REG files for $100M IPO: The Complete Digest Analysis

July 19, 2011 |

REG becomes the 9th industrial biotech player to file an IPO in the 2010-11 greentech bull market.

Will it fly? Should it? The risks, the rewards, the rationale.

In Iowa, Renewable Energy Group filed for a $100 million IPO, becoming the 9th elite integrated biorefining company to file an S-1 in the past 18 months. The REG filing follows the successful IPOs by  Codexis, Amyris, Gevo, Solazyme, and KiOR. Ceres, Myriant and PetroAlgae have not yet completed theirs.

A successful IPO would cap a remarkable comeback for biodiesel from the depths of “The Troubles” in 2008-09. It’s a second time through for REG: the company filed for a $150 million IPO in 2007, but withdrew the registration in early 2008 when markets soured.

REG background

From the S-1: “We are the largest producer of biodiesel in the United States. We have played a leading role in developing the United States biodiesel industry since our inception in 1996. In 2010, we sold nearly 68 million gallons of biodiesel, representing approximately 22% of United States biodiesel production. Our strategy is to optimize and grow our core biodiesel business, to diversify into renewable chemicals and additional advanced biofuels, and to expand internationally.

Consolidation leader. “We have led the consolidation of the United States biodiesel industry. We operate six biodiesel plants, with an aggregate nameplate production capacity of 212 million gallons per year, consisting of five wholly-owned facilities and one leased facility. We have acquired four of our six facilities since February 2010.”

Low-cost producer. “We are a low-cost biodiesel producer. We primarily produce our biodiesel from a wide variety of lower cost feedstocks, including inedible animal fat, used cooking oil and inedible corn oil. Our scale allows us to quickly transfer best practices at one of our facilities to the others to maximize production volumes and cost efficiencies.

Producer for a huge global market. “Biodiesel is a low carbon, advanced biofuel and drop-in replacement for petroleum-based distillate fuel, which, according to the United States Energy Information Administration, or EIA, was a 522 billion gallon per year global market in 2007.  In 2009, the United States market for distillate fuel was 52.7 billion gallons, according to the EIA.”

Growing market demand. “On July 1, 2010, RFS2 became effective, requiring that Obligated Parties use 800 million gallons of biomass-based diesel in 2011, and 1.0 billion gallons in 2012. Recently the EPA, proposed that 1.28 billion gallons be used in 2013. Biodiesel is currently the only commercially significant RFS2-compliant biomass-based diesel fuel produced in the United States. In the first five months of 2011, 297 million gallons of biodiesel were produced in the United States, while 311 million gallons were produced in all of 2010.”

Rising biodiesel demand, from the REG SEC filing

The rationale for the IPO.

We see this as another capitalization effort – in the same vein as Amyris, Solazyme etc – rather than as a straight liquidity event for early investors. REG will need working capital to increase production, and sales, and capture the RFS opportunity. Also, a public stock currency will come in handy in terms of using stock to make acquisitions, and further its consolidation strategy.

Strategy

Optimize. From the S-1: “We intend to enhance the capabilities and increase the production capacity of our existing plants by investing in high-value processing upgrades to further improve yields and optimize the range of usable lower cost feedstocks at our production facilities. We also plan to continue to consolidate the biodiesel industry and expand our existing biorefinery platform by continuing to strategically acquire biodiesel plants.”

Diversity. From the S-1: “Our track record of successfully commercializing new biorefinery technologies positions us well to diversify into the production of renewable chemicals and additional advanced biofuels, such as renewable diesel and jet fuel. We also plan to vertically integrate by producing next generation feedstocks, such as algae oil.”

Expand. From the S-1: “We intend to expand into select international markets, which may include Europe, South America and Asia, where we believe we can leverage our existing fully integrated biorefinery platform or leverage our existing strategic relationships with industry participants operating in such markets. In addition, we plan to acquire or invest in biodiesel, renewable chemicals or other advanced biofuel production and distribution assets targeting large end-user or large feedstock generating markets.”

Customers and partners

From the S-1: “We have established strategic relationships with other industry participants, particularly Bunge North America, Inc., or Bunge, ED&F Man Holdings Limited, or ED&F Man, and West Central Cooperative, or West Central, with whom we trade feedstock and biodiesel. These relationships enable us to more effectively address market opportunities and provide us with an advantage over our competitors that have not been able to establish such strategic relationships.

“For the year ended December 31, 2010, we had 217 customers, only one of which, Pilot Travel Centers LLC, or Pilot, accounted for 10% or more of our total revenues. Sales to Pilot during this period were $62.6 million, representing approximately 29% of biodiesel revenues and 29% of our total revenues for the year.”

Competition

Integrated agribusiness. “In the United States and Canadian biodiesel markets, we compete with…ADM, Cargill, [and] Louis Dreyfus…major international agribusiness corporations. These agribusiness competitors tend to make biodiesel from higher cost virgin vegetable oils such as soybean or canola oil, which they produce as part of their integrated agribusinesses.

Independents. We also face competition from independent biodiesel producers. Unlike us, most of these competitors own only one biodiesel plant and thus, do not enjoy the benefits of scale that we do.

Trader co-opetition. We face competition from biodiesel traders such as Mansfield, Astra, Gavilon, Tenaska and ED&F Man. These trading companies have far greater financial resources than we do and are able to take significant biodiesel positions in the marketplace. These competitors are often customers of ours as well.

Renewable diesel. In the RFS2,  we are in competition with producers of renewable diesel. Renewable diesel, like biodiesel, is a petroleum-based diesel substitute made from renewable feedstocks. As of January 2011, there was less than one hundred million gallons of renewable diesel production capacity in the US, and no operating facilities in Canada, but more facilities are planned.

Sugarcane ethanol. In the RFS2 advanced biofuel market, we also compete with other producers and importers of advanced biofuels such as Brazilian sugarcane ethanol producers.

Competitive advantage

From the S-1: “Lower cost feedstocks allow us to produce biodiesel at a cost of approximately $0.37 to $0.67 less per gallon than our competitors who use higher cost virgin vegetable oils. For 2010, approximately 91% of our total feedstock usage was lower cost inedible animal fat, used cooking oil or inedible corn oil feedstock and 9% was higher cost soybean oil.”

Scale-up to date

From the S-1: “Through our consolidation efforts, we have completed a total of nine acquisitions, including five biodiesel plants, with eight of the nine acquisitions closing since early 2010. Our current six operating biodiesel plants have a nameplate production capacity of 212 mmgy.”

As REG sees itself

Advanced biofuels at scale, today. From the S-1: “We believe the scale of our operations allows us to enjoy several advantages over many of our competitors. First, we offer lower cost feedstock producers consistent access to the renewable fuel industry on a scale that we believe our competitors generally cannot match. Second, our size allows us to provide our customers with larger volumes of biodiesel than our smaller competitors. Third, our larger size also generally allows us to reduce our overhead costs per gallon compared to our smaller competitors. Fourth, we are able to transfer best practices among our six operating facilities to maximize production volumes and reduce operating costs, in a manner that our competitors who do not operate multiple facilities cannot.”

Multi-feedstock. From the S-1: “We utilize our proprietary technology and knowhow to efficiently convert a wide variety of lower cost feedstocks into high quality biodiesel. We believe our ability to process lower cost feedstocks at scale enables us to be a low cost producer and provides a distinct advantage against many of our competitors. Several of our competitors’ facilities are only able to process higher cost virgin vegetable oil feedstocks. Our competitors that are able to process lower cost feedstocks generally operate at a smaller scale, making it more difficult for them to reliably procure and efficiently process lower cost feedstocks.”

The roll-up guys. “We have led the consolidation of the United States biodiesel industry, acquiring six biodiesel plants since our inception. We have developed an ability to target and acquire strategic assets and quickly add value to them through upgrades and integration onto our biorefinery platform. We believe our in-house expertise will allow us to continue to acquire and effectively integrate new production facilities as we grow and further consolidate the biodiesel industry.

Monsters of the Marketing Midway. “We are a leading marketer of biodiesel in the United States, marketing both biodiesel we produce as well as biodiesel produced by others. The scale of our operations, combined with our logistics capabilities, allows us to satisfy local and national customer needs in a manner that we believe most other biodiesel producers and marketers cannot match. In addition, the customer support provided by our large sales and technical teams provides us with further competitive advantages.

The RINs

(note to readers: Renewable Information Numbers – RINs, are the cap-and-trade compliance tool for the Renewable Fuels Standard. Obligated parties either have to acquire them with wet gallons of fuel as they blend, or buy them in the open market. Their price, plus the price of fossil fuels, determines the “effective price” of mandated biofuels in the US.)

From the S-1: “In July 2010 when RFS2 became effective, biomass-based diesel RINs began trading at approximately $0.55 per RIN. By the end of the year, the 2010 biomass-based diesel RIN value had increased to $0.74. As of June 16, 2011, biomass-based diesel RINs were $1.38 per RIN, contributing $2.07 per gallon to the price of biodiesel.

“The value of RINs has become increasingly significant to the price of biodiesel, contributing approximately $0.7904, or 25% of the average OPIS Chicago spot price of a gallon of biodiesel in July 2010 and $2.07, or 38% of the average OPIS Chicago spot price of a gallon of biodiesel in June 2011.”

RIN prices for 2010 and 2011, from the REG SEC filing

Spreads

From the S-1: “During 2010, 91% of our feedstocks were comprised of inedible animal fats, used cooking oil and inedible corn oil while in 2007 we used 100% refined vegetable oil. We have increased the use of these feedstocks because they are lower cost than refined vegetable oils.

“The average closing price for soybean oil during 2010 was $0.42 per pound, or $3.16 per gallon, in 2010, compared to $0.25 per pound, or $1.88 per gallon, in 2006. The average monthly spread [between oil and biodiesel prices] was $0.32 in Q1 2011

“Over the period from January 2008 to May 2011, the price of choice white grease, an inedible animal fat have ranged from $0.0950 per pound, or $0.76 per gallon, in December 2008 to $0.5175 per pound, or $4.14 per gallon, in March 2011. The average monthly spread [between white grease and biodiesel prices] was $1.02 in Q1 2011.”

Biodiesel prices and crush spreads 2009-2011, from the REG SEC filing. Note that SBO stands for soybean oil, and CWG stands for choice white grease

Rewind to 2007

From the 2007 S-1: “By the end of 2008, we expect to have approximately 492 mmgy of production capacity in our network.

“We operate in two principal segments, Biodiesel and Services. Through our Biodiesel operations, which represented approximately 58% of our revenues in 2006 or approximately 49% on a pro forma basis, we operate our wholly-owned biodiesel production facilities, currently consisting of our 12 mmgy capacity production facility in Ralston, Iowa, and we purchase and resell biodiesel produced by third parties.

“Through our Services operations, which represented approximately 42% of our revenues in 2006, or approximately 51% on a pro forma basis, we provide construction management services, whereby we act as general contractor for the construction of biodiesel production facilities, and facility management and operational services, whereby we provide day-to-day management and operational services to biodiesel production facilities that, together with our wholly-owned facility, form our network.”

Changes from 2007’s S-1 filing. Well, the company is overwhelmingly less dependent on construction, the distribution that comes from management contracts, and soybean oil. Diversification of feedstock has been matched by consolidation of ownership. But the experience of 2007-08 reminds us that the way forward for biodiesel is exceedingly hard to see, and rapid expansion is even tougher to survive than it is to accomplish.

The Risks: The Digest’s English Translation

From the S-1

Loss or reductions of governmental requirements for the use of biofuels could have a material adverse affect on our revenues and operating margins…Loss or reductions of tax incentives for biodiesel production or consumption would have a material adverse affect on our revenues and operating margins.
In English: Uncle Sam is our Daddy.

One customer accounted for a meaningful percentage [29%] of revenues and…Our business is primarily dependent upon one product.
In English: Uncle Pilot is our other Daddy.

We have limited working capital and a recent history of unprofitable operations; these working capital constraints may limit our growth and may cause us to curtail our operations or forgo sales.
In English: We would like to use your money to replace ours, which we lost.

Our gross margins are dependent on the spread between biodiesel prices and feedstock costs.
In English: It’s called a crush spread, which is to say, “if there’s no spread, you get crushed.”

The costs of raw materials that we use as feedstocks are volatile and our results of operations could fluctuate substantially as a result.
In English: Final score, sports fans, from the 2008-09 world biodiesel scale-up championship: Feedstocks 49, Processors 0.

If we fail to maintain effective internal control over financial reporting, we might not be able to report our financial results accurately or prevent fraud; in that case, our stockholders could lose confidence in our financial reporting, which would harm our business and could negatively impact the value of our stock.
In English: That’s spelled M-A-D-O-F-F.

In the event we enter into new construction contracts, we may be exposed to a variety of risks that could affect our ability to realize profit.
In English: If we build it, they may not come.

We intend to pursue strategic initiatives to diversify our business that will require significant funding and management attention and these initiatives may not be successful.
In English: Our Big Bang may be followed by a Big Crunch.

The European Commission has imposed anti-dumping and countervailing duties on biodiesel blends imported into Europe…We may face competition from imported biodiesel.
In English: As far as demand for US biodiesel goes, nothing in Brussels sprouts.

There is currently excess production capacity and low utilization in the biodiesel industry..…competition in our industry would increase if new participants enter the biodiesel business.
In English: Those stranded Mom and Pops are still out there.

Perception about “food vs. fuel” could impact public policy…Concerns regarding the environmental impact of biodiesel production could affect public policy..Nitrogen oxide emissions from biodiesel may harm its appeal as a renewable fuel.
In English: There are no “best friends forever” in the environmental movement.

Winner or loser? The Digest’s Take.

Winner, with two caveats. We admire REG – they have made the right strategic moves in terms of diversifying feedstock, and consolidation through ownership, since the downturn of 2008-09. Their management is as Kennedy said of the US in 1960, “tempered by war, disciplined by a hard and bitter peace.”

We would like to have seen one more strategic investor or shareholder rights offering, pre-IPO, to top off the working capital, which is low for a company of this size – and the company’s ability to take advantage of the huge increase in demand via RFS2 may well depend on this IPO capitalization effort.

Our two concerns?

One, that the rise in white grease prices indicates that the market is potentially going to suffer the same rapid price increase, and potential for upside-down economics, as happened during the biodiesel scale up of 2007-08.

(But then, REG says that their “feedstock base is actually much wider than just choice white great. We heavily using inedible corn oil, other animal fats (tallow) and used cooking oil as well. Just wanted to let you know that we are not affixed to choice white grease pricing only.”)

We note with some alarm the fast rise in “choice white grease” feedstock prices, from $0.09 per pound in 2008 to $0.51 per pound in 2011. REG has managed to maintain the spread between white grease and biodiesel, because the biodiesel price has shot up to $4.85 per gallon, and RIN prices of $2.00 per gallon support that spread between the price of diesel and biodiesel, in terms of maintaining demand from blenders. But there is unlikely to be much of a B100 biodiesel market, or demand for high blends such as B20 or B50, at these prices.

Two, that the company’s scale-up is entirely dependent on mandated blending under the RFS, and that reconstruction of that mandate may materially affect the financials.

REG has shown real leadership in pioneering the use of white grease – they may well have to demonstrate, in their investor presentations, their ability to source and process low-cost feedstocks such as yellow grease, brown grease, waste fish oils, and so on. That will assure investors of its ability to scale with the expansion of RFS2 mandates, and have a fallback in the B2/B5/B20/B100 markets based on enlightened fleet owners and state mandates, should the RFS be materially altered, or existing feedstock prices go crazy.

With those caveats, REG has demonstrated ability to scale, manage scale-up and maintain margins and market share in tough times. If any biodiesel producer is going to claim the lion’s share of rewards in the RFS2 era, this is the one. They have touted their ability to source and process the “tough feedstocks,” and the era for delivering on that promise and collecting the rewards therein is nigh.

Category: Fuels

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