US BioEnergy (USBE)

TOP CONTRIBUTORS

Jonathan Kolb

www.zacks.com

U.S. BioEnergy (USBE) is a rapidly growing ethanol producer founded in 2004 and came out with its initial public offering in December 2006. The company currently owns and operates four ethanol plants with a combined production capacity of 310 million gallons per year. Rapid expansion is in the pipeline for USBE. The company currently has four more ethanol plants under construction. Also, its slated merger with VeraSun Energy (VSE) during the 1st quarter of 2008 will enhance combined capacities. Taking into account ongoing capacity expansion plans, the combined entity will have an expected capacity of 1.64 billion gallons per year by year-end 2008. This is higher than what the existing largest domestic ethanol player Archer Daniels Midland (NYSE: ADM) plans to have. ADM plans to have a capacity of 1.62 billion gallons during the same period. USBE acquired Val-E Ethanol, LLC in April 2006. Also, in August 2007, it completed the acquisition of Millennium Ethanol and rechristened the company US Bio Marion, LLC.

Business Segments

While ethanol production made up the bulk of company revenues in the first-half of 2007, USBE also has co-production of distillers' grain as well as a marketing and services segment. The company s two business segments are Production and Marketing & Services.

The company's production segment accounted for more than 98% of revenues in the 3rd quarter of 2007. The company s main product other than ethanol is distillers grains. This is known as a "co-product" of ethanol and it is sold by the ton as animal feed.

The company's marketing and services segment is comprised of three subsidiaries, the most notable of which is Provista Renewable Fuels Marketing, LLC. This subsidiary is a marketing vehicle for ethanol and leases rail cars in order to transport ethanol to producers. USBE owns its marketing arm through a 50/50 joint venture with CHS Inc. During the first half of 2007, Provista and the company's service segments provided only nominal revenues.

VSE & USBE MERGER ON THE TABLE

The U.S. bio-fuel industry is facing narrow margins and escalating corn and energy costs coupled with weak ethanol prices. This generated a wave of consolidation within the industry. After acquiring a couple of small firms like Val-E Ethanol, LLC (April 2006) and Millennium Ethanol (August 2007), U.S. BioEnergy is itself being acquired by VeraSun Energy. VeraSun Energy is buying U.S. BioEnergy in an all-stock purchase, paying 0.81 shares of VSE for each share of USBE. VSE is paying 11.1% premium to U.S. BioEnergy's shareholders based on November 23, 2007 closing prices. The $700 million transaction is expected to close during the 1st quarter of 2008. With ongoing expansion plans, the combined company will grow to 16 facilities operating with common technology, and 1.64 billion gallons annual capacity by year-end 2008. This represents a nearly twofold increase from U.S. BioEnergy's existing annual capacity of 310 million gallons, and VeraSun Energy's 560 million gallons. This will make the entity the largest bio-fuel company of the world, surpassing Archer-Daniels-Midland Company's (NYSE:ADM) expected capacity at the end of 2008, of 1.62 billion gallons annually. This will result in further economies of scale in the consolidating bio-fuel industry. Additionally, U.S. BioEnergy was already on a major expansion drive and incurred substantial capital expenditures during the 3rd quarter 2007 totaling approximately $117 million. For the most part, these expenditures were related to the ongoing facility construction at Hankinson, Dyersville, Janesville, and Marion. At the end of the recent 3rd quarter, estimated construction expenditures required to complete these plants totaled approximately $265 million. The combined entity will start operations with seven new plants under construction. This will facilitate future growth, however, may also put the company in a resource crunch situation in the short-term.

VeraSun Energy and U.S. BioEnergy were among the most profitable companies in the tight-margin ethanol industry. This merger should further improve the profitability of the resulting combined company. As per conservative estimates by U.S. BioEnergy, the merger would be accretive with gains from synergies standing at $80 to $160 million annually within a couple of years after the merger.

Consolidation will help the company as rapid expansion of U.S. ethanol output has witnessed corn prices sky-rocketing. The United States currently produces almost seven billion gallons of ethanol from corn. This is slated to continue as the 2007 energy bill mandates an ethanol target of 36 billion gallons by 2022. It also created an excess supply situation of ethanol in the Midwest, where most of it is produced. Also the profitability of ethanol producers has been hit by rising commodity prices and a sharp reduction in the price of ethanol. The price of corn has risen to about $3.80 a bushel on the Chicago Board of Trade from less than $2.50 in September 2006, whereas the price of ethanol has fallen to about $1.86 a gallon versus $4.33 in June 2006. Corn prices due to rising demand from ethanol producers and have gone to $3.73 per bushel as of September 28, 2007 (as per Chicago Board of Trade). The dependency on corn increased in recent years with the government mandates and subsidies included in the 2005 energy bill and phasing out of Methyl Tert-Butayl Ether (MBTU) in the U.S. due to groundwater contaminations. We expect strong demand for corn will keep prices high while the on-going battle with soybeans for U.S. acreage will make matters worse. Meanwhile, natural gas prices, another key input cost for ethanol producers, have held at elevated levels along with other energy prices. Natural gas price stood at $6.87 per MMBTU as of September 28, 2007 (as per the New York Mercantile Exchange).

The announcement of US BioEnergy's pending merger with fellow bio-fuels company VeraSun Energy paved the way for the formation of the biggest bio-fuel company in the world and sent valuations upward due in part to expected synergies and complementary nature of the companies. The two companies have common assets and complementary geographical presence. After the merger, the company will have nine plants in operation, seven plants under construction, and two plants under development all located in the center of the Midwest. Additionally, historically all the facilities have corn procurement costs below the Chicago Board of Trade price. This will help the company to keep down their transportation costs and other costs that could squeeze other smaller producers.

With the merger all the facilities will benefit from both US BioEnergy and VeraSun Energy's unique strengths. For example, U.S. BioEnergy developed some unique process and production technologies, which help in yielding more gallons per bushel of corn, higher production rates, and consistent product. To capitalize on this the company created a distillers grain brand "SOLOMON". On the other hand, VeraSun developed, a unique corn oil extraction technology process to extract the corn oil from distiller's grain leading to improved economies of scale.

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