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Bioceres (NASDAQ:BIOX) is an Argentina based developer of agricultural solutions for row crops. It has a relatively mature segment based on its subsidiary Rizobacter’s strong presence in the adjuvants and micro beaded fertilizers markets. Then it has development segments about to start their growth phase based on its HB4 technologies.
In April 2021, we wrote an article on Bioceres stating the main trends and risks in our understanding, with a neutral recommendation. To summarize the company’s drivers stated in the article:
- Rizobacter’s profitable segments generate the cash flows necessary to sustain some debt, R&D expenditure and acquisitions, that is, a growth strategy.
- Rizobacter’s profitable segments are relatively mature, with an already significant share of the existing market. Profit expansion would be driven mostly by commodity prices and secondarily by market adoption.
- Bioceres’ original growth strategy is based on HB4, a genetic technology that gives soy and wheat drought resistant enhancements. HB4 varieties are the only drought resistant varieties of soy and wheat, and HB4 wheat is the first genetically modified wheat in the market.
- Bioceres was priced as a growth stock based on the potential of HB4, which is a source of uncertainty. Debt added to that uncertainty because it exposed the company to a bear market in commodity prices.
Almost a year has passed and the main drivers of risk and uncertainty are the same as before. However the situation relating to those drivers has changed significantly, sometimes as a result of company decisions and sometimes as a result of macroeconomic trends.
On the macro side, Bioceres has benefited from the increase in agricultural commodity prices during the last year, which has increased Rizobacter generated gross profits by 50% on a YoY basis. Also on the macro side, the expected increase in interest rates and in market risk aversion will put additional pressure on Bioceres’ debt, refinancing conditions and multiples.
On the company side, Bioceres has not reduced its debt but rather increased it. The company has also expanded its growth strategy by the acquisition of the remaining participation on one of its joint ventures related to HB4, Verdeca. Finally and in this vein, Bioceres has recently announced its intentions to merge with Marrone Bio Innovations (MBII), a growth company with little leverage, for a significant premium.
All in all, we believe that Bioceres’ valuation depends on the same drivers that we stated a year ago, but that the magnitude of the uncertainty is much higher. On one side, with higher debt sustained by higher commodity prices, the risk of a collapse in commodity prices is much higher. On the other side, the problem of valuing HB4’s potential is now accompanied by the problem of valuing Marrone’s potential.
Note: Unless otherwise stated, all of the information in this article has been obtained from Bioceres’ filings with the SEC.
Rizobacter, the pillar below Bioceres
Rizobacter is the only component of Bioceres that is actually profitable and that can be discounted on an operational basis. As explained in last year’s article, Rizobacter specializes in adjuvants and micro beaded fertilizers.
In this respect, and according to Bioceres’ 2021 20-F, Rizobacter holds a respectable share of the world market and a significant share of the Argentinean market, where these solutions have more penetration.
It is from the figures from third and fourth calendar quarters in 2021, compared to 2020, that we gauge the effect of commodity prices in profitability. In this case, we have seen a 50% increase in gross profits for the two quarters, from $43 million to $66 million. In both 2019 and 2020, those two quarters gross profits ended up being half of the annual gross profits. Therefore, if we interpolated the figures available for 2021, we can expect gross profits in the order of $130 million for this year, against $90 million for last year.
We also believe that Rizobacter’s profits are showing a lag with respect to commodity prices. The reason to believe this is that although the price of soybean increased by 100% between June 2020 and June 2021, FY21 gross profits grew only 15%. In comparison, between June and December 2021 (first and second fiscal quarters FY22), gross profits grew the mentioned 50%. This may be explained by the lag in investment normal in any business but more so on seasonal crops. South American farmers needed to plant between September and January, when the prices were moving between 2020 and 2021. Farmers may have taken investment decisions thinking in prior prices. With the new price level, farmers invested more in the 2021-2022 campaign.
How sustainable are Rizobacter’s profits
The answer to this question depends completely on the dynamic of agricultural commodity prices. We are not commodity traders and therefore will not do that kind of analysis in this article.
However, we can consider the effect under different scenarios, because fortunately, the 2019/20 and 2020/21 campaigns in South America were based on soybean and wheat prices that were at decades’ lows. We believe Rizobacter’s gross profits in FY20 and FY21 provide a conservative worst case scenario with commodity prices returning to levels prior to the COVID-19 pandemic.
Again, we are not commodity experts and therefore cannot gauge the long term effect of the changes in general global macroeconomic conditions that have occurred since 2019. Whether or not markets are over or under reacting to recent developments is outside of our scope.
But we can work with a range between $90 and $130 million in yearly gross profits for Rizobacter, to then analyze how sustainable Bioceres is in general.
A more aggressive growth strategy
As we said, Bioceres uses the profits generated by Rizobacter to fund part of its growth strategy. These months have brought new developments in this area, and we believe they reflect Bioceres’ management changing strategy towards growth in the years to come.
Originally, and as it was written in last year’s article, Bioceres was concentrating on launching the HB4 technology, with soybean variants getting approvals and scaling production faster than wheat variants.
At that time, it seemed as if Bioceres had a mature segment and a developing segment that would eventually mature. Therefore, at some point in the future, Bioceres would become a mature company with a stable product line.
However, Bioceres has given signals that it plans to become a perma growth company, that is, a company that consistently reinvests profits in new product development or acquisitions to keep fueling growth.
Three facts sustain this belief.
First but less important, Bioceres announced a small participation in Moolec, a startup company that is working on plant based protein. This was announced in May last year and did not represent a big investment.
Second, Bioceres acquired the remaining 50% interest in its joint venture Verdeca from Arcadia Biosciences (RKDA). Verdeca holds the licenses to commercialize HB4 soybean in America and some related patents.
Third and very important, Bioceres has announced this month a merge understanding with Marrone Bio Solutions, not yet completely agreed on. Marrone is in the business of bio insecticides, herbicides and fertilizers. It is a young company that is not profitable yet although it is quite close to achieving profitability and has a conservative balance sheet. The company purports itself as a growth play in the coming agtech market.
Because many of Marrone’s products are still under development, Bioceres has effectively announced that it is trying to significantly extend its product development pipeline for years to come.
The effects of aggressive growth in valuation
If this strategy change is solidified and continues, it will mean that Bioceres valuation will have to come from growth without a specific terminal value, at least not in the foreseeable future.
In our understanding, the difficulties with valuing perma growth in Bioceres are similar to those generally mentioned about Amazon (AMZN).
First, the company will spend a significant amount in R&D, either directly or through acquisitions. R&D is expensed if done directly but goes to goodwill if it is acquired. The accounting treatment of this type of investment is tricky.
Second, the company will require increasing amounts of working capital to sustain the growth of the products that are in the growth portion of the cycle. Depending on the company’s aggressiveness, it may require financing to scale working capital quickly enough. This is what has happened to Bioceres with HB4.
In our understanding, if the company has shown the ability to develop products to market, then investment should be considered a bringer of profitability in the future. That is, we should consider Bioceres’ capacity to invest in growth as true profitability, rather than as expenses in the case of R&D, or cash flow drains in the case of working capital.
This is the case only because Bioceres (and Marrone if merged) have shown the capacity to bring products to market. The same treatment is not valid for a single product, untested company.
But, even though that treatment simplifies understanding the company’s current profitability, it does not help in gauging future profitability. Especially important in this respect is that Bioceres’ and Marrone’s products are new to the market and is therefore very difficult to calculate a market size that has any connection to reality. Truth is, the products may be great but the timing may be inconvenient, or the products may be good but expensive.
Our strategy is to pay a premium over the previously mentioned growth capacity, which we can calculate only after deducting debt expenses and taxes. This has to be adjusted by the risk that the company cannot continue investing in growth or even paying its debts, if revenues or margins fall.
The effects of aggressive growth in debt and equity
Growth has to be financed either internally or externally, and in the former case either with debt or with equity.
If growth is financed internally, then it reduces the amount of cash available for distribution to capital owners. That means either that debt does not get repaid, or not as fast as it could be, or that shareholders receive no dividends.
With a company with no debt, then the question is dividends or investment in growth. In this case, if we trust in management’s ability to invest, then we would be happy with reinvestment.
If the company has debt however, the question is more tricky, because not repaying debt can make future growth, which is already risky, even more risky. Not only growth may not provide profits, but also if something bad happens we could be in trouble. The same is true for debt financed growth, which is the same as not repaying debts.
Finally for equity financed growth, there is the problem of dilution, or investment in general. The comparison is between the price at which the company issues shares and the uses it can give to that capital. At least share issuance is a one time thing that does not have to be repaid.
Unfortunately, Bioceres has gone for all three forms of financing in the hope to speed up growth, and it does not seem to be planning to stop.
In June 2020, Bioceres’ financial debt stood at $150 million, and operating liabilities stood at $70 million. By December 2021, financial debts had climbed to $190 million and operating liabilities to $130 million.
Of these financial debts, $160 million were dollar denominated, paying an average of 8% according to Bioceres, or $13 million. The $30 million remaining amounts to about $3 billion pesos paying 38%, or a dollar equivalent of 13%, compared to 2021’s 25% devaluation, that is $4 million. The total is $17 million.
In 2021 the company offered bonds in Argentina through Rizobacter for an aggregate of $40 million and paid an effective rate of 8%. These bonds are attractive to investors because they pay Argentinian pesos at the official exchange rate and obtain a dollar paying asset in exchange.
Bioceres has not been clear announcing these offerings, because it has disclosed only the nominal rate, both in the announcement and on its quarterly financial statements. The reader may believe that Bioceres pays 1.5% annual, which is the nominal interest rate. However, we read the result reports from the Argentinian stock exchange (in Spanish) to find out the bonds were offered at a 20% discount, therefore providing an effective 8% interest rate.
Bioceres has also made use and continues to plan to use equity as a financing mechanism. At the end of 2021 it converted 24 million warrants into 3 million shares, a 10% dilution to shareholders. Then another 2 million shares and $5 million in cash to buy the 50% of Verdeca from Arcadia.
Finally, with the announcement of the merger understanding with Marrone, Bioceres announced that it plans to issue 15 million shares to pay for the acquisition and 5 million shares to repay the convertible notes mentioned previously. In the same announcement, Bioceres also announced that it plans to issue a new convertible note program for another $40 million with a conversion price of $18 per stock and an interest rate undisclosed.
Again, this is not to say that aggressive financing is the wrong strategy, everything depends on the expected returns on capital. The problem is that this kind of financing generates a lot of risk and complicates valuation from the investor’s perspective.
Also, having too much financing and little restrain on capital allocation is not great for capital efficiency. For example, the price announced by Bioceres and Marrone is 8.9% of a Bioceres share for each Marrone’s share. On the date of the announcement on March 16th, Bioceres’ stock traded at $14.8, implying a price for Marrone of $1.3 per share, or a company price of $236 million. That is a premium of 60 to 70% to the price Marrone’s stock traded in the previous three months.
We personally would prefer a company growing more slowly and even having a limit to its future growth, but that can finance growth internally, or at least reduce external financing needs to a minimum.
An attempt at forecasting
Following the approach described, we first calculate how much can the company dedicate to investment in product development and working capital.
We said Rizobacter’s businesses can generate between $90 and $130 million in gross profits, depending on commodity prices in the lows or highs seen in the last few years.
Non R&D operating expenses were around $50 million for FY19, 20 and 21, years that we considered in the low range of profitability. For the first two quarters of FY22, we have seen a 70% increase in those expenses, interpolated to about $85 million. As you can see, there is not a great difference at the level of operating profits before R&D expenses.
As we mentioned, the cost of servicing the current $190 million in debt is about $17 million. That number will change depending on the refinancing rate that Bioceres obtains for its dollar denominated debt and the relation between interest rates and devaluation in Argentina.
Finally we have to account for taxes. The thing with taxes is that they are based on the different jurisdictions in which Bioceres operates. For example, Rizobacter’s sales pay taxes in Argentina, but the Argentinian tax authority might not recognize the purchase of Verdeca as an expense through amortization because the purchase was made by a subsidiary in the US.
Fortunately, we know that most taxes will be paid in Argentina, because Rizobacter operates in Argentina and because Rizobacter holds a significant portion of Bioceres’ debt. So we can calculate a tax rate of 30% to the operational profit before R&D expenses and after interest expenses. For the period FY19 to FY22 that income would have been about $30 million, meaning $10 million in taxes.
That leaves about $20 million of “free cash flow” that can be used to repay debt or to invest in working capital or R&D. This is Bioceres’ profitability and organic growth capacity, as we discussed previously. Again, please do not confound this figure with accounting profits posted by Bioceres, that include special charges and capitalization of some expenses.
Then we have to add Marrone’s own organic growth capacity. An analysis of Marrone’s filings with the SEC would require another article. However, by covering their latest years we get the idea that Marrone has been improving its profitability, reaching the point this year where it nears operational profitability before R&D expenses. This year the company generated a loss of $6 million after interest expenses but before R&D expenses. Fortunately, Marrone recapitalized in 2018, repaying most of its debts at the cost of severe dilution to its shareholders.
Therefore in a static analysis, the combined entity between Bioceres and Marrone would have about $15 million to invest in R&D or working capital after paying for its operational costs, interest expenses and taxes. The combined entity would have 60 million shares, approximately, therefore providing a free-cash-flow to investment of $0.25 per share.
Interestingly enough, Bioceres alone before merging with Marrone, as of this year, has more free cash flow to investment per share than the after-merger entity. As we mentioned, Bioceres can generate about $20 million to dedicate to investments, and would have about 45 million shares, meaning about $0.45 cents per share.
As we have seen, this number seems to be independent of the price of commodities because Bioceres has not been able to keep its operational costs from rising less than its revenues. This number is not independent from the future price of Bioceres’ debt, which will have to be refinanced in the next two years.
Conclusion
Following our approach to valuing a perma growth company based on its availability of profits to dedicate to investment (either working capital or R&D), both Bioceres alone and Bioceres merged with Marrone are expensive. A share price of $13 for a stock that can provide about $0.25 to $0.50 per share of cash flow to investments seems excessive.
We understand that some investors may use a different approach, based on calculating the profit Bioceres and Marrone could generate once their products are commercialized. We believe that this approach is difficult because it requires significant estimations. Even if the market estimation is correct, developing a market requires capital, and we have seen that if capital is not internally generated, then it has to come through expensive and risky debt or shareholder dilution.
We prefer the free cash flow to investment approach because we believe it is more conservative. It allows the investor to pay not for expectations but actually for the capacity to realize those expectations using internally generated capital.
The investor may then apply a multiple to those cash flows based on its belief on the company’s management ability to develop markets and its assessment of the company’s market and credit risk.
In summary, we prefer to miss an opportunity rather than to buy based on difficult to predict expectations. If Bioceres’ or Marrone’s prospects improve in the future, then its stock will still be there to consider investing in.
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