Description

Summary: Chardan Acquisition was formed in early 2004 with the intent of identifying and then consummating an acquisition in China. The company raised $25m for this purpose through the sale of 5 million shares at
$5/each. I was naturally skeptical of this, but believe that the company has found a real gem. After an exhaustive search, CAQC announced a transaction in December of 2004. CAQC will pay $10m in cash and 10.2 million shares to acquire Origin Seed Technology. In short, Origin has been growing its top and bottom line 30-90% and should continue to do so, is an excellent cash generator, has high barriers to entry, should be a consolidator in its sector, and is trading at only 15x 2005 eps and 10.5x 2006 eps. If you subtract the net cash from the balance sheet, the company is trading at just 12x 2005 eps and 8.2x 2006 eps.

Background: Origin Seed Technology is a supplier of crop seeds (mostly corn, but also rice and cotton) in China. The company has the leading position in the highly fragmented $2B market for seed in China. Its
share is only about 4% in corn and less than that in cotton and rice. The market is highly fragmented because, unlike the U.S., The average farm in China is only about 1.5 acres large. These are mom and pop farmers (about 975 million of them). 8 companies, including Origin, control 25% of the market, and the remaining 75% is controlled by 5000 smaller companies. The large multinationals-- Monsanto, Syngenta, and
Pioneer— have tried to get into the Chinese market, but have had miserable experiences because of cultural/language barriers, the long & beauracraic process that needs to be followed to introduce a new
hybrid in China, and because the customer is the mom & pop farmer, not the agribusinesses they are used to dealing with elsewhere around the world.

Management: The CEO and COO have a combined 35 years of experience in hybrid seed development and marketing and both hold degrees from U.S. institutions. (The CEO has a Ph.D from the University of Iowa, a leader in the field of plant breeding). The CEO can be contacted in Beijing and speaks English very well. In addition, the head of Chardan, Richard Propper, can be contacted here in the U.S. Dr. Propper (a venture capitalist with an admittedly mixed record) will remain on after the merger as the U.S. contact person, and will also be involved in Origin's consolidation strategy.

Financials: As you can see from my model Originn has generated attractive, net aftertax margins in the mid-high teens, while growing revenues (all organically, no acquisitions) in the 30-90% range. with such a small market share, with 46 new hybrid seeds currently in the government testing program (which takes 3 years), with a cash horde post-transaction and post warrant-coversion of about $40M, and with potential acquisitions, Origin should be able to mainatain top line growth in the 40% plus range. It will grow even faster on the bottom line as it introduces more of its own hybrids (some of its original hybrids were licensed and carry about a 35% gross margin verus 45% for proprietary hybrids) and as it leverages overhead.

(note: after the transaction, there will be 15.2 million shares out plus the 8.0 million warrants). I have used 23.2 million f/d shares for my calcualtion. plus, i have added in 4 traunches of 1.5 million shares each that are due to Origin's management for hitting profit targets in 2006-2009.)


here is my model for the company:

2001 2002 2003 2004 2005 2006 2007

revs 9.1 11.9 23.1 35 57 82 119
net 1.0 3.2 3.5 6.3 11.9 17 25
eps NM NM NM NM $0.51 $0.73 $1.08

there will be approximately $1.72 in net cash on the balance sheet post-acquisition and assuming conversion of the warrants. In addition, Origin's net income will approximate free cash flow, so the cash should keep growing (ex-acquisitions).

In addition, this company has great visibility: 80% of 2005 revenues are already known by the end of 2004, as seed is ordered well in advance, so there is great vsiibility on the 57M in revenues for 2005. In fact, mgmt guidance is 55-60million. since we are already into 2005, the actual amount of revenues already ordered is about 95%.

Again, here you have a company with leading, but very low market share in a highly fragmented market, where there are significant barriers to entry, in a sector that is relatively insensitive to the economy, growing very quickly, with additive acquisition prospects already lined up (i expect 1-2 to be completed in calendar 2005), trading at 8-9x 2006 ex-cash. The merger will be complete soon and once the stock is listed on nasdaq and mgmt is able to do a roadshow (each expected over the next 2 months), I expect investors to place at least a 20x on it. While I am not counting on it, this story has the potential to get a very high multiple (30-40x) given the high barriers to entry and its robust growth.

longer-term, i expect the company will be bought by one of the larger players. Monsanto recently paid approx 3x sales for a no growth hybrid seed company. what would monsanto pay for a 40% grower? 5x on 2006 revs give you an $18 stock.

risks:
1. natural disaster or unusual weather pattern in china affecting the growing season
2. acquistion by chardan not completed

Catalyst

-completion of acquisition of Origin Seed in April/May
-management visit to U.S. in April/May
-NASDAQ listing expected in May
-Acquisition announcements
-Ongoing qtly results and greater investor awareness
-medium to long-term buyout candidate