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Sino-Forest Peek Made Buyers ‘Run Away’: Corporate Canada

Sino-Forest Glimpse Made Buyers Run Away
A DHL Worldwide Express missed package slip sits on the door of Sino-Forest Corp.'s office in Mississauga, Ontario. Photographer: Norm Betts/Bloomberg

Sino-Forest Corp., the Chinese tree grower that filed for bankruptcy protection last week after failing to shake off fraud allegations, will struggle to find a buyer, according to timber industry professionals.

Sino-Forest obtained an initial order for creditor protection in Ontario’s Superior Court on March 30. The move is part of an accord with bondholders owed $1.8 billion to either sell the company to a third party or undergo a restructuring that would give them most of the remaining assets.

“We know a number of prudent investors who have looked at Sino-Forest and run away screaming,” David Edson, chief executive officer of Old Town, Maine-based James W. Sewall Ltd., a forest valuation adviser, said by telephone. He declined to identify the potential buyers. “If you cannot, through reasonable efforts, verify clear title to the resource, you’re just asking for trouble,” he said.

The company was accused in June by short seller Carson Block of exaggerating its revenue. A $50 million, eight-month probe by Sino-Forest directors concluded that some of the allegations may never be disproved. Chairman William Ardell said in February the company hasn’t been able show it controls a purported 788,700 hectares (3,045 square miles) of timber.

Stan Neve, a spokesman for Hong Kong- and Mississauga, Ontario-based Sino-Forest, declined to comment. Robert Chadwick, a lawyer representing the bondholders, didn’t immediately return a telephone call seeking comment.

Chinese Buyer

Richard Chandler, the Singapore-based investor who’s the largest investor in Sino-Forest, said today he’s appointed a team to help lead a proposed restructuring of the company.

“There’s a lot of investment funds looking for timber ownership, but there are many far less risky opportunities that have much more provable cash flows,” Kevin Mason, managing director of Gibsons, British Columbia-based ERA Forest Products Research, said by telephone. “Anyone with any fiduciary duty probably shouldn’t be touching this thing at all.”

While China’s appetite for timber used in construction, packaging and paper is still increasing, investors may be deterred by its forestry industry’s business practices and a lack of confidence in the country’s legal system, Edson, 64, said. A Chinese buyer may make the most sense, he said, a view shared by Mason.

“From a Western standpoint, the systems and how things work over there don’t fit neatly with how we do things,” Mason said.

About 80 percent of Sino-Forest’s timber assets measured by value are held by subsidiaries based in the British Virgin Islands, Ardell said in a February interview.

‘Black Hole’

Those units use suppliers and what the company calls “authorized intermediaries” in China to buy and sell timber and plantation harvesting rights. That structure is “an unjustifiable black hole” used to fabricate sales, avoid taxes and overstate timber holdings, Block’s research firm Muddy Waters LLC said in a June 2 report.

Sino-Forest has denied the allegations. “I have a belief in the business,” Ardell said in February.

Sino-Forest filed a lawsuit, also in Ontario Superior Court, on March 30 against Muddy Waters and Block relating to the allegations, which it says are defamatory. The company said it’s seeking damages and the recovery of profits made by Muddy Waters and others in connection with the report. Block said in a March 30 e-mail that the lawsuit is “entirely without merit” and that he stands behind the report.

‘Cleansing Process’

Sino-Forest’s collapse would have happened “sooner or later” even if the report hadn’t been published, Block said today in an interview with Erik Schatzker on Bloomberg Television’s “InsideTrack.”

Muddy Waters’ allegations increased investor scrutiny of Chinese companies trading on North American stock exchanges. The Bloomberg Chinese Reverse Mergers Index, which tracks 82 Chinese companies trading on U.S. bourses, fell 43 percent in the year to March 30, while the S&P 500 Index rose 6.2 percent.

“There are a lot of Chinese companies that have been unfairly punished in their valuations because of some of the allegations of fraud,” Kevin Pollack, a fund manager at Paragon Capital LP in New York, which invests in U.S.-listed Chinese stocks, said in a telephone interview. Pollack said he’s never been a Sino-Forest investor.

“Clearly there are some situations where short sellers have provided value to the space in the cleansing process,” he said. “Sino-Forest is one of those cases.”

Richard Chandler

Shares of Sino-Forest, once the largest Chinese forestry company by market value, plunged after the report. They dropped 74 percent before trading was halted in Toronto on Aug. 26, losing investors including John Paulson’s hedge-fund firm Paulson & Co. about C$3.3 billion ($3.3 billion).

The largest Sino-Forest shareholders are Chandler with 19.5 percent, Tucson, Arizona-based Davis Selected Advisers LP with 12.6 percent, and Boston-based Wellington Management Co. with 11.5 percent, according to data compiled by Bloomberg. While Paulson & Co. sold its holdings after the Muddy Waters report, booking a C$462 million loss, Chandler and Wellington bought shares.

Sino-Forest’s 6.25 percent notes due in October 2017 fell to 32 cents on the dollar on March 21, according to the most recent data on Trace, the bond price reporting system of the Financial Industry Regulatory Authority.

The International Swaps & Derivatives Association said today it will rule if there has been a bankruptcy credit event that would trigger credit-default swaps on Sino-Forest.

Licenses Withheld

Sino-Forest founder Allen Chan resigned as chief executive officer in August after the Ontario Securities Commission and the Royal Canadian Mounted Police started probes.

His successor, Judson Martin, said in November that the company may go private or seek a merger. By December, Sino-Forest had missed an interest payment on some of its bonds. It agreed to a waiver with bondholders the following month, pledging to submit a strategic plan by the end of March.

Houlihan Lokey, the Los Angeles-based investment bank advising Sino-Forest, has begun soliciting interest from “prospective strategic or financial parties,” Sino-Forest said March 30.

“There are limited potential buyers for these assets,” Martin said in affidavit filed with the court. The Chinese government has been less supportive of the company since the Muddy Waters report and has withheld timber-cutting licenses, he said. Potential Sino-Forest buyers will need an “in-depth and intimate knowledge” of the Chinese market, Martin said.

“No one’s kidding themselves: finding a buyer will not be easy,” Derrick Tay, a lawyer at Gowling Lafleur Henderson LLP who’s working for the bankruptcy monitor, FTI Canada Inc., said in court on March 30. “The process that has been constructed gives us the best shot.”

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