Citron Research Covers China New Borun (BORN)- Is this Company All Wet???

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We are going to keep this sweet, simple and to the point.  China New Borun (BORN) is a producer of corn-based alcohol for baijiu liquor in China.  Basically, the sell a commodity … nothing real sexy.  In June of 2010 they lowered the pricing of their IPO by a whopping 40% from initial estimates of $12-14 and sold 5.5 million shares at $7.  The stock immediately broke syndicate and spent the summer in the $5 range.

According to the company and its supporters, it is not just your run-of-the-mill corn based alcohol producer.  They have created a new mousetrap, a secret sauce if you wish, called the “wet process” which according to their prospectus, “has led to a consistently higher yield of edible alcohol from corn.  The Holy Grail of Baijiu.  This is the sizzle of the company.

The “wet process” is so important to them that they listed it in their prospectus as one of their top competitive strengths:

“Efficient Production Technology”
Our production management professionals have independently developed the Borun Wet Process for the production of edible alcohol. Based upon our knowledge of our industry and our ongoing patent application, we believe that compared to the dry milling process used by other producers in China, our Borun Wet Process has a higher production yield and consumes less energy and water due to our higher degree of waste energy recovery. Our wet process also enables us to produce corn germ, which generates an additional stream of revenue compared to producers utilizing the dry milling process.

http://google.brand.edgar-online.com/EFX_dll/EDGARpro.dll?FetchFilingHtmlSection1?SectionID=7262909-13053-44250&SessionID=AWiYHjneTZrtJ27

This advanced process must really be something!  As a recent IBD article about BORN mentioned,

“Borun says its proprietary wet-process production method consumes less energy and water than the typical dry-milling process used by other edible alcohol producers in China. It also results in higher yields and generates added revenue streams from byproducts.”

http://www.investors.com/NewsAndAnalysis/Article.aspx?id=549603&ven=yahoo&p=2

So we are told that BORN has basically revolutionized the distilling business — in China!  (Set aside for the moment that fermenting and distilling of grain into alcohol is the world’s oldest industrial process…)   How much did this cost them?  Please read your prospectus, I swear we could not make this up if we wanted to.

Research and Development


We spent approximately RMB79,200 ($11,602.9), RMB120,000 ($17,580.1) and RMB201,600 ($29,534.6) during the fiscal years ended December 31, 2007, 2008 and 2009 and RMB150,400 ($22,034.0) during the three months ended March 31, 2010, respectively, on Company-sponsored research and development activities, including, without limitation, all activities in respect of our in-house developed Borun Wet Process, as determined in accordance with US GAAP.

Yes, you read the correctly they have spent $80,000 US dollars in 3 1/4 years.  What could they have really done? C’mon we believe that McDonalds spent more than $80,000 deciding that Thousand Island is the secret sauce on the Big Mac … and they didn’t even need to apply for a patent.

Conclusion
Yes, we can ask the obvious questions about corporate structure and book value which are as warped as many Chinse small cap names.    Not to mention raising money at fire-sale discounted IPO prices while supposedly having huge cash balances in the bank.   We could discuss the apparent discrepancies between tax documents filed in China and SEC documents … but we will leave that for another time and place.    In simple form, if you tell Wall Street that your company should have a premium because you have a better mousetrap, and you want us to believe it, at least make sure you spent some cheese to create it.

Cautious Investing To All