February 09, 2016 - 1:38pm EST by
2016 2017
Price: 3.95 EPS 0 .2
Shares Out. (in M): 40 P/E N/A 20
Market Cap (in $M): 160 P/FCF N/A 20
Net Debt (in $M): -20 EBIT 0 0
TEV ($): 140 TEV/EBIT N/A 9x

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  • Micro Cap


Codexis, Inc. (“Codexis”, ticker CDXS) is a designer of customized enzymes currently focused
on the pharmaceutical manufacturing industry. Initially marketed as a biofuels technology play
during the ethanol boom, Codexis IPOed at $13 per share in 2010. In August 2012, Codexis lost
its key biofuels partner, Royal Dutch Shell plc, and responded by replacing management,
dramatically cutting costs, and shifting focus away from biofuels toward the more promising
pharmaceutical manufacturing market. During this transition, the stock traded down to nearly $1
per share, and now trades at ~$4 per share, a $160mm market cap. We believe Codexis is an
exceptional long investment opportunity, that the company can grow revenues 2-3x over the next
few years, and that the business is worth multiples of its current price.
Product Background
Enzymes are proteins that catalyze the transformation of one substance to another. Naturally
occurring, enzymes underlie many vital life processes such ashuman digestion. Like other
proteins, enzymes are strings of amino acids.Each ordered string is made from an alphabet of
twenty common amino acids, and the strings tend to be a few hundred characters long. Central
to an enzyme's function is its exact shape, as dictated by the exact amino acid sequence, as well
as by temporary environmental characteristics such as temperature, pressure, and pH. The
potential for undiscovered enzymes to facilitate chemical transformations that would not
otherwise occur is practically boundless. However, given the incomprehensibly large number of
possible enzymes, discovering such an enzyme for a particular transformation without
sophisticated technology is far worse than a needle-in-the-haystack proposition. Codexis' core
technology, CodeEvolver, is meant to facilitate the search for customized enzymes to catalyze
particular chemical transformations in the manufacturing of drugs and other fine chemicals.
Central to the Codexis value proposition is the CodeEvolver platform, which has been built over
10+ years with more than $500mm cumulatively spent on R&D. The platform has three core
parts: 1) a starting library of active enzymes built over 10+ years of projects, 2) a constantly
improving set of algorithms to suggest potentially beneficial mutations, and 3) an evolutionary
engine that allows for thousands of enzyme candidates to be produced in parallel, tested for
fitness, and further combined and mutated such that each generation improves. Using
CodeEvolver, Codexis engineers are usually able to determine in a matter of weeks whether a
particular custom enzyme is feasible for a given chemical purpose and are able to evolve that
enzyme with a 95%+ success rate in a matter of months.
Compared to traditional chemical processes, enzymatic transformations are generally cheaper,
simpler, and cleaner. Thus, there is a strong general trend toward augmenting traditional
chemistry with enzymes, a trend led by large enzyme manufacturing powerhouses such as
Novazymes and Dupont. Codexis' niche is in the manufacturing of fine chemicals complex
substances made to exacting standards at high cost and typically in small volumes for which 
off-the-shelf marketed enzymes are inadequate and the potential cost savings and efficiency
benefits of a CodeEvolver enzyme are the most compelling.
The first industry that Codexis has targeted to commercialize this technology is pharmaceuticals
because enzyme-based manufacturing processes are well suited for the complex engineering of
novel small molecules. We estimate that over one-third of all small molecule drugs could be
produced at double digit cost savings with the use of CodeEvolver enzymes, which indicates an
addressable market of more than $1B in annual enzyme sales. Codexis has overcome regulatory
and bureaucratic obstacles to win over the A-list customers and now does business with seven of
the top ten big pharma companies worldwide under Master Service Agreements. There are no
other significant direct competitors, apart from the in-house research and development teams
within pharmaceutical companies, none of which have relevant experience comparable to that of
Business Model
With pharmaceutical customers, Codexis makes money in a number of different ways. The
simplest is contract research a team of three to four Codexis scientists works to develop a
custom enzyme for a customer on a cost-plus model, with Codexis retaining ownership of the
patentable enzyme. The custom enzyme is usually developed when the customer is first
developing a process to manufacture commercial amounts of a drug, which is around the time of
phase I / II human testing. If the drug is a success it will come to market two to four years down
the line, at which time Codexis can earn significant revenues each year selling enzymes to the
customers for its commercial manufacturing. For a drug generating $1B in annual sales, Codexis
might earn $2mm per year, with the customer saving multiples of that.
As an alternative to per-project work, Codexis has allowed two of its largest customers, GSK and
Merck, to in-license the CodeEvolver platform for its own enzyme discovery uses. In exchange
for an up-front payment and royalty / milestone payments down the line, Codexis trains these
customers to evolve their own enzymes using the CodeEvolver platform. This model gives
customers the means and know-how to incorporate biocatalysis into their manufacturing
processes, while allowing Codexis to retain and control all intellectual property, including
innovations made by platform customers. After training customers to use CodeEvolver and
guiding them through a couple of projects, Codexis has no on-going obligations, and is simply
cashing checks as customers use the technology. Codexis plans to launch a new platform deal
every one to two years, and can earn additional revenues by selling platform upgrades to the
existing customers. The up-front payments for the licenses are attractive but the back-ended
milestone payments can be much more substantial as drug candidates are developed and brought
to market.
Beyond using its enzymes to make the drugs, Codexis is also testing the ability of CodeEvolver
to develop proteins that are themselves the drug. The initial focus is the treatment of PKU, a rare
disease caused by the inability of the body to process the amino acid phenylalanine. While
existing PKU treatments have limited efficacy, Codexis has evolved an oral enzyme drug
candidate that appears to survive the harsh environment of the stomach to break down
phenylalanine in the lower gastrointestinal tract. It is too early to say if the highly evolved
CodeEvolver enzymes will make useful and differentiated therapies, but there is tremendous
upside if this is the case.
With each new project, Codexis is becoming more efficient at discovering enzymes that meet
their clients’ targets. The speed and efficiency of CodeEvolver are improving such that, within a
few years, Codexis may be able to eliminate up-front charges for its best customers so that using
Codexis for every project is virtually a zero-risk proposition. Leading indicators such as
biocatalyst R&D project revenues suggest that Codexis should be able to achieve average annual
growth in excess of 25% for many years to come within pharmaceuticals.
Other Markets
In addition to the pharmaceutical industry there are other large fine chemical markets where
CodeEvolver technology is applicable. Codexis is expanding into the food ingredients industry
(e.g., Cargill, Nestle, Coke). It has landed two undisclosed blue chip customers and will soon
ship its first multi-million dollar enzyme order for that industry. Fragrance, agriculture, and
industrial chemicals represent other large attractive markets.
Codexis has a novel platform and strong penetration among large customers; however, current
revenues are low because of the back-ended nature of many of its contracts. As existing
customers develop drugs with CodeEvolver, we believe the company can increase its revenues 2-
3x over the next several years just with current drugs in the pipeline. Incremental revenues
deliver high contribution margins, as the gross margins for enzyme deliveries are similar to that
of pharmaceuticals (80 90%) and the primary operating expense are scientists who are working
on the sales pipeline that will generate substantial revenues 2+ years in the future. On top of
that, the company has substantial additional growth available through new platform deals with
other large pharmaceutical companies and within other industries. Over time the character of the
company’s revenues will shift from up-front payments to milestone and royalty payments. Once
a customer develops and manufactures a drug with CodeEvolver it is extremely difficult to
displace Codexis with alternative technology and thus the royalties tied to these drugs can be
seen as extremely stable.
Despite this growth and cash flow profile, Codexis trades at just 3x 2016 revenues and its
enterprise value of $140mm is far below the $500mm of research and development invested in
the technology. There is no clean comparable to use to assess what the "right" multiple ought to
be, but given the strength of the technology, the barriers to entry, and the growth opportunity far
into the future, we believe fair value of the stock is multiples of current trading value.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Additional platform deals

Roll out in food/ingredient

Success in PKU

Passage of time

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