Has Solazyme Clawed Its Way Back to Growth With This New Partnership?

Fracking wells dot the landscape. Image source: Simon Fraser University/Flickr.

Who knew partnering with a sub-$1 billion company on drilling-fluid additives could pack on an additional 25% to your market cap in one day?

That's exactly what happened with renewable-oils manufacturer Solazyme (TVIA) after it announced multiple strategic agreements with the $980 million dollar oilfield-technology specialist Flotek Industries (FTK 2.61%). The pair will develop, enhance, and commercialize a new portfolio of drilling-fluid additives, in addition to an agreement that will see Flotek help market and distribute Solazyme's existing Encapso drilling lubricants.

It's still incredibly early for the alliance, which makes it difficult to believe the announcement alone is worth more than 25% in share gains. But to be fair, investors have been waiting for Solazyme to regain momentum since it overhauled growth plans last November due to manufacturing delays at its largest facility in Moema, Brazil, and higher-than-expected production costs across the board. Is this how Solazyme begins clawing its way back to its previous growth potential?

Poking the bear
Solazyme's Encapso drilling lubricants launched in March 2014, as its first commercial-scale production facility in Clinton, Iowa began ramping operations. The product consists of a lubricant oil encapsulated within algal cells, which saves the company an additional processing step (the oil doesn't have to be extracted) and delivers lubricant to locations within a well bore hole that need it most (only locations with high levels of friction will be able to break the algal cells open).

Unfortunately, a collapse in global petroleum prices later in the year slashed a good chunk of potential demand in American energy basins. If you add that to fierce competition from established and fully integrated oilfield services companies such as Baker Hughes -- which offers a comparably effective vegetable-based product -- you wouldn't be criticized for being less optimistic about the opportunity for Encapso.

But maybe all of those market factors poked the bear.

In early November 2014, Solazyme announced a distribution and marketing partnership with Versalis, the chemical division of oil and gas leader Eni. That provided the company a bit more muscle when positioning Encapso in the marketplace by allowing it to leverage Eni's expertise, in addition to guaranteeing more than 3,000 metric tons of sales through the end of 2015.

Fast forward to this week, and Solazyme has allied itself with Flotek Industries to market and distribute Encapso in the energy-dense Middle East, again with guaranteed, albeit undisclosed, offtake volumes. Better yet, the pair will commercialize a new advanced-drilling fluid additive portfolio of products named Flocapso, which combines proprietary technology from each company, or more specifically, Encapso from Solazyme and Complex nano-Fluid, or CnF, chemistries from Flotek. That's important because it fully aligns the companies with the portfolio's success.

Yeah, but, who is Flotek?
While Flotek is no Eni, the company has achieved very impressive growth in the last few years. Take a look for yourself, with a special focus on the company's Energy Chemical Technologies, where Flocapso sales will likely be reported:

Source: SEC filings.

As you can see, Flotek is no chump. And it clearly has a knack for pursuing high-value opportunities. But what wasn't included in the press release announcing the alliance with Solazyme was exactly how the company has managed to grow sales so quickly. Sure, the American energy revolution and strategic acquisitions have gone a long way, but something else has catalyzed a quick ramp in CnF sales: modeling software.

Flotek recently launched FracMax software that models the performance of its products in fracking wells and the economic benefits they deliver, which was cited as a major reason for the 33% jump in Energy Chemical Technologies' revenue from 2013 to 2014. By comparison, the segment grew sales just 9% from 2012 to 2013. From the company's last annual SEC filing:

Patent-pending FracMax software statistically demonstrates the positive production and economic impact of using Flotek's CnF chemistries in unconventional well completions. [In 2014] the FracMax software has led to a record number of new validation projects and accelerated commercial acceptance of the Company's CnF completion chemistries.

Whether or not FracMax can be used to model the performance of Flocapso remains unknown at the moment; but if the modeling software can be applied to the new product -- and demonstrates a clear economic advantage to drilling companies -- then sales would certainly benefit. It will still take time to ramp sales -- they're starting from zero, after all -- so investors need to have realistic near-term expectations; but FracMax could be a big deal for Solazyme moving forward.

Reasons to exercise caution
Considering the lack of optimism recently, it's easy to see why Solazyme shares have erupted higher on the announcement alone; but it's important to remain realistic. Several things to consider:

• Flocapso is in the early stages of commercialization.
• The unfavorable market conditions -- falling American rig count, subdued petroleum prices, and the like -- that tanked the potential of Encapso in late 2014 persist today.
• Solazyme will need to share revenue and profits with Flotek. It may be more or less than 50%, but the company will exchange higher production volumes of Encapso, the ingredient it contributes to Flocapso, for lower value capture from sales. That will likely be beneficial for investors, although it's a simple reminder to be realistic.
• Encapso is produced in America and Brazil. A big part of the Flotek alliance revolves around marketing and distribution in the Middle East. How will transportation costs affect margins?
• The current production costs of Encapso remain unknown.
• Much of the share gain resulting from the announcement may be caused not by enthusiastic investors, but by day traders having a field day with "technicals" -- whatever those are -- and short-sellers covering their positions.

What does it mean for investors?
Overall, the alliance with Flotek is overwhelmingly positive for Solazyme. The company will be able to increase production volumes of Encapso, and more fully monetize its underutilized production capacity in Clinton and Moema, even if there's a long way to go to full utilization. Gaining the marketing and sales expertise and customer base of Flotek will be quite advantageous, too, not to mention the potential value-add from FracMax modeling software.

I would simply remind investors to exercise caution, and to keep realistic near-term expectations for the alliance's performance. After all, Solazyme still needs to demonstrate favorable production costs of its products. But this is one small step in the right direction -- and one that helps the company claw its way back to its previous growth potential.