Sino-Forest: more questions, fewer trees?

Posted by John McDermott on Jun 20 14:35.

Now, about them trees.

Canada’s paper of record, the Globe and Mail, on Saturday published the results of a two-week investigation into Sino-Forest’s assets.

On Monday morning Sino-Forest responded (details below), saying the paper had misunderstood its business model. It also described the reporters’ account of a local “litter-strewn office” and “dusty cement staircase” as “very poetic but completely irrelevant”.

(It’s called colour, guys.)

Like Muddy Waters, the short-seller that first alleged Sino-Forest has fewer trees than it claims, the paper visited Yunnan province, site of Sino-Forest’s largest holdings according to its 2010 annual report.

As we outlined at length, Muddy Waters alleges that Sino-Forest exaggerates the amount of Yunnan timber it buys, owns and sells.

The Globe and Mail deepens rather than broadens the allegations, concentrating on the 2007 “master agreement” Sino-Forest signed with Lincang City, Yunnan. We posted the key sections of the agreement in this post but here they are again:

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”).

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.

The paper says it spoke to officials from Gengma Dai Wa and Tribe Autonomous Region Forestry Co. Ltd (“Party A”) who threw doubt on whether the agreement involved all those many hectares.

Xie Hongting, the chairman of Gengma Forestry, said in an interview that the transactions carried out so far by Sino-Forest amounted to less than 14,000 hectares.

Asked how many deals Gengma had conducted with Sino-Forest, Mr. Xie said: “I’ve told you that we sold them almost 200,000 mu.” (Mu is a Chinese unit of land measurement; 15 mu equals one hectare.)

There’s more in the article — and this supplementary piece — but that’s the gist: local sources contradicting Sino-Forest’s account.

Sino-Forest, echoing arguments it made in last week’s Q1 earnings call, argues the Globe and Mail doesn’t understand its business model and that the report has “factual misunderstandings”.

You should read the release in full but the thrust is that Gengma Dai (“Party A”) sells timber both directly and indirectly to Sino-Forest subsidiaries, and that its quote in the Globe and Mail article only refers to the former. Sino-Forest also make the point, as they did in response to Muddy Waters, that Yunnan is a big place and stretches beyond Lincang City, the area mentioned in the master agreement.

This breakdown is completely consistent with the Company’s public disclosure of its total acquisitions of standing timber hectares in Yunnan Province in its first quarter 2011 MD&A of 230,200 hectares (3.453 million mu) acquired pursuant to the Yunnan Master Agreement and is also consistent with the comments of Mr. Xie of Gengma Dai and Wa to The Globe and Mail. When asked in the interview how much he has sold to Sino-Forest, he accurately says he has sold the Company “almost 200,000 mu” (13,333 hectares) which represents land use rights on land provided by Gengma Dai and Wa and is an approximate total of the Company’s land lease certificates in Yunnan. In addition, Gengma Dai and Wa has sold standing timber for a total of another 34,667 hectares (520,000 mu) in Lincang City both as owner and as agent, and acted as an agent on another 182,867 hectares (2.743 million mu) elsewhere in Yunnan Province.

Oh, and apparently the Globe and Mail visited the wrong empty office.

The Globe and Mail’s article is further inaccurate in a critical part of its research. It refers to “Gengma Forestry”, with its “litter-strewn” office “up a dusty cement staircase”; and its office manager Zhang Ling. Very poetic, but completely irrelevant, because based on the information that The Globe and Mail provided to the Company, the Company believes that this is the address of a business known as Gengma Dai and Wa Autonomous County Forestry Industrial Co., Ltd. (耿马傣族佤族自治县林产有 限责任公司). It is a different organization from Gengma Dai and Wa Tribes Autonomous County Forestry Limited (耿马傣族佤族自治县林业有限责任公司), with whom Sino-Forest has its Master Agreement, which is based at an entirely different address.

Where does this leave worried investors and not-so-worried shorts? Waiting for Sino-Forest’s “independent” investigation to conclude in 2-3 months, probably. Until then, it’ll be hard to get a firm answer on whether Sino-Forest’s assets have been exaggerated.

But at the very least the Globe and Mail report is further evidence that the very poetic complexity of the Sino-Forest business model has not been recognised, understood or forgiven by shareholders.

Related links:
Key partner casts doubt on Sino-Forest claim – Globe and Mail
On the trail of the truth behind Sino-Forest – CTV News
Globe & Mail vs Sino-Forest – FT Tilt
Sino-Forest coverage – FT Alphaville

This entry was posted by John McDermott on Monday, June 20th, 2011 at 14:35 and is filed under Capital markets, Commodities. Tagged with , , , .

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