Description

ORGN – Origin Material – Long $5.69, Market Cap $823mm

Introduction

I think ORGN is the most mispriced de-SPAC opportunity I have ever come across (even more mispriced than Betterware that I wrote up on 8/4/20).  At current levels, the shares offer 426% return to my base case and 1,316% return to my upside case over the next 4 years.

Note: EV adjusted for Origin I and Origin II capital spend

ORGN is a carbon negative producer of PET, which stands for polyethylene terephthalate - PET is a clear, strong and lightweight plastic belonging to the polyester family.  ORGN’s PET can be used in food and beverage packaging, apparel, building products, activated carbon amongst other industries.  In fact, ORGN has announced agreements with leading brands in those respective spaces including Pepsi, Danone, Nestle (all 3 are investors), Ford, and others.  Most importantly, ORGN’s PET is cost comparable to petroleum-based PET and can be dropped into existing production lines with no retooling required.  The PET is chemically identical to the petroleum-based PET in use today.

The demand picture here is very attractive.  ORGN has nearly sold out of planned capacity at its second plant, which hasn’t even commenced construction.  Pepsi, Danone, and Nestle alone have enough demand to drive $8bn of revenue and $4bn of EBITDA to Origin.

Origin started life as a SPAC (Artius Acquisition Inc.).  SPACs and de-SPACs (i.e., SPACS that complete their mergers) have come under pressure.  After peaking in February, the SPAC market has more sellers than buyers.  This has manifested itself in terrible share price performance and elevated redemption levels.  2/3 of de-SPACs since March are trading below $10 and in the second half of July, we saw the average redemption rate exceed 50% vs. sub 20% through April.  Don’t get me wrong, there are plenty of terrible SPAC deals out there, however, the market is undiscerning and as a result there are a few “baby with the bathwater” opportunities.

There is a helpful investor presentation on the website: https://investors.originmaterials.com/static-files/5ca7896d-4270-43df-bac4-7c20a353443e

ORGN currently trades for $5.69 per share, down 43% from the SPAC price of $10.  You would think that for a share price move of this magnitude, there was a significant earnings revision, or the peers have traded down significantly – neither of these things have happened.  Instead, ORGN is a casualty of the SPAC market sell off, exacerbated by its lack of revenue for 2 years and lack of material revenue for 5 years.

Origin Materials is one of the most mis-priced companies I have ever seen, partially due to it being a recent de-SPAC, and offers one of the most asymmetric risk/reward opportunities I’m aware of for investors.

Origin merged with Artius Acquisition Inc to raise capital for plant construction.  Despite elevated redemption levels, the minimum cash level was satisfied, securing enough capital to construct the first 2 facilities and bridge the company to EBITDA positive.  Construction risk is perceived to be the biggest headwind for the company, however, after diligencing this issue, I don’t think the risks are that large (more on that below).  Unfortunately, construction takes time and that means that Origin 1 won’t be up and running until the end of 2022 and Origin 2 won’t be up and running until the end of 2025.  I am confident the market will wake up to this story before then, however, it requires patience in the meantime.

In exchange for our patience and undertaking construction risk, we can purchase shares at 2.8x 2026 Base case EBITDA or 1.1x 2026 upside EBITDA (assuming no excess cash/debt on the BS. I think the upside case is more likely). The difference between base case and upside EBITDA is increased capacity at the existing facilities.  Based on conversations with management and industry players, we believe they have increased their conviction in being able to achieve the upside supply case.

The company has done a poor job of driving investor awareness and telling its story.  We have done multiple calls with the company, and it has become evident that there is an asymmetry of information out in the marketplace.  The management team is very accessible, and we would recommend potential shareholders do a call with the ORGN team.

Company Overview

Origin Materials’ business is helping customers meet their net zero pledges.  Half of emissions come from the products that are made.  The typical playbook is to utilize renewable energy and electrify transportation fleets, but reducing carbon emissions from the actual production of products is challenging.  Other carbon competitors are 2-3x the price. 

Origin Materials is a specialty chemicals company that uses wood detritus as their primary input. Their products are drop-in ready (no machine or process changes required), priced competitively with existing petrochemical products (unheard of in the bio space), and the company has nearly $2bn in contracts with the likes of Pepsi, Mitsubishi, Nestle, Danone, and others; all of whom are also invested in the company. There is no technology risk here like you get with an early stage biotech. The company is building their first of two commercial scale plants, of which they have the capital to build both, assuming expected financing can be achieved.  

Origin Materials manufactures PET that is carbon negative and chemically identical to petroleum-based PET.  As a result, the product can be dropped into a company’s existing infrastructure resulting in an instant decrease in their carbon footprint.  Unlike competing products, ORGN can manufacture its version of PET at comparable prices to petroleum-based PET.

Most investors initially think of use cases such as plastic bottles, but ORGN’s PET can be used in consumer-packaged goods, apparel (polyester), auto, building products and other.  The TAM is massive.

Origin’s first facility, Origin 1, is currently under construction in Sarnia. Ontario (Canada).

Secular Tailwinds

We are currently in a once in a lifetime transition to sustainable materials.  The world is increasingly focused on carbon and most important, prominent companies have been publicly sharing their carbon goals – this has become a board level issue.  The biggest challenge for many of these companies is that they need to choose between the environmentally friendly option or the cost-effective option.  With ORGN, there is no need to choose.  Additionally, the increasing value of carbon credits should drive pricing power for ORGN.

We are witnessing increased importance of ESG within the investment community.  In May 2021, a small hedge fund, Engine No. 1 unseated directors at Exxon Mobil (ticker: XOM).  The fund successfully rallied support from institutional investors and shareholder advisory firms upset with Irving, Texas-based Exxon for its weak financial performance in recent years. Among those were BlackRock Inc (ticker: BLK), Exxon's second-largest shareholder, who agreed to vote for three members of Engine No. 1's slate.

https://reenergizexom.com/

“It has been a stunning fall from grace for ExxonMobil.”

No public company in the history of oil and gas has been more influential than ExxonMobil (NYSE: XOM).  It is clear, however, that the industry and the world it operates in are changing and that ExxonMobil must change as well. 

On August 5th, 2021 it was reported “Exxon mulls pledging net-zero carbon emissions by 2050”

Licensing / Partnership Opportunity

I asked management if there is any way to accelerate construction/revenue generation.  They explained that engineering and construction just take time.  However, they said that asking if the timeline can be accelerated is the wrong question. The right question is how much additional capacity can be brought online concurrently with Origin 2.

Licensing and partnerships were one of the most interesting dynamics we spoke about with management, however, this seems to be an underappreciated part of the story.  I haven’t heard other investors discuss it, nor is it mentioned in current sell side notes.

Management noted that there are several interesting ways to partner with an existing chemicals player to construct more capacity. 

How would this work?

Economically large E&Ps have high-teens hurdle rates.  With proprietary and well controlled technologies, the agreements are typically structured such that the capital provider receives their hurdle rate with an economic split thereafter.  Management noted that a 50/50 split would be conservative.  These plans would need to be finalized in H2 2022 and management’s first choice would be a multi-billion dollar, multi-year program.

Management noted everything they are doing now is supportive of multiple plants in 2025

Management’s familiarity with these sorts of agreements and key terms leads me to believe that these dialogues are ongoing.

I asked why you would consider partnerships if your returns on invested capital are so high, to which the company responded: 

“In order for us to reach our full market there needs to be something like $250bn of capital deployed.  It would take us a long time to get there alone. XOM has a capital budget of $25bn per year. It makes a lot of sense to do this with a partner. Large oil and petrochemical companies have huge capital budgets and they are getting pressure from everyone: customers, regulators, and shareholders.  They can’t change their revenue profile doing business the way they always have; they need to invest in new assets.”

The benefit of partnering for 1 additional plant could add ~$150mm+ to EBITDA and drive 50% accretion to EBITDA, while producing an attractive ROIC for the capital partner.

Construction and Financing is Less of a Risk than the Market Believes

Construction

ORGN contracted with Koch Modular for Origin 1.  Koch Modular does engineering and fabrication, essentially plant construction for companies like ORGN.  Koch Modular does soup to nuts all the engineering, manufacturing, and construction.  Once the plant is mechanically and electrically complete, Koch comes back with their startup team and commissions and starts up the plant.  Koch gave ORGN performance guarantees on the hydraulics, thermal and mechanical performance of the plant which is an expression of how confident they are.  It is unusual for a manufacturer to provide performance guarantees.

We believe the Koch performance guarantees meaningfully de-risk the construction risk of Origin 1 and this is another dynamic that is not well appreciated by investors.

Risk of Scaling

There have been some concerns about the ability to scale.  I asked the company what they thought and this was their response:

“If you look at classical chemical processing, you don’t really see technical failures at scale very often.  I reached out to my network, and we can’t come up with a technical failure at scale in classical processing where we sit.  You see lots of technical failures in gasification and fermentation of commodity chemicals – very few successes.  I think this says a lot about gasification and fermentation vs. scaling technology.  If you look at our team it is filled with literally the best of the best from the industry.  We are working to get third party reports on the scalability of our technology.”

Financing

There are concerns that due to the high redemption rate, ORGN will be forced to raise equity at unfavorable terms, however, we disagree.  Unlike many SPACs, ORGN did not waive its minimum cash condition.  In fact, they raised incremental cash from Apollo and some insiders to ensure they hit their min cash number.  I don’t think the street appreciates the level of time and precision in formulating the minimum cash requirements. The market doesn't seem to appreciate footnote 6 in the company's 8k on 6/29, which states: "The Company has confirmed its estimate for construction cost after considering the latest input from various suppliers, construction companies and consultants specializing in chemical plant constructions. The Company has built into its capital budget for Origin Plant 1 and Origin Plant 2 contingencies as a reserve for any unexpected construction "overrun" that are appropriate at this stage of planning."

The problem is that ORGN never disclosed their project level financing assumptions – so the street can’t appreciate if they are aggressive or conservative.  The below slide was published at transaction close – I don’t think column 1 was previously disclosed.  The key question is if the $804mm of project level finance is aggressive?  $804mm implies a LTV of 70% based on the Origin 1 and Origin 2 Capital costs.  Based on my calls with management and more importantly some bankers it seems that project level financing is currently available at much more aggressive LTVs.  Additionally, as you can see in the second slide PCT is forecasting 80% debt to capital for its future expansion.

I think (not confirmed) that the Artius SPAC was actually too large for the ORGN transaction.  That is the reason they only raised a $200mm PIPE in arguably the hottest PIPE market of all time.  The PIPE was highly oversubscribed with many investors being scaled back and even zeroed.  Artius had to show very conservative financing assumptions otherwise it just wouldn't make sense for this target - particularly in February when SPACs were reaching for bigger and bigger targets.

Intellectual Property

Management believes their patents are very strong (they are process patents).  The steps to get economic conversion of feedstock are patented.  The company has a lot of “know how” which is below that in “trade secrets.”  It takes 10 years to develop a process like ORGN’s from scratch, likely longer.  It would be more economical for a firm to partner with ORGN rather than try to recreate what they have done.

Timeline and PNL

Management has provided a timeline that calls for Origin 1 to be completed at the end of 2022 and revenue generating in 2023, Origin 2 completed in 2025 and revenue generating in 2026 and Origin 3 completed at the end of 2026 and operational in 2027.  Note, management is already taking orders for Origin 3.

Origin 1 is a smaller facility and was not built to optimize unit economics, but rather proof of concept for non-PET market development. As a result it is expected to generate revenue of $122mm and break even on plant profit.  Origin 2 on the other hand is ~16.5x the size of Origin 1 in terms of lbs. of product sold.  It is expected to generate revenue of $708mm and plant profit of $385mm.

Why does this opportunity exist?

As mentioned above it has been a challenging period for the SPAC market as a whole.  We are seeing meaningful underperformance, however, ORGN seems to be in a league of its own.  There are other SPACs such as ATIP, which are trading worse, however, in their first quarter they gutted the forecast they provided just a few weeks earlier.

In addition to poor trading, ORGN’s PIPE was registered to trade on August 2 which put even more downward pressure on the stock.

There are reasons not to own the stock and they all create the opportunity

(1)    SPACs are bad and all fraudulent

a.       This sponsor is very well-respected Charles Drucker who was the CEO of Worldpay until selling it to FIS in 2019 and Boon Sim who was formerly the head of Temasek North America and the Global Head of Mergers and Acquisitions at Credit Suisse.

b.       The amount of diligence and customer calls is impressive including hiring 2 separate consulting firms – one of which was the same firm Pepsi, Danone, and Nestle hired to diligence Origin’s PET.  There is good detail in the S-4

            i.      In conjunction with the consultants, Boon and Charles did 40 customer calls.  Each call was 60-90 minutes where they reviewed detailed questions on pricing, demand, alternative, etc.

            ii.      The consultants also reviewed the unit economics of the business, line by line including chemical costs, feedstock costs and building out a very detailed PNL

(2)    No revenue until 2023 and the key catalyst isn’t until 2025

a.       This gets placed in the “venture opportunity” bucket

b.       Unlike many other companies going public with no revenue, ORGN has a strong contracted backlog

c.       They are also currently the only game in town for carbon neutral PET at the same price as petroleum based PET

(3)    The chart – let’s face it, most managers are closet momentum chasers and the chart right now is just ugly

Catalyst Path

The lack of catalysts and announcements following de-SPAC have added to investor concern.  Although to be fair, prior to the transaction closing the stock had no reaction when they announced partnerships with Ford and Palantir.  I see the following catalysts:

• Inaugural earnings on August 22

• Likely not a lot of new information, but updated metrics on demand trends

• I am hopeful they will emphasize why they don’t need to raise capital to fund construction of Origin 2 - this is clear if you speak to management, but less clear otherwise

• Management said they would update the order book on a quarterly basis

• We may also learn that Origin 2 is nearly if not completely sold out

• Analyst coverage: Timing TBA, but would expect sooner rather than later

• While Freemium, Raymond James and Craig-Hallum have initiated, I would expect bulge bracket coverage from Goldman and Credit Suisse as they were underwriters on the SPAC

• Origin 2 site selection: before year end

• Origin 1 up and running late 2022/early 2023

• Origin 2 financing and construction start Q1 2023

Valuation

At today’s valuation, you are making a binary bet on the successful construction of Origin 2.  Shares are currently trading at 2.6x/1.0x Base/Upside 2026 EBITDA.  Dupont (DD) currently trades at ~10x EBITDA.  Dupont is a mid-single-digit revenue grower, and if you believe ORGN can continue to build plants they will have a far superior revenue trajectory.  The management team forecasts a 48% revenue CAGR.

I am using management forecasts as my own.  The team had consultants build the PNL by line item and if anything I would say pricing power is increasing (resulting from carbon credits).  The margin of safety is so wide that even if these forecasts are slightly off it shouldn’t impact the risk/reward skew from current level.

To review the timing of key PNL events: Origin 1 is expected to go online at the end of 2022 and ramping during 2023 and 2024.  Origin 2 is expected to come online with its first full year of revenue and EBITDA profitability in 2026.

Note: EV adjusted for Origin I and Origin II capital spend

In the base case, shares are worth $29.91 (+426% upside) at 20x EBITDA and $45.94 (+707% upside) at 30x EBITDA. In the upside case, shares are worth $80.60 (+1,316% upside) at 20x EBITDA and $121.97 (+2,044% upside) at 30x EBITDA.  The upside case assumes more capacity comes online faster and new contract pricing comes in moderately higher. In the downside case, shares are likely worthless.  The risk/reward with the stock at $5.69 is extremely compelling. Note: I think the multiples are conservative if the company is able to execute its plans based off peers multiples with lower growth and the earnings upside.

This excludes the upside potential from partnerships which we estimate can drive $147mm of EBITDA per plant which equates to $8 per share of value at 10x and $17 at 20x.

As you can tell I think many of the investor concerns I’ve heard are overstated.

Catalyst

The lack of catalysts and announcements following de-SPAC have added to investor concern.  Although to be fair, prior to the transaction closing the stock had no reaction when they announced partnerships with Ford and Palantir.  I see the following catalysts:

• Inaugural earnings on August 22

• Likely not a lot of new information, but updated metrics on demand trends

• I am hopeful they will emphasize why they don’t need to raise capital to fund construction of Origin 2 - this is clear if you speak to management, but less clear otherwise

• Management said they would update the order book on a quarterly basis

• We may also learn that Origin 2 is nearly if not completely sold out

• Analyst coverage: Timing TBA, but would expect sooner rather than later

• While Freemium, Raymond James and Craig-Hallum have initiated, I would expect bulge bracket coverage from Goldman and Credit Suisse as they were underwriters on the SPAC

• Origin 2 site selection: before year end

• Origin 1 up and running late 2022/early 2023

• Origin 2 financing and construction start Q1 2023