China New Borun IPO: All the Booze in China

Jun. 8.10 | About: China New (BORN)

China New Borun (NYSE:BORN) is the country's third largest producer of corn-based edible alcohol, which is primarily used by distilleries as an ingredient in baijiu, a grain alcohol beverage that is the most popular liquor in China. After acquiring a competitor out of bankruptcy in 2008, the company has rapidly increased annual production capacity to over 260,000 tons. Because supply currently outstrips demand, the PRC has prohibited new facility construction and the multi-billion dollar market for China New Borun's products is expected to grow at a 17% CAGR through 2012. The company plans to raise $71.5 million by offering 5.5 million shares at a proposed price range of $12-$14. Piper Jaffray (NYSE:PJC) is acting as bookrunner on the deal, which is expected to price this week and trade on the NASDAQ under the symbol "BORN."

Market Leader with a solid track record

The company plans to use the proceeds from the offering to build out approved capacity at its existing facilities and acquire mid-sized production firms in the industry. Management plans to invest $60 million in 2010 to increase production capacity to 380,000 tons (+46% y/y), which will make China New Borun the leader in the highly fragmented industry in terms of production capacity with a 4% market share. The company has a solid track record of growth and profitability, boasting a 3-year sales CAGR of 48% (FY09 revenue was $156 million) and EBITDA margin of 24%. China New Borun has also pre-sold 90% of its existing capacity in 2010, providing strong visibility, and the rapid capacity expansion should allow it to benefit from the strong expected growth in its end-market.

Key Issues

Growth in 2011 and beyond will be tied to the successful and timely completion of this capacity expansion plans, and the company has not pre-sold any new capacity. The expansion strategy is capital intensive and will likely keep free cash flow negative in the near term. The model is also sensitive to volatile corn prices (84% of COGS). The recent rise in raw material prices could lower margins for its products if the company is unable to pass on increased costs and the PRC government has the power to intervene in the market.

Technical headwinds may overshadow a discounted valuation

The recent market volatility has pressured pricing activity in the IPO market as investors have pushed for a larger IPO discount. Additionally, of the last six Chinese IPOs to attempt to list in the US, three have postponed and the remaining three have priced down and traded off in the aftermarket. Given these two factors, we would not be surprised to see this deal face some headwinds getting done despite the stock offering an attractive discount to peers at the midpoint.