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China Forestry Probe Verifies Under 1% of Reported Sales

China Forestry Logging Assets Hold Value
Sino-Forest filed for bankruptcy protection last month. Photographer: Qilai Shen/Bloomberg

China Forestry Holdings Co., the logging company that last week said its only able to account for 1 percent of its historical sales, still has value in its assets, according to its third-largest holder, Carlyle Group.

“We believe the company has stabilized and is recovering,” Brian Zhou, a Beijing-based spokesman of private equity firm Carlyle, said today by phone. “It still has real value. We’ll continue to be one of its shareholders.”

Chinese companies are facing increased investor scrutiny after short seller Muddy Waters LLC last year alleged tree grower Sino-Forest Corp. had overstated its timber holdings. China Forestry said last week records kept by its units prove only 8.8 million yuan ($1.39 million) in revenue for the three years through 2010, compared with 2.4 billion yuan in earlier disclosures.

“The valuation of forestry assets is more abstract, leaving room for discrepancies,” as calculations may be done on sample size forests, Ronald Wan, a Hong Kong-based managing director of China Merchants Securities Co., said by phone. Corporate governance in China also hinders valuations, he said.

Beijing-based China Forestry has been halted from trading in Hong Kong since January last year as an independent committee investigated accounting irregularities brought to light by its auditor. Carlyle Group, the world’s second-biggest buyout firm by assets under management, holds 10.5 percent of the group, according to data compiled by Bloomberg.

Carlyle Holding

Washington-based Carlyle held 322.7 million shares since China Forestry sold shares at HK$2.07 in an initial public offering in December 2009, according to a statement by China Forestry. Investors have lost about HK$4.2 billion ($541 million) since China Forestry shares peaked in November 2010, according to data compiled by Bloomberg.

Acting Chief Executive Officer Li Jian resigned April 15, after the company’s net loss widened in 2011 as it struggled to rebuild its management and business relationships, according to separate filings on April 27. China Forestry hired Crowe Horwath HK CPA Ltd. as its auditor in January replacing KPMG LLC which resigned, saying the company needs to verify ownership and valuation of assets.

“Last year, the company experienced difficulties in resuming its business operations as more effort was put into the investigations,” Chairman Li Kwok Cheong said in the 2011 annual report, which was released April 27. “As a result, the recovery of our business was slower than expected and harvesting and trading business were limited.”

Outstanding Bonds

China Forestry, which began operations in 2003, has forests in Yunnan and Sichuan provinces. It owned or operated about 171,780 hectares of forests at the end of 2009, according to its website.

China Forestry’s net loss for last year was 4.19 billion yuan, compared with a net loss of 2.71 billion yuan in 2010. Sales fell 63 percent to 392.3 million yuan

The company has $180 million of bonds outstanding with 10.25 percent interest rate, it said in its annual report. It had 749.6 million yuan ($119.3 million) in cash and bank balances as at Dec. 31, it said.

Financial statements for the years from 2006 through 2009 aren’t verifiable because the independent board committee conducting the probe found that some of the underlying supporting information isn’t available, the company said on April 27, detailing findings from the investigation.

Police Detention

Most former managers who were involved in irregularities refused to cooperate, the computer hard drives of key former managers were reformatted and major customers declined to provide information, according to the statement. Kunming Ultra Big Forestry Resource Development Co., a unit in southwestern China’s Yunnan province, was keeping a second set of accounting records to those at the head office, China Forestry said.

China Forestry’s former CEO, Li Han Chun, was detained by police in China’s Guizhou province in February 2011 for alleged embezzlement of 30 million yuan, the company said in March 2011. Li and his personal company allegedly committed insider dealings when they sold 119 million shares of China Forestry through a share placement, Hong Kong’s securities regulator said in March 2011.

The company formed a committee of independent directors in January 2011 to conduct an inquiry after KPMG identified irregularities. China Forestry said last April the bank statements given to KPMG by the former management team were falsified and some logging permits were fake.

Sino-Forest Bankruptcy

Hong Kong-and Mississauga, Ontario-based Sino-Forest conducted an eight-month investigation that wasn’t able to reach “definitive conclusions” about certain relationships with suppliers and intermediaries of the company, it said in February.

Sino-Forest filed for bankruptcy protection last month as 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.

China Forestry said tax payments that could be verified by Chinese authorities in 2008 and 2009 are “significantly less” than amounts the company claimed, according to China Forestry’s April 27 statement. The area covered by forestry rights certificates reviewed by investigators represents about 41 percent of the area the company said it owned the rights to in its 2010 annual report.

Personal Accounts

The investigation also discovered use of personal bank accounts in receiving funds from sales of logs by some units, and employees of indirectly held unit Yichun Jingfeng Forestry Development Co. altered bank statements to cover up unapproved payments, according to the filing.

Chairman Li will be the acting CEO before the company finds a replacement. The company didn’t give a reason for Li Jian’s departure.

Sino Forestry said today in a statement it’s making improvements to its internal controls as recommended by a consultant. Review of internal controls found that the company lacked an internal audit department and standard procedures for sales, it said.

Hong Kong’s Financial Reporting Council announced April 11 that it had identified 13 Chinese companies in need of close monitoring. The agency, which investigates auditing and reporting irregularities of publicly traded companies, declined to name them.

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