CANADIAN JUDSON MARTIN, a greying, soft-spoken former accountant at PricewaterhouseCoopers and retired business executive is a likeable guy, but he must have felt like the captain of a passenger liner heading towards an iceberg in his latest role. In late August, Martin was handed a job that few in their right minds would accept. Following the suspension of the beleaguered Toronto-listed, Hong Kong-managed, Chinese timber resources firm Sino-Forest Corp from the Canadian bourse and the resignation of its founder and CEO Allen Chan, Martin, a long-time director of the firm, was asked to temporarily lead the firm while investigators tried to determine whether there were deliberate corporate wrongdoings and if there was anything left to salvage in the company.
Given the kind of publicity Sino-Forest had attracted, even Titanic’s captain might not have envied Martin’s job. Better to charge ahead towards an iceberg with a semblance of hope than lead a company destined to end up with a liquidator. Martin’s job a few months ago seemed merely to ensure that the firm got a decent burial.
If you have followed my columns, you know the gist of the long-running Sino-Forest saga. Hong Kong entrepreneur Chan founded the firm by “buying” tracts of Chinese forests in 1993. A year later, he listed the assets via a reverse takeover of a dormant Canadian firm. By March this year, Sino-Forest had grown into a behemoth with a market capitalisation of US$6 billion ($7.78 billion) and its stock price had surged to more than C$25. The firm’s business model seemed simple: It owned the forests but sold the standing trees to authorised intermediaries or parties related to them and often sold them the rights to cut the trees as well. It didn’t really do any of the grunt work of maintaining the forest, or tree felling, wood processing, transportation or logistics. Its detractors said the model looked too good, too clean to be true. The bubble burst in June when gadfly analyst Carson Block’s one-man research outfit, Muddy Waters, published a damning report on Sino-Forestry, calling it a “scam”, a “fraud” and a “Ponzi scheme”, which the firm vehemently denied. Block also alleged that Sino-Forest “massively exaggerates its forestry assets”, citing “evidence” that the firm had overstated its Yunnan timber investments by US$900 million.
Sino-Forest’s stock plunged more than 70%. There was a stampede of investors for the door. Some lost hundreds of millions. Prominent hedge fund manager John Paulson wrote off more than US$460 million after he too rushed to offload his stake. The shakeout then attracted a bunch of “vulture investors” such as Singapore’s richest man, New Zealand-born Richard Chandler, who now owns a 19.6% stake in the firm. By the time the Ontario Securities Commission in Toronto suspended the stock and forced out Chan, alleging he and key executives “appear to be engaging or participating in acts... which they know or reasonably ought to know perpetuate a fraud” even Chandler had lost a substantial portion of his investment.
Three months on, it looks like Sino-Forest might just live to fight another day and Chandler’s shares and those of other investors still holding Sino-Forest’s paper could actually be worth something.
In mid-November, Sino-Forest released a 111-page interim report of the Independent Committee investigating its board of directors. The good news: Sino-Forest isn’t a complete shell bereft of any assets. It actually does own some plantation assets. The report confirmed that Sino-Forest had legal title to 151,000 ha of plantations. Though it seemingly also has contractual rights to another 606,000ha, they are just confirmation letters that Chinese court officials might be loathe to accept as proof of ownership. Though Sino-Forest might not be quite like Bernie Madoff’s fund, the committee’s report disclosed missing records as well as an absence of an internal audit. Having talked to some of the people who have read the report, I get a sense that peering into Sino-Forest is like peeling a large onion. There is little beneath the layers other than a big stink and a cloudy vision. Indeed, the more you peel, the more it stinks and the more you want to weep.
So now, the bad news: Sino-Forest’s condition is no laughing matter. It has been burning cash at a rapid rate and Nomura Securities’ fixed-income analyst Annisa Lee estimates that there may not be much more than six months’ worth of cash left. As such, the company needs to raise cash either from banks, equity or debt capital markets early next year. With its stock suspended, a rights issue is out of the question and the company is still under a cloud — an array of Canadian agencies are not done with their separate investigations. So, debt markets or even bank lending might not be the solution.
Moreover, the Independent Committee’s report has cast doubts on the company’s carefully packaged “business model”, the intriguing relationship between its suppliers and “authorised intermediaries” or its customers, which analysts say suggested heavy related-party transactions. As for some of the unanswered questions, Nomura Securities notes that the committee’s report focused on the firm’s standing timber business but did not address issues related to its wood logs business, which requires harvest quotas and actually accounted for more than 64% of the firm’s revenues last year. There is also the small matter of potential non-compliance of its tax obligations in China.
A more immediate issue is Sino-Forest’s ability to stay listed on the Toronto bourse. A continued listing would make it easier for the firm to access capital that it needs to keep going as a viable corporate entity. Last week, CEO Martin told journalists in Hong Kong that while his immediate focus was to get the Ontario Securities Commission to lift the suspension on the stock when it meets on Jan 25, the firm was keeping its options open. He said Sino-Forest might seek to merge with another forestry firm, bring in a strategic investor or raise funds from capital markets or even banks. Still, even he was realistic about his expectations: “It is going to be real tough to get back to where we were,” he was quoted as saying.
What happens next will depend on what is in the firm’s 3Q results, which will be published on Dec 15. Analysts are expecting major writedowns and a start from a clean slate. The firm has said it has had repeatedly delayed the results announcement because it needed to verify its relationships with many of its authorised intermediaries. Since it has taken the firm this long to verify its own longstanding customers, some analysts say there is more than meets the eye and there might be more drama in the aftermath of the results. Once that is out of the way, there might still be more in the findings of Canadian regulators as well as the police, who have been going through Sino-Forest’s dealings with a fine-tooth comb.
Yet, there is new hope that Sino-Forest can be revived in some form, though it would be only a shadow of its former self when it does get back on its feet again. The lesson from Sino- Forest’s tale and the ongoing saga of Japanese camera and medical equipment maker Olympus is that listed firms and their directors cannot be left to their own devices. Auditors, independent directors, regulators and, indeed, even the media need to be more vigilant instead of accepting top management’s word.
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