Bodisen Biotech: The Little Fertilizer Company That Could

| About: BioShares Biotechnology (BBC)

Investors in Bodisen Biotech, Inc. (NASDAQ:BBC), a manufacturer of organic fertilizers and pesticides targeting Chinese agricultural markets, saw the value of their holdings’ lose about 17% last week, as the Company’s past relationship with a ‘colorful’ adviser to emerging Chinese companies came to light.

Bodisen Biotech has since ended its relationship with the advisor, Benjamin Wey, and New York Global Group.

In addition to public relations work here in the U.S., according to an SB-2/A filed with the SEC in February 2006, the Company had an oral agreement with the Beijing office of New York Global Capital, Inc. for the payment of a corporate finance fee of $300,000 for help Bodisen acquire a dual listing on the London Stock Exchange.

Company and Market Description
Emerging from the shell of a start-up stage Internet-based commercial mortgage originator called, Inc., Bodisen is now a highly profitable, one stop solution provider of the entire planting needs for Chinese farmers. With over 60 different products (sold in all seasons) in four categories: compound fertilizers, liquid fertilizers, pesticides, and agricultural raw materials, the Company has enjoyed—on average—a net margin of approximately 30% across its product lines.

The 10Q Detective first learned of Bodisen when we did our due diligence on China Natural Gas (OTC:CHNG), because the Company beneficially owns approximately 2.03 million, or about nine percent, of the Common Stock of CHNG (at $1.39 per share). Through the investment, Bodisen is looking to leverage CHNG’s relationships with urea suppliers to obtain price discounts. Urea is a natural gas byproduct used in fertilizer production.

Bodisen's organic products have many advantages over chemical fertilizers. Its fertilizer products improve crop yields by 10% to 35% and are sold at prices similar to chemical fertilizers. Additionally, Chinese farmers that use Bodisen’s organic fertilizer can have their fruits and vegetables government certified as "organic produce," which command as much as 200% higher in retail prices compared to non-organic produce, therefore substantially increasing farmers’ income levels.

Bodisen's compound fertilizer products offer ease of use, because they are applied one time while each type of chemical fertilizers may have to be applied separately.

The Company is growing its business in a favorable market environment. The agricultural industry is strongly supported by the Chinese government. China, with 1.3 billion people, is one of the largest importers of grains in the world. Much of China's urban population of 500 million depends on imported grains to support higher demand for meat. In order to reduce dependence on foreign grains, the Chinese government supports the agricultural industry by providing many incentives to agricultural product companies. Bodisen enjoys tax-free status and is exempt from sales tax, VAT, agricultural product tax and income tax (income tax holiday through the end of 2007 and renewable thereafter).

Financial Analysis
The Company generated revenues of $26.9 million for the six months ended June 30, 2006, an increase of about $13.8 million, or 105.3%, compared to $13.1 million for the prior year period. Management believes that the strong first half of the year was made possible by repeat business from a loyal base of customers buying more items from Bodisen’s product line (as they keep achieving greater crop yields).

Gross margin, as a percentage of revenues, increased from 37.4% for the six months ended June 30, 2005, to 39.6% for the six months ended June 30, 2006. The increase in gross margin was primarily attributable to an across the board increase in the selling price of its products.

Comprehensive income increased by 117.1% to $7.6 million (share-net of $0.48) during the six months ended June 30, 2006, as compared to $3.5 million (share-net of $0.22) for last year. The increase was attributed to a successful marketing campaign focused on increasing cross selling of all Bodisen’s products to its customer base, and growing demand in new markets and regions throughout China. The Company also benefited from a prudent decision made in December 2005 to lock in raw material costs before cost increases were announced in the 1H:06.

[Ed. note. Talk about controversy! On December 8, 2005, Bodisen issued a $5.0 million promissory note to Amaranth Partners L.L.C. The obligation was used to lock in hedges against the aforementioned raw material cost increases in the current fiscal year. Amaranth Partners L.L.C. is a Delaware-registered subsidiary of the Greenwich, Conn.-based hedge fund Amaranth Advisors that collapsed after a misplaced bet on natural gas! The loan has since been paid back.

However, in connection with the issuance of the Note, the Company agreed to issue to Amaranth a warrant to purchase 133,333 shares of the Company’s common stock at $7.50 per share (subject to adjustment). Given the liquidation going on over at Amaranth, one would suspect that these shares will hit the market--putting some short-term pressure on the price of Bodisen, too.]

Accounts receivables rose by $10.0 million in the 1H:06, resulting in negative cash flow from operations of about $(3.7) million.

The Company also advances credit to certain vendors for purchase of its material. The advances to suppliers are interest free and unsecured. The advances to suppliers amounted to $9.9 million at June 30, 2006.

Although red flags do exist, in our view, we can shrug them off (for now) because the Company does have a strong balance sheet without any long-term debts. As of June 30, 2006, working capital was $29.0 million (net unsecured advances to suppliers and monies kept in a bank account for investment in a new compound fertilizer plant in Xinjiang Province A La Er City).

Book value stood at $3.36 per share.

Valuation Analysis
In a short time the Company has gained a reputation for producing "green" products that address farmers' concerns in a market that is growing exponentially. Bodisen could easily earn $1.00 per share this fiscal year and is selling for a fraction of the [TTM] 36.5 and 22.5 P/E multiples commanded by agri-chemical giants Monsanto Co. (NYSE:MON) and Swiss Syngenta AG (NYSE:SYT), respectively.

The 10Q Detective prefers to look beyond Bodisen’s short-term worries, because we see a favorable profit picture in this Company’s future (forward five-year average growth of about 35 percent per annum).

Bodisen has one of the largest Chinese agricultural product distribution networks. The Company has Product Sale Agreements with more than 155 wholesalers in addition to the current potential to reach more than 60% of China's agricultural markets. As previously mentioned, the Company is building a new compound fertilizer plant in Xinjiang Province.

Our two-year target price is $26.00 per share, which implies (among other variables) the issuance of an additional seven million shares for future capex needs; the Company growing at 35% per annum; gross margins of at least 36.7%; equity risk premium of 5.0%; and an assumed WACC of 10 percent.

Investment Risks and Considerations
Risks to our opinion include gross margins squeezed by unanticipated raw material cost increases; unexpected competition from international agri-chemical giants; and, pricing power erosion related to declining economic benefits to farmers (defined in terms of crop yield and prices).

Management owns a significant amount of the Common Stock, giving them influence or control in corporate transactions and other matters, and their interests could differ from those of other stockholders. Two of Bodisen’s principal executive officers, CEO Wang Qiong and President Chen Bo, collectively own approximately 45.48% of the Existing Common Stock. As a result, they are in a position to significantly influence or control the outcome of matters requiring a stockholder vote, including the election of directors and the approval of significant corporate transactions.

Bodisen’s financial success depends upon the development of The People's Republic of China’s agricultural industry. Roughly half of the PRC’s labor force is engaged in agriculture, even though only about 10% of the land is suitable for cultivation. Although the PRC hopes to further increase agricultural production, incomes for Chinese farmers are stagnating. Despite the Chinese government’s continued emphasis on agricultural self-sufficiency, an inadequate infrastructure, from port facilities to a lack of warehousing and cold storage facilities impedes the domestic agricultural trade.

Bodisen relies on local farmers to purchase its products, which are generally purchased under a “Cash on Delivery” or (as previously mentioned) on a 9-12 months credit; the farmers’ inability to sell their agricultural goods could therefore hinder their ability to timely pay their credit obligations to the Company.

Of concern, in the 2Q:06, days-of-sales outstanding jumped almost 21 days to 97 days (as compared to the 2Q:05). To our new readers, this means that it is taking longer for Bodisen to collect on what it is owed by its customers—indicative of an ‘easy money’ lending policy? Management does note, however, in its SEC filings that credit terms of the sales vary from COD through a credit term up to 9 to 12 months.

However, should central China be hit with an 'Act of God'--floods, drought, or locusts--the allowance for doubtful accounts of $697,209 might prove to be woefully inadequate.

The People’s Republic of China’s Economic Policies could also affect the Company’s business. Substantially all of the Company’s assets are located in the PRC and substantially all of its revenue is derived from operations in the PRC. Accordingly, results of operations and prospects are subject, to a significant extent, to the economic, political and legal developments in the PRC.

BBC 1-yr chart:

Editor David J Phillips is long shares of Bodisen Biotech and China Natural Gas but has no financial interest in any other company mentioned in this posting. The 10Q Detective has a full disclosure policy.

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