The Short Case for Origin Agritech

Investors want to hear the good news. What's going to propel their stocks forward? What are the growth drivers for revenues and earnings? What is a company's competitive moat? Gainsay a company, and you're labeled a short seller. Point out flaws, and you're ridiculed as part of a mob driving shares lower. Many investors simply don't want to hear or can't handle the ugly truth about the companies they own.

That's not me. I want to know what can go wrong with my stocks. If my money's on the line, I don't want to be blindsided. That's why one of the first parts I read in a company's annual report is the section on risks. It's the dumping grounds for companies to lay out all the things that could go wrong with their business. In essence, I want to know the short case for my stock.

The germ of an idea
Origin Agritech (Nasdaq: SEED) has planted the seeds of a high-growth business. It develops corn, rice, cotton, and canola seeds for sale in China and operates in a field where foreign competitors such as Monsanto (NYSE: MON) are severely restricted or prohibited. With products that meet a burgeoning Chinese market need and a government license to be the sole manufacturer of a new genetically modified (GM) corn seed, Origin Agritech would seem poised for a bountiful harvest. So what might cause a blight on this investment?

Lend me your ears -- of corn
Origin's GM phytase corn is expected to be one of the first transgenic corn products approved and sold in China. The enzyme phytase is present in the digestive systems of many plant-eating animals and enables them to breakdown phytic acid. By genetically modifying the corn, Origin Agritech hopes to reduce the need for inorganic phosphate supplements to be added to the feed, thereby reducing phosphate pollution, which can lead to algae bloom and freshwater contamination -- potentially serious environmental hazards.

Yet critics derisively refer to GM foods as "Frankenfoods," and many people vehemently oppose them. European Union officials are considering a ban on certain GM corn seeds grown by Dow (NYSE: DOW) and Syngenta (NYSE: SYT), and China itself has only just begun warming to them. Origin's GM corn seeds are the first allowed to be commercially produced in the country, and there's no assurance that China's farmers will adopt the GM seeds.

Worse, there's an abundance of corn seed on the Chinese market now. China forced provincial seed authorities to separate from existing sales affiliates last year, and they ended up liquidating their inventories, thereby depressing prices. Origin ended up reporting a $22 million loss last quarter as a result, and it foresees sustained lower prices for the immediate future.

Sowing seeds of discontent
The controversy that surrounded the introduction of StarLink corn by Aventis -- now Sanofi-Aventis (NYSE: SNY) although it sold off its agricultural business to Bayer -- where GM corn found its way into the food chain is a cautionary tale for Origin investors. The biotech will need to keep its traditional corn segregated from the GM corn to ensure that the two don't mix. A slip-up like Aventis' where even Kellogg (NYSE: K) cereal and Yum! Brands' (NYSE: YUM) Taco Bell brand tacos were "contaminated" could be devastating to Origin, particularly since it has no insurance to cover lawsuits against such an occurrence.

China's already had its own little scandal with GM rice seeds that were illegally sold to unwitting farmers. The scientist at the heart of the scandal is associated with the Chinese Academy of Sciences, an institution that Origin works closely with. Although there are no apparent ties between him and Origin, any whiff of impropriety on its part and the damage to Origin's reputation could be irreparable.

Foolish final thoughts
There's no perfect stock. Every company has a flaw. Yet the Foolish investor would do well to know what those flaws are before committing money to a stock. There's nothing to say that the potential problems identified above will come to pass for Origin Agritech, but Fools can do right for themselves by knowing what can possibly go wrong.