KiOR: The Fat Lady Warms Up Her Voice
In January of this year, as I do each year, I made several predictions for 2014. One was that natural gas prices would be higher. That prediction is looking pretty solid, with natural gas inventories this week dropping below 1 trillion cubic feet for the first time since 2003 — 49% below the level of one year ago. As I have argued in recent articles, this is likely to mean a year of higher natural gas prices than what we have become accustomed to over the past couple of years.
Among the other predictions I made for 2014 was “KiOR will declare bankruptcy in 2014.” While it is still a bit early to write KiOR’s (NASDAQ: KIOR) obituary, the patient is looking pretty unhealthy. I have been getting a lot of emails asking for comment on their recently released annual report, and I would have had something posted already, but I was traveling during the first half of the week. So let’s dissect what has happened.
First, a quick review.
KIOR is one of three advanced biofuel companies that venture capitalist Vinod Khosla took public in 2011. The other two were Amyris (Nasdaq: AMRS) and Gevo (Nasdaq: GEVO).
In a nutshell, KiOR’s process is to rapidly heat wood chips and break them down to form a bio-oil which is essentially pyrolysis oil (not “just like crude oil” which has been a frequent misrepresentation) that is then upgraded into finished products like diesel and gasoline. The process itself has been around for a while, and similar processes have been carried out in many labs and at smaller scale by a number of companies. So it is a real, working process.
The problem has always been the cost. As I explained in Why Biofuels Tend to be Costly, when you have to use human labor and energy inputs to replicate something nature did for free, costs are going to be an issue. Further, yields from this process tend to be low because a lot of the pyrolysis oil is converted to water, carbon dioxide, and light gases during the upgrading process. Add in the fact that the process requires a lot of natural gas — and as I have been saying the outlook for natural gas prices is high for the next year — and KiOR faces some tremendous challenges.
Here is what KiOR’s stock chart looks like since Khosla took the company public in 2011:
The share price is down 96 percent since its IPO, and 96 percent since I wrote Why I Didn’t Short KiOR — an article that argued that the company was overvalued by the market (but also explaining my philosophy not to short stocks).
Many of KiOR’s backers oversold the technology, and continued to do so even as it became clear that they were facing serious challenges. KiOR was the company that Vinod Khosla highlighted in the recent 60 Minutes piece on cleantech; the one that featured this exchange:
Vinod Khosla: Nature takes a million years to produce our crude oil. KiOR can produce it in seconds. And we take that, add this magic catalyst-
Lesley Stahl: This is the secret sauce?
Vinod Khosla: Yeah.
Lesley Stahl: You throw that on top of the chips?
Vinod Khosla: And then, out comes something that looks that looks just like crude oil. It smells like crude, it works like crude except it’s 100 percent renewable. Then it’s distilled onsite into…
Lesley Stahl: Clean gasoline?
Vinod Khosla: Clean green gasoline.
Lesley Stahl: This goes right into the tank, right? You don’t have to build a new infrastructure?
Vinod Khosla: Absolutely.
Lesley Stahl: You make it sound almost – sorry – too good to be true. There must be a downside.
Vinod Khosla: There is no downside.
If you have read or heard Vinod Khosla’s claims before, you probably know he exaggerates and misrepresents things. There are three examples in the above exchange. By calling the catalyst “magic”, he is really trying to stress that they can achieve the impossible. But KiOR’s catalyst is now known to have had some big problems. Many catalysts have a problem with deactivation or poisoning, and KiOR’s process produces lots of odds and ends that would be challenging for any catalyst.
Also, as noted above, what they produce isn’t like crude oil. To turn it into something more like crude oil requires more expensive downstream processing. But the biggest misrepresentation is Khosla’s last statement: “There is no downside.” Of course there is a downside. The high cost of the process is a huge downside. Khosla is projecting a future in which they scale up the process, gain efficiencies, and produce something that is cost competitive. He is once more making the mistake of believing that Moore’s Law works on biofuels, and this mindset continues to be the biggest reason that he consistently over-promises and under-delivers.
The Dreaded Annual Report
That brings us to KiOR’s annual earnings release this week. There were signs that something was amiss with KiOR when they postponed the earnings announcement that was scheduled for March 13th. I guessed that they had really bad news to share, but there was also the possibility that they had found more money, or maybe were going to take the company private.
Most of the recent news over the company has been bad. They under-delivered their own projected volumes all last year. Board member Condoleezza Rice resigned in December 2013. Also in December, KiOR’s CFO left abruptly with no advance notice, and has not been replaced. Major KiOR shareholder Stuart Peterson has been dumping shares for months, at a huge loss. KiOR CEO Fred Cannon sold nearly 71,000 shares on the day before earnings were announced. He unloaded his shares at $1.10 on March 17th. But the delayed announcement saved him some money, because on March 18th when earnings were actually announced the share price fell by 40%. And in fact, several KiOR executives were dumping shares just ahead of the earnings announcement.
KiOR’s annual report was full of bad news, but I wasn’t too surprised at what they reported. For KiOR investors and employees, it’s close to a worst case scenario. Among other things the company said that the SEC served them a subpoena seeking documents about the progress at their Columbus, Miss., facility and the timing of projected biofuel production levels. An SEC investigation is certainly unwelcome news for the company.
Other important items from their 10-K filing:
- They need more money to keep operating.
- They reported an impairment of $185.0 million for their Columbus facility because it was not generating positive cash flows and they were unable to get the facility to “steady state” operations.
- They have a commitment from Vinod Khosla for up to $25 million, but can borrow no more than $5 million a month, and it is subject to achievement of performance milestones.
- A 2nd tranche of financing from Khosla and Bill Gates is unlikely to be received, because it requires KiOR to raise $400 million, and that seems highly unlikely.
The bottom line is that they are out of money, which translated into the annual report as “We have substantial doubts about our ability to continue.” They made this comment in the report 9 times, as if to emphasize that they really, really mean it. They indicated that they will need to secure additional funding by April 1st or they will be forced to default on their debt.
But KiOR isn’t dead, because I don’t think Khosla is yet ready to throw in the towel. There were many worrisome statements in the annual report, but the following commentary leads me to believe they are going to be funded for at least a few more months:
“Other than the Commitment from Mr. Khosla to invest in us a cash amount of up to an aggregate of $25,000,000 in available funds in a number of monthly borrowings of no more than $5,000,000 per month, we have no other near-term sources of financing. Because the Commitment is subject to the negotiation and execution of definitive financing documents and the achievement of performance milestones, we cannot be certain as to the ultimate timing or terms of this investment. There is no assurance that we will be able to successfully secure such additional financing and if we are unable to do so, we do not expect to find other sources of near term financing.”
So once more Khosla may step forward with a lifeline. Of course his credibility and a lot of his cash are also on the line, so I believe his strategy is to keep them afloat for a few more months as he tries to reel in another investor. Ultimately I think the company will end up in bankruptcy regardless, but as I said when I made the prediction, Khosla can keep writing checks to keep them afloat.
I think they will get the additional $25 million commitment from him finalized, but then by about August if Khosla hasn’t convinced someone to step up with a more substantial investment they will be out of options. I can’t see him funding this perpetually without a clear indication that they are on a path to profitability, and it’s going to take a much larger investment before they can move in that direction. My guess would be that by the fourth quarter he will swallow his pride and let them go under.
Who is Accountable?
While we won’t be doing an autopsy on what went wrong until/unless they actually do fold, at this point it is clear that once more Vinod Khosla has overpromised and under-delivered. I know that he thinks he needs to do a lot of cheerleading, but when people assign credibility to you and you make claims that fail to materialize, you have some accountability to those people. In this case, KiOR didn’t accept federal funding (beyond a per gallon credit for biofuel actually produced), but they did accept a $75 million loan from the state of Mississippi that will likely not be recovered, and investors have lost billions. Those investors include Khosla himself, as well as Alberta Investment Management, which invests on behalf of the Alberta government.
Vinod Khosla likes to say that failure is a part of venture capital investing, and that is true, but at some point you have to have some success. This isn’t like making a number of small bets on two guys working on an Internet startup in a garage. Each Range Fuels or KiOR-sized bet comes at a cost of hundreds of millions of dollars. And Khosla continues to bat zero on his “big biofuel bet.”
To be clear, I am not celebrating KiOR’s troubles. Predicting something and then reporting on it doesn’t mean I am celebrating it. It would have been nice to see them succeed. As I have indicated before, I have friends who work at KiOR, and I don’t want to see them lose their jobs. I also strongly support renewable energy, and when a company like KiOR fails it damages the credibility of the sector.
KiOR is in serious financial trouble, but I think Khosla will keep them solvent for a few months while he works the phone to get other investors involved. I would like to see them work through their problems, but I think the chasm is too deep. They require a very large investment just to demonstrate claims that were supposed to have already been demonstrated, and there are no assurances even then that they will achieve their targets. Bill Gates had invested some money with them by buying shares at $2.32 each (now worth $0.65 — a loss of 72%), and had committed to a second round of funding contingent upon enough other people climbing on board that the company raised $400 million. They admit that this is highly unlikely, and therefore the 2nd tranche from Bill Gates isn’t expected to be received.
So my prediction remains that I believe they will go bankrupt, but I don’t think it’s going to happen until later in the year.
Link to Original Article: KiOR: The Fat Lady Warms Up Her Voice