In the previous post we tried to identify Muddy Waters’ (MW) main allegations concerning Sino-Forest Corporation’s (TRE) assets in Yunnan province, China.
This post looks at TRE’s response and makes some new information publicly available.
On Monday TRE said:
The Company believes Muddy Waters’ report to be inaccurate, spurious and defamatory. Muddy Waters’ self-interest is transparent: to make money from the fall in Sino-Forest’s share price on the back of a decline that itself precipitated. Since the report’s release, the Company has been working to address the allegations. The Company’s Board of Directors is wholly sympathetic to stakeholders who are urging the Company to respond forcefully and quickly. However, the Company wants to respond definitively and it is the Board’s fiduciary duty to address these allegations with an unrestricted thorough and independent review, through the Independent Committee that was set up late last week. The Independent Committee has appointed independent legal counsel, appointing Osler, Hoskin & Harcourt LLP to support it in Canada and both Mallesons, (a leading international law firm with offices in Beijing, Shanghai and Hong Kong) and Jun He Law Offices a leading Chinese law firm. The Independent Committee is also expected to announce the appointment of an independent international accounting firm later today.
It said it would be posting the the following material on its website:
1. A signed copy of the master (framework) agreement (in Chinese) for Lincang City and surrounding areas in the Yunnan Province (together with a version translated to English for ease of reference) pursuant to which individual purchase contracts are then entered into;
2. A summary schedule, as at December 31, 2010, showing the 186,700 hectares of purchased plantations in cities of Yunnan province such as Lincang, Lijiang and Pu’er;
3. Signed copies of contracts relating to the acquisition of plantations in Gengma county of Lincang City and Ninglang county of Lijiang City, together with examples of the applicable plantation rights certifications or confirmations from the relevant government forestry bureau (as described in the AIF extract below). English translations will be also posted for ease of reference. Such contracts have been made available, at individual contract level with accompanying government confirmations, to the Company’s auditors as part of its annual audit process for numerous years;
4. An extract from the Company’s annual information form (AIF) for the year ended December 31, 2010 describing the nature of the Company’s ownership interests in purchased plantations.
TRE is being a bit cute when it says it’s posted the documents — they’ve been uploaded to the firm’s members-only “data room” and are locked from copying, printing and emailing. FT Alphaville has, however, had a look through the evidence, which is being updated as and when TRE gets permission from the relevant Chinese local governments to share its contracts.
Arbortrage rebutted
1. The “master framework”, a.k.a. “Yunnan Plantation Acquisition Contract_23 Mar 2007_EN.pdf”
This is supposed proof that TRE owns — or, at the very least owned as of 2007 — around 200,000 hectares of forest in Yunnan, way more than the 20,000 or so MW alleges it has. Inevitably, there’s a fair bit of legalese but here’s the main paragraph:
Party A has accepted the full commission of the original forest proprietor and forestland use right proprietor (“the Original Forest Proprietor”) to sign this Contract and to transfer to Party B the pine forest, oak forest and broadleaved shaw of approximately 3,000,000 mu (approximately 200,000 hectares) located in Lincang City and its surrounding areas in Yunnan Province (“the Forests”).
And in case you were wondering:
Party A: Gengma Dai and Wa Tribe Autonomous Region Forestry Co. Ltd., a civilian operated company established in Lincang City, Yunnan Province.
Part B: Sino-Panel (Asia) Inc., a limited company established in British Virginia Islands, and a wholly owned subsidiary of Sino-Forest Corporation.
2. The “summary schedule” of Yunnan assets as of the end of 2010. This is the breakdown provided by TRE (and lovingly put together into a table by FT Alphaville). As we note below, the ever bullish Raymond James is keen to point out that this shows MW didn’t do its homework.
3. “Plantation Rights Certificates” There are the purchase agreements between Sino-Panel and local Chinese agents. These, TRE say, prove the asset breakdown above. But MW will likely push for analysts to keep asking questions about the identity of these Chinese agents and the role of the subsidiary Sino-Panel. As we show below, Nomura has alleged that one of these agents — Huaihua Yuda Wood Company — seems to be “related” to Sino-Panel, an allegation already made by MW. At pixel time, this was the only subsidiary named (in English) by TRE that was also feature in the MW document. As more of these agreeements are uploaded this will be where a lot of attention is focussed.
4. We couldn’t find the AIF extracts at pixel time but there are financial statements and balance sheets, which we’ll try to return to later.
So where does this leave us?
Defence and prosecution are still mostly talking past each other. To put it simply, TRE is figuratively waving its contracts around, while MW alleges they’re simply not a true reflection of its Yunnan assets. (In its report MW alleges that: “The value of purchases made under Yunnan master agreement is overstated by approximately $800 million.”)
In other words, TRE is not yet getting into all the specifics of the MW allegations outlined in the previous post — for that we’ll have to wait for the independent report. Nevertheless, it has taken issue with a couple of the allegations made by MW about its asset holdings.
A supportive Raymond James research note out on Tuesday says that TRE has rebutted a couple of howlers from MW:
There are two glaring inaccuracies in the MW accusations Sino addressed prior to the release of findings of the independent audit committee – detailed below:
With respect to revenues generated from plantations in Yunnan province, MW alleged the volume of revenues generated in the associated area would greatly exceed the harvest right quotas in the region and available trucking capacity. However, it was clearly disclosed in Sino’s MD&A for 1Q10 and 2Q10 that these revenues were derived from the sale of standing timber (as opposed to harvested logs) which requires no transportation and does not count against harvesting quotas until such time as the buyers of the standing timber harvest the trees. This is a very basic error regarding one of the primary allegations by MW considering the large number of purported man-hours spent in the “investigation” by MW.
MW alleged Sino overstated assets in Yunnan based on the assumption that the only purchases in the province included 21K ha in Gengma County. However, Sino’s purchases in the province included 173K ha in 25 other counties – a summary of which has been released with some accompanying plantation purchased agreements (Chinese and English translations), refuting this allegation.
This second point is the prose version of the table above.
In contrast however, as well as its worries about Sino-Forest’s issued bonds and cash balance situation, Nomura remains more sceptical about TRE’s asset claims:
While the company provided information related to the forest ownership in Yunnan, the company only provided purchase agreements of about 16k ha of plantations and forest and woodland rights certificates of 0.6k ha in Yunnan versus its total holdings of 186.7k ha. We view such information is not sufficient to address concerns over potential asset inflation as suggested by Muddy Waters (MW). [DN: As of the note's publication time]
We are very surprised to know that Poyry only took 0.1% of the company’s plantation holdings as the sampling size to conduct its valuation work. This raises doubt as to how credible its valuation report is especially Poyry indicated that it had not verified the ownership certificates of the company’s plantation holdings.
Corporate disclosure is weak – no breakdown of its standing timber and wood log sales based on geographical location has been provided, making it difficult to verify if these sales have obtained relevant harvest quotas, if at all.
- Company does not provide details of its customers. Based on our findings, most buyers of standing timber and wood logs are provincial or even county-based traders with relatively small operations. To the knowledge of our industry consultants, there is no sizeable log trader operating across the country, particularly of the size suggested by Sino-Forest. As per Sino-Forest’s 2010 annual report, Sino-Forest’s top customer accounts for 17% of its total revenue in 2010, which is equivalent to US$325 million based on 2010 revenue of US$1.9 billion. Its top five customers accounted for about 71% of its total revenue in 2010. The company has so far not provided the names and details of these customers.
And here’s a bombshell — which harks back to the allegations MW has made about the agents TRE uses in China.
As per one of the timber purchase contracts (16 47-1)2007-9-21 林木收购合同_Eng.pdf) provided by the company yesterday, Huaihua City Yuda Wood Limited (Huaihua) was a seller of timber assets to Sino-Panel (Yunnan) Limited, a subsidiary of Sino-Forest. That said, based on the weblink from – [Link here - FT Alphaville] – it seems like Huaihua is also related to (or owned by) Sino-Forest while details of Huaihua were not disclosed in the offering circular of the 2017 bonds.
This is the relevant section from the MW report:
TRE has a significant undisclosed subsidiary, Huaihua Yuda Wood Company Ltd. Huaihua Yuda has taken massive amount from TRE’s subsidiaries, but its existence was never disclosed. In 2007, Huaihua Yuda received a prepayment of RMB 92.0 million from Sino Panel (Hezhou) and another payment of RMB 81.0 million from Sino Panel (Gengma). (Appendix K5 and K6) According to our research from two government websites, Huaihua Yuda is a subsidiary of TRE.
Back to Nomura and some more questions:
- The company recently organized a site visit in Heyuan, Guangdong province, which has obtained FSC certification. We note that the assets in Guangdong account for only 6% of total plantation holdings. It is worth mentioning that the company has all along organized site visits in Heyuan only, and not in other provinces. This raises an element of doubt as to how credible these site visits are given its major plantation assets are located in Yunnan (23% of total), Hunan (21% of total) and Jiangxi (14% of total).
- In our conversation with management (the CFO and IR Manager) a few months ago, they indicated that the ratio of harvest to replanting volume is about 4:1 in Yunnan. This ratio looks high given our understanding of the strict regulations in China which demand companies replant and harvest plantations on a 1:1 basis.
Thus, there are still a great deal of questions that require answering and it’s unlikely they’ll be sorted before the independent report or TRE’s results day on June 14th, whichever comes first.
Meanwhile, Carson Block told analysts in a conference call on Monday evening that there were more allegations to come.
This has got a long way to go.
Related links:
Sino-Forest: the case for the prosecution – FT Alphaville
Need to go China to investigate Sino-Forest? – James’ Analysis
Here’s What’s REALLY In That Massive Fraud Allegation Against Sino-Forest – Business Insider
The other explosive Sino report – Financial Post