.274
Cost of product sales $70.515 $155.615 $77.314 $38.253 $33.202
R&D $55.249 $87.317 $73.630 $56.065 $49.661
SG&A $40.393 $83.231 $78.718 $57.051 $55.435
Other Op. Exp.* $0.000 $0.000 $45.854 $9.366 $4.804
Total Op. Exp. $166.157 $326.163 $275.516 $160.735 $143.102
Loss from Operations ($85.846) ($179.172) ($201.822) ($119.616) ($99.828)
SG&A+R&D % Rev 119.1% 116.0% 206.7% 275.1% 242.9%
Total Op. Exp. % Rev 206.9% 221.9% 373.9% 390.9% 330.7%
*Loss on purchase commitments, write off of production assets, and impairment of intangibles

In reality, getting to profitability is probably much further down the road. As sales grow, so will the cost of product sales, albeit hopefully more slowly. Even if they get those gross margins up to 30%, they’d still need to grow product revenues by more than 700% to break even on an operating basis.

All this ignores interest expenses, which have climbed to more than 66% of revenue as the company has added about $150 million in debt over the past year and a half.

$ Millions 2010 2011 2012 2013 2014
Total Revenue $80.311 $146.991 $73.694 $41.119 $43.274
Interest Expense $1.443 $1.543 $4.926 $9.107 $28.677
Int. Exp. % Rev. 1.8% 1.0% 6.7% 22.1% 66.3%

Now, technically Amyris reported a profit for 2014 of $2.2 million… but that’s just because of a non-cash paper gain from a change in the fair value of derivatives of $133.6 million. If we take out that accounting adjustment, the net loss for 2014 would have been about ($131 million).

What’s more, the company has just $43.4 million in cash left, which is not enough even to cover the $45 million in principal and interest it has to pay over the next year.

This means more debt and more shareholder dilution coming in 2015.

We got the first glimpse of that dilution a few weeks ago with the announcement that the company has entered into a purchase agreement to sell up to $50 million of common stock (at a 3%-6% discount to the market price) to an entity called Nomis Bay Ltd. At the current stock price of $2.30, using the midpoint of the discount that Amyris is offering to Nomis Bay, $50 million would translate to about 23 million shares, increasing the total basic share count by about 29%.

But that’s not the whole story. On the most recent conference call, held February 24, CFO Raffi Asadorian said:

Our debt at year-end was $232.5 million, net a discount of $80.2 million. As we previously noted, while the debt levels may be higher, the nature and quality of our debt should be considered. About 75% of the debt is in the form of convertible notes issued to our leading shareholders such as TOTAL, Temasek, and Fidelity, with another large piece consisting of loans from development banks in Brazil. All the holders of our debt are aligned with the success of the company.

First of all, you’re darn right the debt levels are higher. As noted above, interest alone is now eating up more than 66% of the company’s revenue, and 2015’s payments will consume all of the current cash reserves. But Asadorian does have a point. A lot of that interest would go away if those notes are converted to common stock. It’s better than going bankrupt, but it’s going to cause massive dilution for common stockholders.

For example, if just the $75 million in convertible notes issued in May 2014 were converted to common stock at today’s prices, it would increase the basic share count by more than 20 million—another 20% dilution. While the current basic share count is about 79 million shares, the fully diluted share count with the convertibles is around 147 million.

Now, throw in the 23 million shares that will be issued to Nomis Bay this year because the company won’t be able to afford not to tap that source of equity financing, the total diluted share count would be about 170 million.

In other words, if all those convertible notes were converted to common stock and Amyris issues the $50 million in stock to Nomis Bay, it would dilute the average shareholder by more than 50%. And remember there’s likely more debt and more equity that will be issued this year and beyond.

Not a great proposition for your average retail investor.

There is one thing that could fix a lot of the company’s problems (aside from the dilution)—growing revenue, fast.

So, you might be encouraged to hear that management is currently guiding for 2015 revenue between $100 million and $110 million, a 143% growth from 2014 at the midpoint.

The problem is management has promised that before. It guided for 2014 revenue between $100 million and $115 million, a growth of 161%. But actual growth was a mere 5%.

It’s hard to believe management’s projections given how badly they missed last year. What’s more, the company has missed revenue estimates in each of the last eight quarters according to Thomson Reuters’s Eikon.

Is it possible for Amyris to actually hit 2015 projections and turn things around going forward? Sure, anything is possible. In the long run, AMRS could turn out to be a great investment opportunity. But there are a lot of red flags here.

If you’re looking at the stock today, don’t fall prey to the tech investor’s classic mistake: being blinded to problems with the business because the technology sounds so compelling.