Verenium Corporation (VRNM)

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Avinash Gandhi

Pcushing

Verenium Corporation (NASDAQ: VRNM) is a biotechnology firm that produces enzymes used in industrial processes and agricultural feedstocks. The company also does U.S. Army funded research on antibodies for potential biological weapons like SARS and anthrax. Verenium has been receiving a lot of attention recently because it has developed enzyme processes that break down biomatter to produce cellulosic ethanol, a developing, expensive source of fuel that gained strong government backing with the passage of the Energy Independence and Security Act of 2007.

Verenium's current main product is Phyzyme phytase, which helps livestock to get nutrition from wheat-based diets by improving their absorption of phosphorus, and the market for this enzyme is growing steadily in both domestic and international markets. The market for cellulosic ethanol, however, is much more volatile. Though the U.S. government is supporting cellulosic development through research grants and subsidies to the tune of $1.18 per gallon, the world's current dependence on oil makes a transition to ethanol very difficult. Competing with Verenium in the cellulosic market are companies like Bluefire Ethanol, VeraSun Energy, and Pacific Ethanol.

Business and Financials

Verenium, formerly known as Diversa, is a biotechnology company that develops enzymes used in a variety of applications:

• Energy: Verenium recently became heavily involved in researching enzymes to produce cellulosic ethanol, and will soon start construction of a 1.4 million gallon-per-year pilot plant in Louisiana and a 1.4 million liter-per-year pilot plant Osaka, Japan^[1]. The company hopes to start construction in early 2009 on a 30 million gallon-per-year plant in the Southeast U.S.
• Industrial Processes: Verenium develops enzymes to be used in industrial process; examples include an enzyme that aids in the process of bleaching paper pulp, eliminating the need for costly, hazardous chemicals.
• Health and Nutrition: Currently, Verenium's most lucrative product is the enzyme Phyzyme phytase, which is used in agricultural feedstocks to help animals process phosphorus more easily, reducing the need for costly nutritional supplements. Other Verenium projects in this segment include antibody optimization to fight diseases like SARS, Anthrax, and CD3.

Source: Verenium 4Q07 and FY 2007 Earnings Release^[2]

Despite the fact that the Phyzyme phytase enzyme earns almost twice the revenue as the rest of Verenium's products combined, the company is receiving most of its investor and media attention due to its enzymes that synthesize ethanol by breaking down cellulose. Cellulosic ethanol differs from traditional ethanol because traditional ethanol is produced using corn. In the past few years, the strain that ethanol production has put on corn production has caused a landslide of negative effects across a range of industries. Essentially, corn is needed for too many products, and there isn't enough production capacity in the U.S. for corn farmers to meet the demand. Because demand is so high, corn prices have gone through the roof, making traditional, corn-based ethanol more expensive and, to many, socially irresponsible because of its effect on food prices. Verenium (and the U.S. government) hope to make cellulosic ethanol mainstream, taking pressure off of corn prices while creating a new source of sustainable fuel.

The "Collaborative" segment refers to business collaborations for enzyme research and production that Verenium is engaged in with such corporations as DuPont (for cellulosic ethanol), Danisco (for Phyzyme phytase), Bayer (for animal antibodies), and the U.S. Army (for anthrax, SARS, and other disease antibodies).

Verenium formed in 2007 when Diversa merged with Celunol Corporation; this added roughly $42 million to the company's research and development expenses, explaining the company's higher expenses during 2007.

Trends and Forces

There is Strong Growth Potential for Phyzyme phytase in the International Market

Currently, Verenium earns $16.2 million per year in revenues from Phyzyme phytase - nearly double that of all its other enzymes. The growth that the company experienced in the Phyzyme's revenues this past year can be attributed to the late 2006 approval of Phyzyme Phytase by European Union regulators; essentially, once the enzyme was approved in the new market, sales shot up. The enzyme is appealing because it increases phosphorus absorption by 20%, so ranchers don't have to spend extra on phosphorus supplements, since phosphorus is necessary for bone development. Furthermore, phosphorus that is excreted by livestock can filter into groundwater and lakes, causing algae and cyanobacteria to bloom. Aside from releasing hepa- and neurotoxins into the water, these blooms can also remove nutrients and block sunlight from the water, causing everything in the lake to die^[3]. Phyzyme phytase decreases phosphorus secretion by 30%, making livestock more environmentally friendly^[4]. When the product went online in 2004, it earned $2 million for the company; in 2005 it earned $5.2 million and by 2006, it was earning almost $9 million^[5]. All this revenue growth occurred in the U.S. alone. With the introduction of the enzyme to the EU and the emergence of the Asian agriculture market, Phyzyme phytase's growth potential is much less volatile than the other market Verenium is betting on: cellulosic ethanol.

Competition

In the field of biotechnology, there is a wide range of competition. Few companies focus on the same problems that Verenium does, however, as agricultural enzymes are not as lucrative to the pharmaceutical industry and the company's collaboration with the U.S. Army crowds out many firms researching anthrax and other cures for potential biological weapons. Some players in the biotechnology industry include:

• Xencor - Xencor is a biotech company that engineers antibodies to treat a range of illnesses, from autoimmune to arthritis.
• Maxygen - Maxygen engineers enzymes to treat problems like hepatitis C, internal bleeding, and pulmonary fibrosis.
• Evotec AG - Evotec's proteins have a variety of uses, from the treatment of Alzheimer's to aiding with smoking cessation, insomnia, and post-op pain.

In the field of ethanol, Verenium competes with:

• Bluefire Ethanol - Bluefire uses "acid hydrolysis" to convert wood waste, green waste, paper, urban trash, rice and wheat straw, and other feedstocks that would generally be thrown into a landfill into cellulosic ethanol.
• VeraSun Energy - VeraSun's production of corn-based ethanol, at 340 million gallons per year, represented 4% of the total U.S. production as of February 2007^[6].
• Pacific Ethanol - Pacific Ethanol won $24.32 million from the Department of Energy to build the first cellulosic ethanol pilot plant in the Northwestern United States. The plant is expected to have a capacity of 2.4 million barrels per year - a full million more than Verenium's pilots'^[7]. Currently, Pacific Ethanol is the largest manufacturer of corn-based ethanol on the west coast.
• Nova Biosource Fuels and ConAgra - ConAgra has agreed to have Nova use its animal wastes to produce biodiesel, and will purchase 130 million gallons of this biodiesel each year from the companies' joint venture to sell on international markets^[8]

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