Description

Shareholders of Canadian food ingredient company Burcon Nutrascience (“BUR”) must be exhausted.  After achieving a US$225 million market cap in late 2010 upon the announcement of an exclusive licensing deal to Archer Daniels Midland of its Clarisoy isolated soy protein product, five years later there is still no material revenue generation.  The market cap today is approximately US$70 million.  Why the delay? Burcon doesn’t know:  its agreement with ADM does not require the licensee to keep the licensor abreast of developments save for a few key milestones.  Thus, Burcon has no real insight into ADM’s timetable and must rely on ADM’s public statements to know what is going on.  Every conference call is a broken record.    Oddly enough, a research report from December 2010 projected US$50 million of EBITDA in 2014.  Aside from the understandable fatigue with the story, the small market cap, the primary Canadian listing with a secondary US listing, the thin liquidity, the primary reason for the expectation gap was (and is) a misunderstanding of the ingredient sales cycle.  Based on numerous interviews and our experience with innovative food ingredients, the timetable that BUR has experienced is actually not that extraordinary.  While there is no crystal ball, the signs are pointing towards better days ahead for Burcon (as will be detailed below).  We estimate that Burcon could see material revenue next year which could quickly ramp up to US$0.50 per share of fully-taxed earnings.  In that scenario, even a 12.5x multiple for a rapidly growing / 75%+ margin stream would yield a several multiple return to investors from current levels with the opportunity for more upside thereafter.  At the same time, the nuclear scenario where ADM walks away seems very unlikely at this point given the resources ADM has dedicated to Clarisoy; this investment is thus less binary than it might appear upon a cursory glance.  It is clear that ADM’s customers are trialing Clarisoy but due to a very long sales cycle, they have not begun ordering.  They must be experiencing some success or ADM would not have committed in 2014 to moving forward with a commercial scale Clarisoy plant.   In summary, we believe that an investor today benefits from Burcon’s long and tedious path to achieve commercial success just before it happens. 

Business Description

The Company is dual listed in the US (NASDAQ:BUR) and Canada (TSX: BU) but is a foreign filer so it files a 40-F.  Its investment presentation can be found here:  http://www.burcon.ca/investors/corporate_factsheet.php

Burcon specializes in extracting highly functional proteins from plants such as soybeans.  Its products can be used as an ingredient to fortify foods with additional protein.  It produces a high-end soy protien isolate.  The health benefit of additional soy protein for heart disease is one of the few health claims permitted in foods by the FDA (they classify most products that improve health as drugs that require a more laborious approval pathway – see:  http://www.fda.gov/Food/GuidanceRegulation/GuidanceDocumentsRegulatoryInformation/LabelingNutrition/ucm064919.htm ).    These plant proteins compare favorably to animal proteins across a number of dimensions including saturated fat content.  They also have a cost advantage over traditional dairy proteins. In addition, Clairsoy is a potential market leader because Burcon scientists figured out how to eliminate the beany or earthy taste that frequently accompanies other plant proteins.  It is also soluble*and* clear in low pH products unlike most plant proteins which means it can be used in juices and sports drinks as a clear solution (if it did not have this functionality it would mean the underlying products were cloudy and/or full of undissolved particles).  Speaking to food scientists, this was quite a technical feat.  This functionality is a very significant differentiator and it is why a tiny company was able to attract the interest of a dominant industry player like ADM. In fact there is an illustrative video of the comparative functionality in ADM’s Clairsoy marketing materials (www.clarisoy.com will take you there). 

As mentioned above, the ADM relationship has not met the stock market’s expectations since its 2011 official beginning (announced in 2010).  What evidence do we have that ADM is serious about Clarisoy and that Burcon’s economics and efforts will not be worthless despite so little to show to date?

·         ADM is heavily emphasizing value-added specialty ingredients, highlighted by its recent major acquisition of Wild Flavors and stated its intent to grow the business from $2.5 billion to $10 billion. 

·         At its December 2014 investor day, ADM’s “scorecard” specifically mentions Clarisoy as the way it will grow Wild Flavor’s sales. For this to be on the radar of a $30B market cap industry leader, it must be able to move the needle.

·         Quotes from the CEO of ADM as well as the President of Wild Flavors both touting Clairsoy are referenced in Burcon’s investor presentation.  The point stands that if something reaches the C-level, it will have a financial impact. 

·         ADM’s March 2014 official notification to Burcon of its intent to expand to full-scale commercial production of Clairsoy (required as part of the licensing agreement)

·         Management’s observation that shortly after the 2014 notification, ADM announced a $250 million plant  in Brazil adjacent to its soybean operations (high suggestive that this is the Clarisoy plant although this has not been definitively confirmed)

·         On its Q3 conference call in February, management indicated that it “further understood” that the construction on ADM’s Brazil facility began in the second calendar quarter of 2014 and that it would generate “earnings” within 18 to 24 months.  This would mean we are very close to an important catalyst for Burcon.     

·         Here is a key point:  based on numerous interviews, the sales cycle for a new, disruptive ingredient can be three to four years (!!!!!)This suggests, given the opening of ADM’s pilot plant in June 2012 so that it could offer samples to its customers, that we are right on schedule for revenues.  Food companies are very conservative and they are collectively terrified of damaging their brands or taking a risk on innovation until someone else has proven it.  They will do many internal tests and then even more field/market tests.  This is especially true for a reformulation (vs. a new product). The backing and resources of ADM should be a huge help to alleviating these risks.  ADM notified Buron in December 2012 of its first commercial sale of Clarisoy but this was likely for a small test and the revenues to BUR were virtually nil.  It likely also gives product samples to companies gratis for testing. 

·         As a further point to underscore the above.  ADM is already marketing six different Clairsoy products (go to www.clarisoy.com which will take you to ADM’s page).  These products have been featured at trade shows and should be in advanced market tests by now. 

An additional source of upside could come from Burcon’s second product, a pea protein called Peazazz.  Management insists that it is close to securing a commercialization partner although it has been saying this for two years with no tangible results.  It has also built a pilot plant to manufacture the product.  Unlike the ADM deal, Burcon is seeking a joint-venture or similar structure that would enable it to maintain control of Peazaaz.  I do not include Peazazz in my valuation.  There are also other canola protein products which the company does not emphasize.  Finally, the company mentions that its IP allows it to extract proteins from other plants. 

Valuation

We do not have enough information from ADM to specifically quantify the immediate opportunity other than to know it is spending $250 million in Brazil on what management very strongly believes is its Clarisoy plant.  Standard soy protein isolate is priced at roughly US$4,000 per metric ton.  Management has stated that it believes the price of Clarisoy will command a premium to standard soy protein. We will assume US$5,000.  We will assume a capacity to process an arbitrary 100,000 metric tons in a plant and see what the potential revenue could be to assess the quality of the assumption.  Next, we need to calculate the yield (i.e. the amount of Clarisoy produced for every unit of Soybean input).  The investor presentation states that 40% of soy is protein.  Thus 100,000 metric tons of soybeans would produce 40,000 metric tons of Clarisoy.  At US$5,000 the plant can produce US$200,000 of revenue (probably small for an ADM plant so this is a good assumption to be wrong to the upside) and assuming an initial 15% royalty (we do not know this number but we know the royalty scales down according to management), that would equate to US$30 million of royalty revenue to BUR.  Assuming CAD$5 million/US$3.8 million of corporate and R&D basin on 2014 levels and a $35% Canadian corporate tax rate,  the plant could generate slightly more than US$0.50 per share to BUR.  Thus BUR today is trading at 3.6x the earnings potential of ADM’s plant.  The plant probably won’t be at capacity at opening but will be filled within several years with either capacity expansion or more plants to follow.  Nevertheless, at 12.5x fully-taxed earnings (this is very high margin and would justify a higher multiple), the plant’s capacity would be worth US$6.50 per share to BUR.  We believe this is a realistic target price within two to three years.

As a gut check, management believes that Clairsoy has $1 billion per year revenue potential (let’s assume its denominated in CAD).  Within the context of the $31.5 billion protein ingredient market by 2018 cited by management, this estimate seems very reasonable given the heft of the ADM  marketing machine. ADM has $78 billion of revenue.  If the ultimate royalty is somewhere between 8 to 10% then the revenue potential to BUR would be CAD$80 to CAD$100 million.  If we assume approximately CAD$5 million of corporate overhead and R&D spending (similar to 2014), then after the 35% Canadian tax rate and assuming 34.1m primary shares and an additional 3m of warrants (388k at a strike of $2.26) and options (currently 2.5m at a strike of CAD$5.66), BUR would generate CAD$1.30 to CAD$1.64 of EPS (FCF would be higher given stock comp and some lingering D&A as well as very minimal capex requirements).  Applying a low 12.5x multiple (this is very high margin and would justify a higher multiple) would give an upper bound for the Clarisoy opportunity of CAD$16 to CAD$20 per share or US$12.25 to US$15.25 per share.   The Company also has approximately CAD$15 million in after-tax NOLs and credits so nearly CAD$0.50 per share on an undiscounted basis (they would be burned through quickly).

In addition Burcon’s patent portfolio includes 59 U.S. issued patents (188 worldwide) and an incremental 375 applications still pending (including 65 in the U.S.).  Given the ADM endorsement, even in an unlikely situation where the relationship fell apart for some reason, these patents would have value to other companies and in a firesale could be worth nearly US$25 million at an arbitrary value of US$250,000 per issued U.S. patent and approximately US$125,000 per U.S. patent application.  Perhaps the patents would be worth significantly more: the company notes that it has spent $62 million developing its technology.      

A final note: BUR is capitalized through summer 2016.  It recently completed a $3.3m financing in April that was oversubscribed.  The largest shareholders backstopped the offering (in return for a small amount of warrants) and we do not believe that the Company would have difficulty raising money if ADM is pushed out further, especially at this valuation.  For many institutions, the only way to invest is through an offering. $5m of additional capital to fund the business for another year would dilute shareholders approximately 7% at current prices.   

Catalyst

Sell through of Clarisoy to ADM’s underlying customers

Royalty revenue from ADM

Continued expansion of Clairsoy capabilities

Peazazz collaboration and commercialization