Sino-Forest, how we’ve missed thee.
Everyone’s favourite Chinese-Canadian timber company released its Q2 2011 earnings on Monday morning. Its share price rose 8 per cent immediately after Canadian markets opened and was up nearly 4 per cent at pixel time.
At first glance, the results look promising for the firm, whose stock is still down around two-thirds since short-seller Muddy Waters alleged it was a “fraud” in a now infamous research report. But a closer look reveals many unanswered questions about Sino-Forest — questions that are taking outside investigators PwC much longer than the firm had previously told investors.
Here are the “highlights” from last quarter (emphasis ours):
Revenue increased 6% in Q2 to $317 million and 19% in H1 2011 to $656 million
EBITDA was down 4% in Q2 to $155 million and increased 14% in H1 2011 to $347 million
In Q2 IFRS accounting for fair value of financial instruments resulted in a non-cash gain of approximately $469.5 million
Net income increased 125% in Q2 to $447 million and 98% in H1 2011 to $425 million
Net income before changes in fair value of financial instruments decreased from $60.8 million to a loss of $9.8 million in Q2
Cash, cash equivalents and short term deposits were $899 million as at June 30, 2011
The Independent Committee continues to make progress with its review, but has advised that additional time will be needed to complete its report primarily due to a prolonged data collection and review process
Sino-Forest, like all timber companies, is hard to judge based on one quarter’s earnings. We’re also still unsure as to the real truth behind Muddy Waters’ allegations. Both sides peddle confusing arguments, which tends to help Muddy Waters and hurt Sino-Forest.
For example, in the small print of this quarter’s earnings are several peculiar nuggets that may give the likes of Richard Chandler*, who now owns 15 per cent of Sino-Forest, pause for thought. Specifically, we spotted some interesting lines on accounting, cash, bonds, trees and the independent report.
Take the highlighted line in Sino-Forest’s income statment.
Without the accounting change in financial instruments, Sino-Forest made a loss in the three months to June 30, 2011. Since Q1 2011 Sino-Forest, like other firms, has been required to change from Canadian GAAP reporting to International Financial Reporting Standards. This has meant a reclassification of two of its convertible notes from equity to “an embedded derivative liability, measured separately at fair value at the end of each reporting period.”
This means it’s now accounted for as a net gain on the income statement. Fine. What’s interesting, though, is the detail in the footnote that Sino-Forest attempted the “elimination of the Company’s option to settle the Convertible Notes by delivering cash or a combination of cash and common shares.” One interpretation of this is that the firm wants to avoid the balance sheet volatility that comes with the new accounting, especially when its share price is highly volatile, too.
Another interpretation is that it shows just how keen Sino-Forest is to hold on to cash. According to the statement, “cash and cash equivalents” are down to $862m as of June 30 from $1,223m at the end of 2010. Sino-Forest watchers may remember that Nomura analyst Annisa Lee was worried about the firm’s cash position and what it means for bondholders, especially those subordinated offshore ones. (Her question about Sino-Forest’s cash position at the last earnings call was never properly answered.) In a note on June 7 she wrote that “the company does not have conservative financial accounting” — the convertible bonds allowed it to understate debt and overstate cash. Hence — perhaps — the attempt to change the way they are accounted for.
In any case, it’s potentially some disturbing news for bondholders, to go alongside Monday’s coincidentally timed announcement that the company had paid off $87.7m of senior notes that mature on Wednesday.
Another thing that caught our attention was the reference to FT Alphaville’s next holiday destination: Yunnan province. This is the Chinese province where most of the Muddy Waters allegations originate. We extensively detailed both sides of the argument here and here. In short, one side says there are loads of trees. The other says there aren’t loads of trees, merely paper trees, so to speak. (For our favourite outside take on Sino-Forest’s assets, see here.)
Sales details in the earnings statement suggest that Yunnan has contributed a lot less than in previous years to Sino-Forest’s bottom line. Yunnan tree sales have better margins than other areas, according to Sino-Forest. But there haven’t been as many in 2011 as in 2010, according to the figures. Of course, this could reflect typical seasonal patterns, but don’t be surprised if it’s picked up by Muddy Waters as evidence to bolster its case.
The fall in the average selling price of standing timber was mainly due to a difference in sales mix. In the three months ended June 30, 2011, most of the standing timber sales were from plantations located in Guangxi and Guizhou Provinces and in the same period in 2010, the standing timber sales were primarily from plantations located in Yunnan Province.
The lower average selling price and higher cost of fibre per m3 was the result of a difference in sales mix. In the three months ended June 30, 2010, 97.8% of standing timber sales were in Yunnan Province which achieved a higher average selling price and a lower purchase cost per m3 compared to the same period in 2011 in which 96.6% of standing timber sales were from Guangxi and Guizhou Provinces where the average selling price was lower and the cost of fibre was higher.
All this confusion may be cleared up by the long-awaited “independent committee” report. But, as noted above, the awaiting is going to take a little longer; Sino-Forest has revised its expected publication date to some time before the end of 2011.
At the beginning of the process, the Independent Committee informed the Board that the review would likely take at least two to three months. On August 11, 2011, the Independent Committee delivered its First Interim Report to the Board of Directors. The Independent Committee advised the Board as to the current scope of the review, provided a progress update and the anticipated timing of its next interim report and the completion of the review. The Independent Committee indicated it expected to provide a further interim report within six to eight weeks and currently believes that its review process will be completed prior to the Company’s year end.
Fair enough, it’s a complicated firm with zany accounting structures. Trees take a while to count — just ask Tolstoy.
But wouldn’t it be nice to get a few excerpts of the interim in the meantime?
Chandler becomes Sino-Forest’s largest shareholder – FT Tilt
Nomura says not a lot of cash growing on Sino Forest’s trees – FT Alphaville
Sino-Forest coverage – FT Alphaville