Is Biofuel Headed Toward Consolidation?



Syntroleum Corp (NASDAQ:SYNM) made headlines on July 17 when its Board of Directors abruptly announced that it was evaluating strategic alternatives — Wall Street speak for potentially selling the company. Less than ten days later, a second press release indicated that it received unsolicited offers (with an “s”) from third parties with respect to a potential sale and confirmed the hiring of Piper Jaffray & Co. to evaluate these various offers.

While shares of the stock have been surprisingly muted amid the news, investors have begun to speculate about the sudden interest in biofuels. SeekingAlpha contributor Robert Wagner recently authored a piece speculating that big oil companies may be increasingly interested in acquiring biofuel companies like Syntroleum or Renewable Energy Group (NASDAQ:REGI) to essentially pay themselves the cost of RINs in order to minimize the impact of RFS2.

These sentiments were echoed in an earlier article by SeekingAlpha contributor Tristan Brown who notes that refiners have seen a drastic increase in the cost of compliance associated with RFS2 in 2013. Over the mid- to long-term, Mr. Brown believes RIN values will be driven largely by the ability to overcome the ethanol blend wall, which remains uncertain at this point. As a result, these refiners will need to take action to mitigate these compliance costs.

Mr. Brown points out a great example of the magnitude of these costs in his article:

Valero Energy Corporation (NYSE:VLO), for example, operates 10.4 percent of U.S. refining capacity … At current values, Valero would need to spend $1.5 billion out of an annual operating income of $4 billion to purchase sufficient RINs to satisfy its portion of the 2013 mandate. (In reality Valero operates 10 corn ethanol facilities with a combined annual capacity of 1,080 million gallons, allowing the company to meet the majority of its portion of the mandate via biofuel production rather than RIN purchases).

Finding Investment Opportunities

The biofuel space has always been a bit volatile for investors. Companies like Renewable Energy Group are trading up more than 160 percent so far this year, while others like Pacific Ethanol (NASDAQ:PEIX) are trading down more than 13 percent. But if big oil companies are seeking to reduce their exposure to RIN prices, many companies in the space could quickly become acquisition targets, particularly for large U.S. refineries that are experiencing the biggest hits.

Aside from Syntroleum’s existing M&A prospects, investors may want to take a look at undervalued opportunities in the space. Methes Energies International (NASDAQ:MEIL) is one example trading with a market capitalization of just over $13 million. With its Sombra facility coming online over the past couple quarters, management plans to up its biodiesel production to upwards of 39.6 mmgy over the comings years.

Basic arithmetic suggests that 39.6 million gallons per year at $1.40 per RIN would offset about $55.44 million per year in RIN exposure. While this is a small figure by many standards, the company’s highly scalable technology could be implemented in multiple facilities. After all, each of its Denami 3000 processors is capable of about 6.5 mmgy of biodiesel output, or about $9.1 million in offset RINs.

Finally, investors may have a built-in margin of safety when it comes to companies like these, as Methes’ projected revenues from this plant could come in at $50 million to $55 million, suggesting the stock is undervalued at its current levels. Interestingly, the company has also developed biodiesel production technology designed for small- to mid-sized producers and acts as a supplier to a network of these smaller operators around the world.

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