About the same time I was warning last year of an ethanol bubble, Bill Gates was sinking money into Pacific Ethanol (PEIX). In the same essay in which I warned of the bubble, I took a look at Pacific Ethanol, and concluded that the underlying fundamentals of the stock – even with the ethanol mandate – were not good.
Since that time, Pacific Ethanol has fallen from $22.54 down to today’s value of $9.97. Given that Gates’ purchase price was $16.00 a share – and the stock ran up to ultimately around $40 before collapsing – it looked like a shrewd move for a while. And I lost count of how many people – when arguing with me about ethanol – pointed out that Bill Gates and Vinod Khosla were investing in it, and that was good enough for them. After all, who did I think I was to contradict a couple of billionaires on their vision of the future? (Of course, one billionaire – Mark Cuban – did listen).
But the fundamentals were not there. I believe that Gates finds himself in this position – and I don’t believe he has seen the last of his (long-term) losses in this stock – because he had to rely on others to give him direction in his case. He was outside his area of expertise. And while people seem to automatically assume that Bill Gates’ genius in the computer industry somehow translates across other industries, this is not the case. I have said the same about Vinod Khosla – expertise in one area does not transfer to a completely different industry, so you better take his ethanol claims with a very large dose of salt. I believe that he will ultimately lose out in a very big way with his ethanol investments. He may sell into some hype and make a bit of money now, but if he stays in for the long haul he will not fare very well.
Continuing on this theme, today several ethanol stocks, including Pacific Ethanol, were downgraded by a major brokerage firm:
NEW YORK (Associated Press) – A Friedman Billings Ramsey analyst downgraded three ethanol producers Thursday, slashing his price targets and predicting the industry’s “growing pains” will continue due to small profit margins and oversupply.
Ethanol production margins have dropped to 15 cents per gallon from 75 cents in mid-May, said Eitan Bernstein, as the price of ethanol has dropped. He said prices will stay low through 2008, and reduced his ethanol price estimates for 2007 to 2010.
Bernstein cut his rating on Aventine Renewable Energy Holdings Inc. to “Underperform” from “Outperform,” reducing his price target to $9 per share from $24. The stock closed at $11.68 Wednesday. He downgraded VeraSun Energy Corp. stock to “Market Perform” from “Outperform,” halving his price target to $12 from $24. The stock finished at $12.02 on Wednesday, and was unchanged in premarket trading. The analyst now rates shares of Pacific Ethanol Inc. “Underperform,” down from “Market Perform.” He cut his price target to $8 from $15. Shares ended Wednesday trading at $11.17.
Bernstein’s downgrades come a day after Aventine President and Chief Executive Ronald Miller addressed investors at a Bank of America conference. Miller said the industry is in a very difficult time due to declining margins, and expects conditions to stay hard until 2009.
Shouldn’t that downgrade have come before the stock price crashed? Of course if you have read this blog for long, you know that I have been warning about this for a long time. Here was a warning I gave 6 months ago:
When a commodity has such incredibly low barriers to entry, it is only a matter of time before capacity is overbuilt and the price crashes. That’s why I expect ethanol producers to continue lobbying congress to increase the amount of mandated ethanol usage and to accelerate the timeline. Otherwise, a lot of ethanol producers will struggle to stay in business in the next few years as their increased demand for corn continues to increase the price, while all the new ethanol capacity is flooding the market. Profit margins will evaporate (although corn farmers should earn a windfall). What we may see is a bail out reminiscent of the Savings and Loan debacle of the 1980’s.
Looks like Wall Street is finally coming around, although a bit too late for many investors. It may not matter much in the end to a billionaire, but it will to the people who tried to emulate them by following their investment strategy.