Mascoma’s IPO: The 10-Minute version

Jim Lane

No appetite for 200 pages of IPO-speak in Mascoma’s S-1 registration statement? Here’s our 10-minute version.

In Massachusetts, Mascoma Corporation announced that it has filed an S-1 registration statement relating to a proposed $100 million initial public offering. The number of shares to be offered and the price range for the offering have not yet been determined, and the company has not indicated yet which exchange it will apply to for a listing of its shares.

Here’s the S-1 registration, in a conveniently downsized 10-minute Digest version – with some commentary along the way as to what is driving value in the Mascoma model, what might be tempting to potential investors, and the risks and pitfalls along the road to cellulosic ethanol riches. Yes, we’ve marched through the hours of brain-numbing legalese and disclaimers, so you won’t have to. Here’s the news you can use.

Mascoma’s IPO: The 10-minute version

It’s been a long journey for Mascoma to develop its technology, in the glare of attention from an adoring (and heavily invested) public, entranced by its revolutionary consolidated bioprocessing “magic bug”, which eliminates the need for costly enzymes in processing advanced cellulosic feedstocks into ethanol.

What is consolidated bioprocessing? A magic bug that simultaneously extracts simple sugars from cellulose and then ferments them into ethanol. As the company observed in it’s S-1: “In a 2006 report on biomass conversion to biofuels, the DOE endorsed the view that CBP technology is widely considered the ultimate low-cost configuration for cellulose hydrolysis and fermentation…Typically, biomass conversion processes require a collection of saccharolytic enzymes (cellulases and hemicellulases), which hydrolyze the carbohydrates present in pretreated biomass to sugars, and microorganisms capable of fermenting the liberated sugars into ethanol or other end-products. When the microorganisms both produce the necessary saccharolytic enzymes and ferment the liberated sugars to end-products, the biomass conversion process is called consolidated bioprocessing, or CBP.”

It needs a good pre-treatment for its feedstocks, which is partly why Mascoma acquired SunOpta’s cellulosic ethanol business and its pre-treatment technology last year. The CBP approach bypasses the need for costly enzymes, which currently are in the $0.50 (per gallon of ethanol) range and have been a key stumbling block in the race to make cellulosic biofuels.

The company signed its landmark commercialization deal with JM Longyear in 2008 with a goal of developing a 20 million gallon commercial-scale facility in Michigan, but has not yet commercialized – and the valuations on Mascoma’s stock have been on a downtrend in the past year, hovering at $3.75 in private capital raises, after reaching a high of $6.40 in 2009.

Under new CEO Bill Brady, the company has continued to improve its results, and has its operating costs down to a projected $1.77 per gallon, and has developed what it calls a “capital light” strategy for getting its CBP magic bug into business. According to its S-1 registration statement, it expects to commence construction in Michigan in the next 3-6 months.

But a new, nearer-term, even more capital light product has emerged – Mascoma Grain Technology, an enzyme-replacement product for conventional corn ethanol that Mascoma says can reduce costs by $0.01 to $0.02 per gallon for ethanol producers today, and could rise to 4% reductions in enzyme costs in the future. Given a 13 billion gallon market, that’s as much as $260 million in savings for the US corn ethanol industry – but the margins are razor-thin, and assume that Mascoma can stay ahead of companies like Genencor and Nozozymes on enzyme cost.

The Commercialization Plan

Phase 1: Mascoma Grain Technology.

From the S-1: “We plan to initially target the large and established first generation corn ethanol industry with our proprietary Mascoma Grain Technology, or MGT, yeast product, that can be used by corn ethanol producers as a drop-in substitute for existing yeasts. We expect to begin selling this product in 2012.

“Our initial MGT product adds value by alleviating the need to purchase most of the expensive enzymes currently used in corn ethanol production, lowering production costs. Based on laboratory test runs and management estimates of ethanol production costs, we believe that our initial MGT product will reduce the cost of producing corn ethanol by approximately $0.01 to $0.02 per gallon.

“Based on laboratory test runs, we believe future generations of our MGT product will be capable of ethanol yield improvements of up to 4%.

Phase 2: Hardwood consolidated bioprocessing for fuels

From the S-1: “We expect that our first two hardwood CBP facilities will be built in Kinross, Michigan and Drayton Valley, Alberta. We anticipate construction of our hardwood CBP facility in Kinross, Michigan to start in the next 3 to 6 months and construction of our hardwood CBP facility in Drayton Valley, Alberta to start within 12 to 24 months.

Phase 3: Consolidated bioprocessing of multiple fuel and chemical products from multiple feedstocks

From the S-1: “Beyond corn and hardwood, we have already shown the flexibility of our CBP technology platform through the conversion into ethanol of a number of additional feedstocks in a laboratory setting, including corn stover, sugarcane bagasse, palm residue, softwood, miscanthus, switchgrass, paper sludge and sorghum…we have demonstrated in a laboratory setting the production of propanol and fatty acids. These chemicals can in turn be used to create propylene and alkanes, which are the building blocks of many petrochemical replacements.”

The Yields and Cost Improvements

From the S-1:
“The operating cost of $3.00 for 2009 is based on a hardwood to ethanol conversion yield of 52 gallons per bone dry short ton.

“The operating cost of $2.13 for 2010 is based on a hardwood to ethanol conversion yield of 67 gallons per bone dry short ton.

“The current operating cost of $2.00 is based on a hardwood to ethanol conversion yields of 71 gallons per bone dry short ton.

“The estimated operating cost of $1.77 [per gallon] for our planned hardwood CBP facility in Kinross, Michigan assumes that the facility is built to our specifications with a hardwood to ethanol conversion yield of 83 gallons per bone dry short ton, which is what we expect when the facility is fully operational.

“All of the operating cost estimates set forth in the table above assume a hardwood feedstock cost of $66 per bone dry short ton of hardwood.”

The Mascoma Markets: First generation ethanol

From the S-1: “According to the Renewable Fuels Association, or RFA, U.S. corn ethanol production increased from 3.6 billion gallons in 2005 to over 13 billion gallons in 2010, which represented a compound annual growth rate of over 30% for that period, and ethanol exports in 2010 hit a record high of 350 million gallons. As of 2010, over 200 ethanol plants existed in the United States. We believe this large and established industry presents a compelling market for our drop-in MGT yeast product.”

Second generation ethanol

From the S-1: “Of the 36 billion gallons of renewable fuels mandated by 2022, 20 billion gallons are mandated to be advanced biofuels (excluding 1 billion gallons of biomass-based diesel), with at least 16 billion gallons required to be cellulosic biofuels. The vast majority of ethanol consumed in the United States today is produced from corn and does not satisfy RFS2 advanced biofuels requirements. We expect the ethanol produced at our hardwood CBP facilities wi
ll be a cellulosic biofuel and we intend to capitalize on this mandated market.”

Challenges

From the S-1: “The market for renewable fuels and chemicals has evolved significantly over the past several years, with many companies seeking to capitalize on the growing market potential and the environmental benefits offered by these products. However, many challenges exist and we believe that companies will need to satisfy the following criteria to succeed in this market:

• Demonstrated and Validated Technology.
• Comprehensive, Integrated Process.
• Low Cost.
• Flexibility.”

Mascoma as it sees itself: 10 Competitive Strengths

The company cites 10 factors in its filing.

1. Proven CBP Technology. It has demonstrated the performance of our MGT yeast product and hardwood CBP technology as follows:

2. Validation of the performance of its initial MGT yeast product by ICM, Inc., the leading provider of engineering services to the ethanol industry.

3. Successful production runs using its hardwood CBP microorganisms, including more than 1,000 continuous hours of operating data on a fully-integrated basis at our demonstration facility in Rome, New York;

4. Validation of its hardwood CBP technology by independent engineers at the U.S. Department of Energy and by independent third parties; and

5. Proven commercial use of the core equipment used in its biomass conversion process, with the front-end pretreatment equipment traditionally used in the pulp and paper industries, and the back-end distillation equipment used in the fuels and petrochemical industries.

6. Comprehensive and Efficient Biochemical Solution for Biomass Conversion. Mascoma contends that no other solution for biofuels and chemicals from multiple feedstocks that covers the full spectrum of the biomass conversion process, including pretreatment, hydrolysis and fermentation.

7. Low All-in Cost Solution. CBP is distinct from other, less integrated configurations, in that it alleviates the need to purchase most of the expensive enzymes associated with most other ethanol production methods while also improving yields.

8. Capital-Light Path to Revenue Generation. The commercialization of its initial MGT yeast product is not dependent on any meaningful capital expenditures. The hardwood CBP commercialization strategy is based on collaboration with third parties to fund, build, develop and operate the facilities.

9. Feedstock Flexible and Adaptable Technology. Beyond corn and hardwood, Mascoma has demonstrated in a laboratory setting the ability to convert corn stover, bagasse, palm residue, softwood, miscanthus, switchgrass, paper sludge and sorghum.

10. Deep Domain Expertise. Mascoma believes believe that its business is differentiated by our ability to leverage the deep domain expertise of an exceptional and distinguished group of executives, scientists and partners.

Commercialization and Grant Partners

JM Longyear. In December 2008, Mascoma and Longyear formed Frontier to develop and operate an integrated commercial-scale cellulosic fuel production facility in the state of Michigan. As of June 30, 2011, we had a 75% ownership interest in Frontier and Longyear owned the remaining 25%.  The operating agreement was amended in June 2010 to provide that Longyear will contribute the land at a date to be determined by the board of Frontier on or after January 1, 2012, upon commencement of development at the site.

The U.S. Department of Energy. In October 2007, Mascoma entered into a $4.3 million DOE grant agreement for the development of an organism for the conversion of lignocellulose to ethanol. As of June 30, 2011, Mascoma has received $4.1 million in proceeds from the DOE under this grant. In September 2008, the company entered into a $20 million grant agreement for the construction of an industrial scale fermenter system and the design, construction and operation of an integrated cellulosic ethanol plant for transforming locally grown mixed hardwoods or switchgrass into ethanol. As of June 30, 2011, Mascoma has received approximately $16.5 million.

The BioEnergy Science Center. In June 2008, Mascoma entered into a subcontract with UT-Battelle as one of more than a dozen participants in the BioEnergy Science Center, or BESC, supporting the multi-year effort to overcome recalcitrance of cellulosic biomass to conversion. BESC will provide up to approximately $6.3 million to fund our portion of the project. As of June 30, 2011, we have received $5.1 million from BESC. The contract lasts through 2012.

The Michigan Strategic Fund. In December 2008, Mascoma entered into a grant agreement with the Michigan Strategic Fund for the planned hardwood CBP facility in Kinross, Michigan, for up to $20 million. As of June 30, 2011, Mascoma has received $12.1 million from MSF.

The New York State Energy Research and Development Authority. In October 2007, Mascoma entered into a grant agreement NYSERDA, to build and operate a biomass-to-ethanol demonstration plant in Rome, New York. In connection with this grant agreement, we were awarded a grant of up to $14.8 million, to be paid in installments upon certain milestones. As of June 30, 2011, we have received $13.8 million.

The Province of Alberta, Canada. In March 2010, Mascoma entered into an Agreement with the Province of Alberta, Canada for the development of a planned commercial cellulosic ethanol facility in Alberta, Canada. Under this arrangement, Alberta will provide up to $0.8 million in funding to be used exclusively for this project.

Proposed Projects

• Kinross, Michigan: The hardwood CBP facility in Kinross, Michigan is expected to be a 20 million gallon per year facility.

• Drayton Valley, Alberta: The hardwood CBP facility in Drayton Valley, Alberta is expected to be a 20 million gallon per year facility that will produce ethanol, as well as coproducts such as renewable electricity and purified xylose.

In addition to Kinross and Drayton Valley Mascoma has identified additional potential development sites in the Great Lakes region and Alberta.

Financing along the way

From inception in 2005 through June 30, 2011, Mascoma funded operations primarily through $105.3 million in proceeds from the sale of preferred equity securities, $10.0 million in proceeds from the sale of convertible notes, $20.0 million in borrowings under secured debt financing arrangements, and $34.5 million in revenue.

As of June 30, 2011, cash, cash equivalents and short-term investments totaled $12.1 million.

Series A. In March 2006, Mascoma sold an aggregate of 5,000,000 shares of Series A preferred stock at a price of $0.80 per share for gross proceeds of approximately $4.0 million.

Series A-1. In September 2006, Mascoma sold an aggregate of 5,000,000 shares of Series A-1 preferred stock at a price of $1.00 per share for gross proceeds of approximately $5.0 million.

Series B. In November 2006, Mascoma sold an aggregate of 11,241,573 shares of Series B preferred stock at a price of $2.67 per share for gross proceeds of approximately $30.0 million.

Series B-1. In October 2007, former shareholders of Celsys Biofuels, Inc., or Celsys, received shares of Mascoma Series B-1 preferred stock, with an aggregate fair value of the shares of $5,250,000 at the time of issue.

Series C. Between February and April 2008, Mascoma sold an aggregate of 9,531,250 shares of Series C preferred stock at a price of $6.40 per share for gross proceeds of $61.0 million.

Series
D. In August 2010, Mascoma issued 2,702,883 shares of Series D preferred stock at a price of $3.75 per share in connection with the conversion of 2010 Notes.  In August 2010, Mascoma also issued 11,268,868 shares of Series D preferred stock at a price of $3.75 per share to SunOpta in connection with the SunOpta acquisition.

In January 2011, Mascoma sold 1,333,333 shares of our Series D preferred stock at a price of $3.75 per share for gross proceeds of approximately $5.0 million.

In August 2011, Diamond Alternative Energy, LLC, or Valero, exercised a warrant for 1,333,333 shares of Series D preferred stock at an exercise price of $3.75 per share for gross proceeds of approximately $5.0 million.

Financial results along the way

Mascoma has generated $34.5 million in revenue along the way, primarily government funding for R&D. They have not yet commercialized their MGT corn ethanol technology or the hardwood CBP process.

The accumulated deficit as of June 30, 2011 was $118.722 million.

The net loss was $30.4 million, $38.3 million and $25.7 million for the years ended December 31, 2008, 2009 and 2010, respectively, and $14.8 million for the six months ended June 30, 2011.

Valuations along the way

Fair Value Per Share, from the S-1:

February 29, 2008 $2.94
October 31, 2008 $2.86
October 31, 2009 $2.95
August 31, 2010 $1.97
June 30, 2011 $2.93

The Risks, translated from SEC-speak

In S-1 speak: We have a limited operating history, a history of losses and the expectation of continuing losses.
In English: “We have spent all of Vinod Khosla’s investment, and would like to spend your investment too.”

In S-1 speak: In order to sell any of our MGT yeast products to corn ethanol producers we must obtain regulatory approval, and any delays in receiving approval could have a material adverse effect on our business, financial condition and results of operations.
In English: “Dad, can I borrow the car? I’ll be getting my license soon, I hope.”

In S-1 speak: “We have no experience applying our CBP technology to the production of renewable fuels or chemicals at commercial scale and our management has limited experience in the renewable fuels and chemicals business, and as a result, we may not be successful in commercializing our hardwood CBP technology.”
In English: “We could be a blockbuster. On the other hand, we could be Blockbuster.”

In S-1 speak: “The market for renewable fuels and chemicals may not develop as anticipated.”
In English: “If they mess with the RFS, we own a pub with no beer.”

In S-1 speak: Our stockholders’ deficit, recurring net losses and history of negative cash flows from operations raise substantial doubt about our ability to continue as a going concern. As a result, our independent registered public accounting firm included an explanatory paragraph in its report on our financial statements as of and for the year ended December 31, 2010 with respect to this uncertainty.
In English: “We’re down to $12 million in the bank and, er, we lost $14 million in the first half.”

In S-1 speak: We have a history of material weaknesses in our internal control over financial reporting, including a material weakness that remains unremediated at December 31, 2010. Failure to achieve and maintain effective internal control over financial reporting could result in our failure to accurately report our financial results.
In English: “Oops, we hired Goofy as our bookkeeper a while back. But we fixed it, sort of.”

In S-1 speak: We may not be able to enforce our intellectual property rights throughout the world.
In English: “Technology piracy? Never heard of it.”

The bottom line

Mascoma is the first company primarily chasing cellulosic ethanol and consolidated bioprocessing, to file for an IPO in quite some time, so this is an important one in every way. There are two aspects to this filing. The near-term commercialization, and the long term in hardwood consolidated bioprocessing.

Near-term. Mascoma Grain Technology – hmmm, those are thin margins and no announced customers. That’s a toughie. The Valero investment in January may well signal that a customer may emerge there.

Long-term. $1.77 per gallon on an operating basis – well, we are not sure we are seeing a completely capitalized cost here – in industry terms, operating cost generally does not include the capital expenditure. But if we added 50 cents a gallon, or even $1.00 per gallon for the capex (assume $7.50 or $15 per gallon in construction, spread over 15 years), the numbers aren’t half bad at all. If the cellulosic biofuels credit survives a while at anywhere near the lofty $1.01 it is at today, that’s purty darn good. But we’re guessing on the capex. It would be nice to have that spelled out.

Upside opportunity. There’s room for improvement in that cost of $66 per dry ton for hardwood.

In the absence of announced customers or partnerships for MGT, or a strong pre-treatment revenue stream, investors may be tempted to continue to focus solely on the cellulosic biofuels business.

In that realm, Digest readers have been hugely strong fans of consolidated bioprocessing for a long, long time, and the numbers continue to look strong, and the timelines continue to point toward commercial volumes of cellulosic ethanol in the 2013-14 time frame, at affordable prices.

The complete S-1 registration statement is here.

Jim Lane is the Editor and Publisher of Biofuels Digest.