OUTTHINK OUTPERFORM REPEAT OFTEN The best ideas are the ideas that make clients money. That s why Paradigm Capital approaches every investment opportunity with calculated boldness and fresh perspectives, supported by meticulous execution. Burcon NutraScience Corp. ADM is a Great Partner Shifting Focus To Soy Proteins Financial Summary (C$M) Paradigm Estimates (y/e Mar) Revenue EBITDA EPS EV/Rev EV/EBITDA P/E FY10 0.0 (6.8) (0.24) nmf nmf nmf FY11e 0.0 (5.6) (0.19) nmf nmf nmf FY12e 20.7 14.2 0.48 12.9 x 18.8 x 19.8 x FY13e 92.7 85.0 1.86 2.9 x 3.1 x 5.1 x All figures in C$, unless otherwise noted. Source: Company filings, Paradigm Capital Inc. Investment Thesis. The global demand for ever higher food value from agriculture is growing at an unprecedented pace, driven by population growth and economic growth. The functional food and beverage markets, comprised of protein, fiber, mineral or vitamin fortified products that promote specific health benefits, is gaining consumer attention. In particular, the addition of protein ingredients into many different foods is increasingly gaining momentum due to scientific advances and a growing health conscious attitude amongst many consumers. The worldwide market for protein ingredients is expected to reach US$15B in 2015 driven by new applications and product development. Event Burcon licenses worldwide rights for the soy protein isolate manufacturing technology to Archer Daniels Midland (ADM N, NR). Details Burcon signed a letter of intent to license the soy protein isolate technology. A definitive agreement to be inked before March 1, 2011. No financial details provided. An agreement should include milestone payments until they receive royalties on sales. Royalties on sales could start in calendar Q42011. First plant construction could start in Q2 2011 and be completed before year end We are assuming four plants to be build with the first one completed by Q4 2011 and the last plant operational by 2013. Total capacity should be 280,000 metric tons (MT)/year. Other assumptions include soy protein isolates pricing of $8,500/MT and Burcon receiving a 12% royalty rate declining to 9% by 2013. Discussions for canola protein manufacturing technology remain ongoing but completion could be delayed until the soy technology agreement is completed. ADM could be a great partner and is currently the second largest oilseeds producer in the world with more than 250 plants worldwide. Conclusion The suspense is now over and we now have better indications of what the future may look like. The main value driver for ADM and Burcon has now shifted to the development of the soy protein isolates technology. It appears that more than one party was interested in partnering the soy protein technology but in the end, ADM presented the better deal. Our financial estimates are revised to reflect the new timelines. Our sensitivity analysis indicates that the soy technology could generate fully taxed EPS of $5.23/sh plus another $1.33/sh for the canola protein technology. We are maintaining our target price of $20.00 based on NPV and our Buy rating. Company Profile Company Profile (C$) Sector Ticker Healthcare BU T Buy Stock Rating Closing Price (C$) $9.45 12 Mth Target (C$) $20.00 Potential ROR 112% Shares O/S Bsc (M) 29.7 Shares O/S FD (M) 29.7 Mkt Cap, Bsc (C$M) $281 Mkt Cap, FD (C$M) $281 Enterprise Value (C$M) $267 TTM Rev/sh nmf Net cash/sh $0.45 Company Description Burcon operates as a research and development company developing manufacturing technologies to extract important ingredients for use in food and beverages. The company develops a portfolio of composition, application, and process patents related to its plant protein extraction and purification technology. Its patented processes utilize oilseed meals for the production of purified plant proteins that exhibit nutritional, functional, and nutraceutical profiles. Burcon has developed Clarisoy from soy that could be used in food and beverages and canola proteins, Puratein and Supertein. Research Team Claude Camire 416.360.1322 ccamire@paradigmcap.com 1-Year Stock Chart 12 11 10 9 8 7 Burcon Nutrascience Corp. (BU CA) Price (CAD) Volume (Thousands) 6 0 Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Volume Burcon Nutrascience Corp. Source: FactSet Prices 01/12/10 FY10 12 EPS lowered 11/10/08 Target raised ($20.00) 10/08/08 Target raised ($15.00) 05/01/08 Initiating target price ($12.00) 250 200 150 100 50 Paradigm Capital Inc, IIROC/TSX member 1 November 16, 2010
Establishing Our Assumptions Even though the announcement is a non binding letter of intent, we think the standstill agreement provides a high level of interest from ADM. We believe it is necessary to fine tune our forecasts based on this new information. Variable #1 Royalty rates The determination of royalty rates (.e. percentage amount that is to be applied to the end user revenues) is guided by the economic fairness to both companies. The value conveyed is a function of specific factors relating to the licensed technology such as the uniqueness and competitive advantage of the licensed products, including the scope and remaining life of any patents. Other factors include the size of the markets in which ADM will sell the products, the degree of complexity in the technology and the length of the agreement to recuperate any upfront/milestone payments and the time to generate a decent ROI. Traditional licensing agreements in the pharmaceutical industry dictate royalty agreements between 5% (pre clinical products) to 30% for FDA approved products for NCEs. Contrary to the drug industry, the food industry margins are much lower which dictates a lower rate for ingredients. Our search provides us with a range of 7 13% for novel/disruptive technology. Variable #2 Soy Protein Isolates Pricing Soy protein has been part of the market (food and beverages) for more than 20 years. In our model, we assume a premium pricing for the soy protein isolates to current products given the significant product advantages (taste, odour, functionality and color) over existing concentrates or isolates. Soy Prices - US$000's Meal 200 Oil 1000 Concentrates 3,000-5,000 Isolates 7,000-10,000 Variable #3 Soy Plant Size and Roll Out Plan With more than 100 oilseeds plants located in every region of the globe, we estimate that the soy technology will be added to existing plants rather than building a new one, hence reducing time to market. For the soy technology we have assumed four plants would be operational by 2013, the first one located in the US with a finished capacity of 60,000 MT/year. We think this strategy will significantly reduce CAPEX for ADM and reduce cost of sales. Paradigm Capital Inc, IIROC/TSX member 2 November 16, 2010
Soy Protein isolates Plants Location Plant size (MT) Operational North America 60,000 Nov-11 Asia 100,000 Nov-12 Europe 60,000 May-13 South America 60,000 Nov-13 280,000 Canola Protein isolates Plants Location Plant size (MT) Operational North America 40,000 Nov-12 Asia 40,000 Oct-13 80,000 Prices FY2015 EPS -Soy protein isolates - only $10,000 $4.30 $4.92 $5.53 $6.15 $6.76 $7.38 $7.99 $9,500 $4.09 $4.67 $5.26 $5.84 $6.43 $7.01 $7.59 $9,000 $3.87 $4.43 $4.98 $5.53 $6.09 $6.64 $7.19 $8,500 $3.66 $4.18 $4.70 $5.23 $5.75 $6.27 $6.79 $8,000 $3.44 $3.94 $4.43 $4.92 $5.41 $5.90 $6.39 $7,500 $3.23 $3.69 $4.15 $4.61 $5.07 $5.53 $5.99 $7,000 $3.01 $3.44 $3.87 $4.30 $4.73 $5.16 $5.60 Royalty 7.00% 8.00% 9.00% 10.00% 11.00% 12.00% 13.00% Prices FY2015 EPS -Canola protein isolates - only $9,000 $1.10 $1.25 $1.41 $1.57 $1.72 $1.88 $2.03 $8,550 $1.04 $1.19 $1.34 $1.49 $1.64 $1.78 $1.93 $8,100 $0.99 $1.13 $1.27 $1.41 $1.55 $1.69 $1.83 $7,650 $0.93 $1.06 $1.20 $1.33 $1.46 $1.60 $1.73 $7,200 $0.88 $1.00 $1.13 $1.25 $1.38 $1.50 $1.63 $6,750 $0.82 $0.94 $1.06 $1.17 $1.29 $1.41 $1.53 $6,300 $0.77 $0.88 $0.99 $1.10 $1.21 $1.31 $1.42 Royalty 7.00% 8.00% 9.00% 10.00% 11.00% 12.00% 13.00% Sensitivity Analysis Our sensitivity analysis covers the expected revenue generation by FY15. We believe ADM could have four plants operational by 2015 with a yearly capacity of 280,000MT and two canola plants by a partner generating 80,000MT. What Happens To The Canola Manufacturing Technology Future ADM and Burcon signed a standstill agreement to give both companies time to complete the soy agreement. ADM has been the Canola development partner since September 2003. We believe the largest value in the near term is the soy technology given it is already approved and has been used for more than 20 years. Company Profile Paradigm Capital Inc, IIROC/TSX member 3 November 16, 2010
Short term Outlook Revised No Change to Long term Until now, our estimates were based on a mixture of revenues from soy and canola royalties in a relatively equal contribution. The interest show by ADM towards soy is a clear indication of the current market forces, putting canola protein isolates in the back seat position. The new timelines that we have determined reflects a different ramp up from our original estimates. Revised Before 2011e 2012e 2011e 2012e Revenues $0 $21 $17 $34 EPS -$0.19 $0.48 $0.40 $0.96 Paradigm Capital Inc, IIROC/TSX member 4 November 16, 2010
Income Statement Fiscal Year March FY09 FY10 FY11e FY12e FY13e FY14e FY15e Canola protein royalties 9.0 39.6 61.2 Soy protein royalties 20.7 83.7 172.5 214.2 Total Revenues 20.7 92.7 212.1 275.4 C$M Gross Margin 20.7 92.7 212.1 275.4 G&A/Mark& Sales 1.6 3.2 2.0 2.2 2.6 3.2 3.8 Research & Development 2.1 2.1 2.3 2.9 3.6 4.5 5.6 Professional Fees 1.1 1.3 1.1 1.2 1.2 1.3 1.3 Mgmt Fees & Services 0.1 0.2 0.2 0.2 0.2 0.2 0.3 Operating Expenses 4.9 6.8 5.6 6.5 7.7 9.2 11.0 EBITDA 5 7 6 14 85 203 264 EBIT 4.9 6.8 5.6 14.2 85.0 202.9 264.4 Other Expenses Other Income 0.1 0.1 EBT 4.8 6.7 5.6 14.2 85.0 202.9 264.4 Income Taxes 29.7 71.0 92.5 Net Earnings 4.8 6.7 5.6 14.2 55.2 131.9 171.8 EPS Fully Diluted ($0.19) ($0.24) ($0.19) $0.48 $1.86 $4.44 $5.79 FD Shares Out.(000's) 25.3 28.0 29.7 29.7 29.7 29.7 29.7 Source: Company filings, Paradigm Capital Inc. Paradigm Capital Inc, IIROC/TSX member 5 November 16, 2010
Disclaimer Section 1. Paradigm Capital Inc. expects to receive or intends to seek compensation for investment banking services from the subject companies in the next 3 months. 2. Paradigm s disclosure policies and research distribution procedures can be found on our website at www.paradigmcap.com. 3. Paradigm Capital research is available on First Call, Reuters or at www.paradigmcap.com. Issued by Paradigm Capital Inc. Research Rating System Paradigm Capital uses the following rating recommendations in its research: # of % of Recommendation Companies B/H/S What our ratings mean: Buy 127 69% Buy Expected returns of 20% or more over the next 6 to 12 months. Buy (Spec) 27 15% Speculative Buy - Expected returns of 20% or more over the next 6 to 12 months on high-risk development or "pre-revenue" companies, such as junior mining and early stage biotech companies. Hold 29 16% Hold - Expected returns of +/-20% over the next 6 to 12 months. Sell 2 1% Sell - Expected returns of -20% or more over the next 6 to 12 months. Total 185 About Paradigm Capital Inc. Paradigm Capital is a research-driven, independent, institutional equity investment dealer focused on sectors and companies that have attractive long-term secular growth prospects. Paradigm Capital s research is available on our website at www.paradigmcap.com. Please speak to your Sales or Trading Representative if you require access to the website. The analyst (and associate) certify that the views expressed in this report accurately reflect their personal views about the subject securities or issuers. No part of their compensation was, is, or will be, directly or indirectly, related to the specific recommendations expressed in this research report. Analysts are compensated through a combined base salary and bonus payout system. The bonus payout is determined by revenues generated directly or indirectly from various departments including Investment Banking, based on a system that includes the following criteria: reports generated, timeliness, performance of recommendations, knowledge of industry, quality of research and investment guidance and client feedback. Analysts are not directly compensated for specific Investment Banking transactions. The opinions, estimates and projections contained herein are those of Paradigm Capital Inc. ( PCI ) as of the date hereof and are subject to change without notice. PCI makes every effort to ensure that the contents herein have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. However, PCI makes no representation or warranty, express or implied, in respect thereof, and takes no responsibility for any errors and omissions that may be contained herein and accepts no liability whatsoever for any loss arising from any use of or reliance on this research report or its contents. Information may be available to PCI, which is not reflected herein. This research report is not to be construed as an offer to sell or solicitation for or an offer to buy any securities. PCI, its affiliates and/or their respective officers, directors or employees may from time to time acquire, hold or sell securities mentioned herein as principal or agent. PCI may act as financial advisor and/or underwriter for certain of the corporations mentioned herein and may receive remuneration for same. Paradigm Capital Inc. is a member of The Toronto Stock Exchange, The TSX Venture Exchange and The Investment Industry Regulatory Organization of Canada (IIROC). Any products or services mentioned on this website are made available only in accordance with local law (including applicable securities laws) and only where they may be lawfully offered for sale. Paradigm Capital Inc. will not open accounts except in jurisdictions in which it is registered. To U.S. Residents: This report was prepared by Paradigm Capital Inc. which is not subject to U.S. rules with regard to the preparation of research reports and the independence of analysts. Paradigm Capital U.S. Inc., affiliate of PCI, accepts responsibility for the contents herein, subject to the terms as set out above. Any U.S. person wishing to effect transactions in any security discussed herein should do so through Paradigm Capital U.S. Inc. Paradigm Capital Inc, IIROC/TSX member 6 November 16, 2010