Carbios — Advancing towards commercialisation

Carbios develops processes for biodegradation, biorecycling and bioproduction of plastics, based on depolymerisation of monomers and subsequent re-polymerisation. The processes used by Carbios are based on naturally produced enzymes selected for their ability to degrade the polymers that make up plastic materials. The bioprocesses under development seek to create fully biodegradable plastics with a controlled lifespan (biodegradation), allow the infinite recycling of plastic waste with no deterioration in quality of the plastic (biorecycling) and produce biopolymers (bioproduction). The company was founded in 2011 and floated on Euronext in December 2013. Currently, Carbios possesses 26 patent families, three innovative bioprocesses and employs 20 people.

We continue to use a DCF-based valuation approach for Carbios, although the timing and scale of future cash flow projections remain highly uncertain, and will be dictated by the pace of technological development and the commercial environment. Our DCF is based on cash flow projections for the two principal business segments: biodegradation and biorecycling. We project cash flows to 2035, assuming a long-term EBIT margin of 60%, a discount rate of 15% and perpetuity growth rate of 2%. Using these unchanged assumptions indicates a valuation for Carbios of c €15/share. At current levels, the market appears to be assuming a 65% probability of Carbios achieving our revenue projections. In addition to the highly uncertain nature of the cash flow projections, the valuation remains sensitive to assumptions on discount rates, perpetuity growth rates and long-term margins. An increase in the discount rate to 20% would reduce the valuation to €5/share.

We expect Carbios to generate its first commercial revenues in 2020, until which time it will generate only modest sums of revenue from the provision of research services to Carbiolice and remain loss making until 2022. At the recent interim results, Carbios revealed a healthy net cash position of €6.7m, in large part due to the equity issue, which took place in July 2017 (€4.2m). The company believes its current cash position is sufficient to fund the business until H219. At some stage before this date, Carbios will have to investigate the possibility of raising additional sources of finance.

Carbios develops enzymatic processes for biodegradation, biorecycling and bioproduction of plastics. A key part of its business is the development of enzymes to degrade (biodegradation) the polymers that make up plastic materials (both biosourced plastics and synthetic polymers derived from hydrocarbons). As part of this process, Carbios embeds enzymes into plastic materials, which facilitate the biodegradation of the plastics in the environment over a controlled lifespan, without compromising the quality of the original plastic materials. The use of enzymes is also fundamental to Carbios’s approach to biorecycling, whereby it aims to achieve the de-polymerization of a single polymer via the action of highly specific enzymes mixed with the plastic recyclate. At the conclusion of this process, the monomer or monomers produced by the de-polymerization process will be purified, with the aim of rendering them fit for re-polymerization. Carbios also claims to have developed, in collaboration with INRA and INSA, the first 100% biological pathway to synthesize polylactic acid (PLA). The process involves the enzymatic polymerization of lactic acid into a PLA polymer of high molecular weight without any intermediate step.

Carbios spans the entire process of technological product development from research to commercialisation. The research stage of the process involved the selection and optimisation of enzymes, after which the process moved to pre-pilot, pilot demonstration and finally commercialisation through licensing. These processes are commonly carried out with a wide variety of scientific, financial and trade partners (eg L'Oréal, Limagrain, Toulouse White Biotechnology, Bpifrance) with a view to reducing operating expenditure and capex. Once commercially proven, Carbios seeks to license its enzymatic technology and processes, as it has already done in the case of Carbiolice.

Martin Stephan joined as deputy CEO in February 2017, but otherwise there has been continuity in the management team (Executive Committee) in recent years. Jean-Claude Lumaret has served as CEO since 2011 and Professor Alain Marty as chief scientific officer since 2015 after a three-year collaboration as a member of the company’s scientific committee. Mr Lumaret, who has a degree in chemical engineering, also has significant experience as a patent attorney, which is of great relevance to Carbios’s business model as the company seeks to protect its technology. Professor Marty has wide-ranging academic and scientific experience in biotechnology, enzymology and bioengineering.

The H118 results confirmed that Carbios’s short-term financial performance remains in line with our FY18 expectations. For the more important long-term outlook, Carbios continues to demonstrate scientific progress and its subsidiary, Carbiolice, is expected to generate commercial revenue from 2020. The potential market remains significant, with most competing technologies in the nascent stage and none yet to achieve a dominant market position, and we believe Carbios is well placed to capitalise on the market opportunity.

Carbios’s has yet to generate commercial revenue from licensing its technology (we expect first revenues from 2020) and the majority of its revenue is derived from the provision of services to its subsidiary, Carbiolice. In H118 revenue declined by 33%, but remains broadly in line with our FY18 projection of €1.1m. Operating expenses rose by 15% versus H117, but operating losses of €2.3m were in line with our expectations for an FY18 operating loss of €4.6m. Net income was helped by a tax credit of €0.635m and at the net income level the loss of €1.7m shows that Carbios is well on track to meet our FY18 expectation of a loss of €3.9m. Cash of €6.7m was c €2m higher than H117, thanks to the equity issue in H217 (€4.2m), but €0.9m (due to cash burn) lower than FY17. Carbios believes its cash position is sufficient to cover its financing needs until the second half of 2019. Given that the results were broadly in line with our expectations, we have no adjustments to our forecasts.

Of greater significance for the prospects of long-term value creation at Carbios is the scale of the market opportunity and the development of its technology. We examine both of these factors in the following section of the note.

According to EU figures, the global production of plastics reached 322 million tonnes in 2015. The 2015 figure represents a twentyfold increase since the 1960s and the production of plastics is expected to double again over the next 20 years. However, European production has remained flat in recent years (at c 60m tonnes), although Europe remains the second largest producer of plastics in the world (2014 market share 20% behind China with 26% of global plastic production). Today, the majority of plastics are manufactured from hydrocarbons, although alternative bio-based plastics are also being developed but at present account for a very small share of the market. In Europe, Germany accounts for c 25% of total demand, with Italy second (c 14%) and France third (c 10%). The largest proportion of plastics in Europe (39.5%) is used for packaging, with a further 20.1% used in the building and construction industry. Polyethylene terephthalate (PET) accounts for c 7% of the overall plastics market.

While Europe has managed to reduce the amount of plastic sent to landfill in recent years, according to the EU, reuse and recycling of plastics remains low in comparison to other materials. The rise in the use of plastics and the low recycling rate present a number of environmental issues. Some plastics are non-biodegradable, whereas others can take 200-300 years to degrade and are responsible for significant pollution in their manufacturing process. EU statistics indicate that c 25.8m tonnes of plastic waste are generated in Europe every year, with an estimated c 8m tonnes of plastic is sent to landfill (c 30% of plastic waste arising), an obvious environmental problem given the slow pace of biodegradation. Less than 30% of waste is recycled, of which ‘a significant share’ leaves the EU to be treated elsewhere, where lower environmental standards may apply. EU demand for recycled plastics accounts for only around 6% of demand. In recent years, the EU plastic recycling sector has suffered from low commodity prices and investment in new plastic recycling capacity has, as a consequence, been undermined. In addition, the EU estimates that plastics production and the incineration of plastic waste are responsible for c 400m tonnes of CO2 a year. Globally plastic waste is estimated to total c 125m tons per year, with 9m tons per year deposited in the oceans.

Policy and legislative requirements suggest increased focus on addressing the issue of plastic waste. In early 2018, the EU published A European Strategy for Plastics in a Circular Economy, in which it set out a ‘vision for Europe’s new plastics economy’. In accordance with the vision, by 2030 all plastics packaging must be either reusable or be capable of being recycled in a cost-effective manner. Also by 2030, more than 50% of all plastic waste generated in Europe should be recycled. The EU believes this vision will require a fourfold increase in recycling capacity (2030 versus 2015), creating 200,000 new jobs, but enable recycled plastic to become a valuable feedstock, help reduce Europe’s dependence on imported fossil fuel and cut CO2 emissions. The EU believes that to fulfil its vision alternative and more sustainable feedstocks for plastic production will also need to be developed. Improving the economics and quality of plastics recycling is central to achieving its vision and the EU has called on key players to improve design to make plastics easier to recycle; expand and improve the separate collection of plastic waste, to ensure quality inputs to the recycling industry; expand and modernise the EU’s sorting and recycling capacity; and create viable markets for recycled and renewable plastics. The EU has called for the industries involved to develop a set of voluntary commitments to back this strategy and vision for 2030. The European Commission (EC) itself has proposed new rules on waste management, including clearer obligations for national authorities to step up separate collection; targets to encourage investment in recycling capacity and avoid the construction of excess incineration capacity; and closer harmonisation of the rules of extended producer responsibility.

In addition, the EC has set the objective of reducing the amount of waste sent to landfill to 5% of all arising by 2030, emphasising the need to recycle (the preferred option) plastic. The French Energy Transition Law for Green Growth, which provides for the minimum level of bio-based plastics in plastic bags, increases the level from 30% in January 2017, to 40% in January 2018 and 50% in January 2020. We believe these legislative trends align with Carbios’s business strategy

Current thermomechanical processes are limited by a number of factors, including the diminished quality of the recycled material and the sensitivity to contamination by other polymers and external impurities. These difficulties restrict the reuse of recycled plastics for their original purposes so that, for example, in France (in 2013) only 27% of recycled PET is reused in bottles and flasks, with the majority (52%) used in fibres.

In an attempt to reduce the level of plastic waste leakage into the environment, biodegradable and compostable plastics have been developed. However, at present these new types of plastics represent less than 1% of the total market. A number of reasons have been advanced as to why biodegradable/compostable plastics have not achieved higher rates of market penetration, including their inability to replace all types of plastic material (poor mechanical qualities), high costs, lack of control over the length of biodegradation but, perhaps most importantly, the fact that plastics are only biodegradable in certain conditions (industrial compost at above 50oC), rather than in the environment more generally (20-30oC). At present, Carbios estimates that biosourced polymers are two to four times more expensive than conventional plastics produced from oil. Despite drawbacks, the growth in biodegradable plastics is expected to continue at c 10-20%.

A key part of Carbios’s business is the development of enzymes to degrade the polymers that make up plastic materials (both biosourced plastics and synthetic polymers derived from hydrocarbons). As part of this process, Carbios embeds enzymes into plastic materials, which facilitate the biodegradation of the plastics in the environment over a controlled lifespan, without compromising the quality of the original plastic materials. The plastics are degraded into the original base molecules, which in turn can be assimilated by the micro-organisms in nature. Carbios’s biodegradation process is estimated to take around three months, compared to 200-400 years for conventional plastics. The specificity of the enzymatic activity inherent in Carbios’s biological process also allows it to degrade all kinds of single-use plastics (bags, films, food packaging etc) and enables it to be adapted to the expected time of use for each application.

The biodegradation research began in 2013 and in 2014 Carbios achieved the key milestone of producing a plastic material (from polycaprolactone, PCL) as the result of the activity of an embedded enzyme capable of biodegradation. The polymer saw a loss of mass of 50% within 15 days and complete biodegradation within three months. The following year, the biosourced polymer, PLA, was similarly degraded as a result of the enzymatic process. In 2016, Carbios commenced the industrial development of this process via the creation of a joint venture, Carbiolice. Currently, Carbios has developed biodegradation processes that are capable of processing both PET and PLA to eco-friendly biodegradable PLA and PLC.

Carbiolice is an industrial and commercial joint venture with Bpifrance and Limagrain Céréales Ingrédients (a global seed producer). Created in September 2016, the project has a financing budget of €18m, including €11m from Bpifrance. The €18m is scheduled to be released in three phases, over four years, on completion of technical and commercial objectives. The three partners of the project invested €4m in 2016 and in July 2018 a second round of financing of €3.35m (€1.1m Carbios) was announced.

In the short term, Carbiolice produces corn-based compounds and biopolymers for plastic manufacturers involved in the production of bags/mulching films. From 2020 Carbiolice will operate patented enzymatic biodegradation technology (licensed from Carbios) to produce enzymated pellets (compound and masterbatch) to be used to produce biodegradable plastics. According to Carbios, the incorporation of its pellets leaves the performance of the polymers unchanged and does not require any modification to the plastic production facilities. Carbiolice will target the market for bags and packaging – 17.5m tons/yr ($28bn), mulching films – 2m tons per year ($5bn) and technical films – 500,000 tons per year ($4bn). Carbiolice will operate one industrial plant capable of producing 4,000 tons per year and will ultimately target a third of the market in the EU for soft biodegradable plastics.

On the formation of Carbiolice, Carbios received an upfront payment of €8m, which was converted into shares in the joint venture. Carbios will also receive R&D collaboration revenues of c €2.5m over a three-year period, which will help support the industrial development of Carbiolice and serve as an additional source of income for Carbios. Commercial launch, expected in 2020, will provide the first commercial revenues for Carbios.

Once again, the use of enzymes is key to Carbios’s approach to biorecycling. Carbios’s process aims to achieve the de-polymerization of a single polymer via the action of highly specific enzymes mixed with the plastic recyclate. At the conclusion of this process, the monomer or monomers produced by the de-polymerization process will be purified, with the aim of rendering them fit for re-polymerization. The low-energy consumption bioprocess should enable the recycling of complex and opaque plastics via a process of continual recycling without any deterioration in the quality of the plastic material produced, and without resorting to the costly mechanical and heating process involved in current thermomechanical recycling processes. Carbios is particularly interested in PET plastic and polyester fibres (its main market focus), but also in PLA and polyamides. These polymers have chains of monomers that are easily identifiable by the enzymes and are thus easier to de-polymerize. Carbios believes that this technology is particularly appropriate for application with plastic bottles, packaging and textile fibres.

Carbios claims to have developed, in collaboration with INRA and INSA (partners in the Thanaplast programme), the first 100% biological pathway to synthesize PLA. The process involves the enzymatic polymerization of lactic acid into a PLA polymer of high molecular weight without the usual expensive intermediate step, which normally requires the condensation of lactic acid into a lactide (the intermediate step) and then its polymerization to obtain PLA. Currently, global demand remains modest (c 190,000 tons per year) but is expected to grow at 15% per year until 2020.

As we have noted, Carbios has focused its scientific endeavours on two polymers: PET and PLA.

Polyethylene terephthalate (PET) is a resin of the polyester family and consists of polymerized units of ethylene glycol and terephthalic acid. PET is a strong, naturally transparent and semi-crystalline plastic, and is one of the most commonly used polymers in the world. PET is deployed in fibres for clothing (accounting for c 60% of global demand and is known as polyester in the textile industry), and plastic containers for food and liquid (c 30%). PET’s strong, stable, durable and lightweight characteristics make it a popular choice in the packaging sector (water and soft drinks).

PET is not biodegradable, but is widely recycled. According to figures produced by the PET Resin Association, approximately 1.5bn lbs of used PET bottles are recycled in the US every year, making PET the most recycled plastic in the US, with a recycling rate of approximately 31%. The recycling rate in the EU is reported to be even higher, at 52%.

Carbios first achieved the 100% depolymerisation of PET into its original monomers, terephthalic acid and ethylene glycol in December 2015, and in November 2016 this technology was made applicable to crystalline PET. Subsequently (in June 2017), Carbios synthesized PET oligomers from terephthalic acid and in October 2017 produced virgin PET from terephthalic acid produced from its biorecycling process of PET bottles. In June 2018, Carbios announced that it had improved the enzymatic hydrolysis step of its process, achieving a conversion rate of 97% within 16 hours (previously 24 hours in April 2018). Carbios is currently seeking to move towards the industrialization of this technology and has been working with TechnipFMC to construct a demonstration plant.

Polylactic acid (PLA) is a thermoplastic polymer produced from lactic acid (C3H6O3) or lactide monomers, derived primarily from renewable resources like corn starch or sugar cane, whereas the majority of plastics are derived from the distillation and polymerization of petroleum reserves. PLA is termed a bioplastic as a result of its biomass origins and is biodegradable. Common applications of PLA include plastic films, bottles and biodegradable medical devices. Currently, bioplastics comprise only a small (but rapidly growing) proportion of all plastics produced on an annual basis and, according to Plastics Insight, total production capacity of bioplastic in 2017 was 2.05m tones, of which PLA has a market share of 10.3% of the raw material used for bioplastics production. According to figures used by Carbios, production of PLA in 2014 totaled 114,000 tonnes.

Carbios first demonstrated its ability to depolymerise PLA in 2013 and has now refined the process, allowing for 90% depolymerisation of PLA in 24 hours to obtain lactic acid. It has now effectively closed the loop and demonstrated the circularity of the process, producing virgin PLA from lactic acid obtained from the biorecycling of the plastic (PLA). Given the limited production of PLA, the recycling of PLA remains, at present, a relatively small but nevertheless emerging market with strong growth characteristics (10%+). Although work on PLA remains in the development stage, Carbios is discussing the potential licensing of its technology with industrialists.

As we have seen, there is a significant need from a regulatory and environmental perspective to increase the rate of recycling, and the market for plastic recycling is sizeable. Carbios aims, via its holding in Carbiolice, to produce enzymated plastic pellets from 2020 which, when incorporated into plastic, will leave its properties undiminished and allow the plastic to biodegrade.

Given the scale of the potential market, there are a number of players developing products and processes in the market for biodegradable and recyclable plastics. Ioniqa, based in Holland, is building its first PET plastic upcycling factory (10,000 tons per year), with a view to commencing production in H119. Ioniqa has signed a partnership agreement with Unilever. Meanwhile, Loop is developing its own depolymerisation technology and is currently in the process of designing a fully integrated manufacturing facility to upcycle waste. It also has an agreement in place with L'Oréal to supply it with PET resin.

The market and competitive technologies remain at the nascent stage and no single approach appears to have established a dominant market position. Given the scale of the market opportunity, we believe ultimately that there is scope for the co-existence of a number of alternative technologies.

Martin Stephan joined as deputy CEO in February 2017, but otherwise there has been continuity in the management team (Executive Committee) in recent years. Jean-Claude Lumaret has served as CEO since 2011 and Professor Alain Marty as chief scientific officer since 2015 after three years’ collaboration as a member of the company’s scientific committee. Mr Lumaret has significant experience as a patent attorney, which is highly relevant to Carbios’s business model as the company seeks to protect its technology. He also has longstanding experience of the starch industry and a scientific background with a degree in chemical engineering. Professor Marty has wide-ranging academic scientific experience in biotechnology, enzymology and bioengineering. In addition, Carbios has a board of directors with eight members and a scientific advisory board with four members. In total, Carbios employs 20 people.

We remain of the view that, in the absence of short-term commercial revenues, the announcement of collaborative deals with brand owners to develop Carbios’s technology will act as the key share price driver. Clearly, there is a low degree of visibility on the scale and timing of such announcements.

The timing and scale of future cash flows also remain highly uncertain and will be dictated by the pace of technological development and the commercial environment. We use a DCF methodology to provide an indicative valuation for Carbios although, given the nature of the business, the projections remain highly uncertain. We recently (see our note Transition year and strengthened balance sheet published on 9 July 2018) updated our DCF methodology to reflect the acquisition of a majority interest in Carbiolice in 2016, and the issue of equity and the additional contribution of €1.1m to Carbiolice in 2018. Our revised DCF is based on cash flow projections for the two principal business segments: biodegradation and biorecycling. We project cash flows to 2035, assuming a long-term EBIT margin of 60% (for the period 2031-35 we assume the margin remains at 60%), a discount rate of 15% and perpetuity growth rate of 2%. By 2035 we project revenues of c €127m. Using these assumptions indicates an unchanged valuation for Carbios of c €15/share. At current levels, the market appears to be assuming a 65% probability of Carbios achieving our revenue projections and margins.

In addition to the highly uncertain nature of the cash flow projections, the valuation remains sensitive to assumptions on discount rates, perpetuity growth rates and long-term margins. Exhibit 3 shows the sensitivity of our valuation to long-term margin projections to 2031 (we assume a continuation of the 2031 margin for the period 2032-35) and, in particular, discount rates.

Our estimates remained unchanged.