Sino-Forest Shares Hit 6-Year Low

From $20 to $3 in two weeks: Sino-Forest’s fall from grace with investors has been fast and precipitous, erasing almost $4 billion of Chinese tree plantation operator's market value just since start of June.

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Management’s attempt to give explanations in response to fraud allegations from research and investment firm Muddy Waters appears to have made the matters worse. Shares of the Toronto-listed Sino-Forest plummeted more than 30 percent Tuesday after a conference call with analysts. On Wednesday, the stock traded sharply lower, at one point hitting a 6-year low of $2.85.

Annisa Lee, analyst at Nomura Securities, continues to see more downside risk after the call.

“We view the company’s corporate disclosure as weak, and management seemed reluctant or unable to provide concrete answers to a number of the questions,” said Lee in a research note.

Muddy Waters, which issued the scathing report questioning Sino-Forest’s business practices on June 2, was also unsatisfied with the explanations provided by the company’s management.

“The selloff in [Sino-Forest] shares following [the call] illustrates our overall feelings about management’s responses to questions”, Muddy Waters said in a reaction to the call.

Notable drops or dismissal of awkward questions by Sino-Forest’s management during the call didn’t go unnoticed by Muddy Waters.

The firm also said that offered explanations only heightened concerns about Sino-Forest’s business practices: “As we wrote in our initial report, a consistent theme of [Sino-Forests’] stated business practices is that they are unnecessary, overly complicated, and risky for a legitimate business.”

Muddy Waters also took issue with the company’s refusal to identify buyers (authorized intermediaries) citing competitive reasons. “This explanation strikes us once again as [Sino-Forest] relying on everybody in the chain (e.g., the farmers) being ignorant,” the firm said in its response.

The call raised analyst concerns over Sino-Forest’s business model and tax liabilities.

“The company does not know if the Als (authorized intermediaries) have paid value-added tax (VAT) and is exposed to potential contingent liabilities if they do not pay the VAT,” said Lee in her note. “The practice does not sound consistent with what we know about doing business in China. To our knowledge, buyers do not purchase products from their suppliers if the latter has not paid the VAT and presented the VAT voucher.”

Moreover, Lee expects management’s refusal to disclose current cash balance to negatively affect investor confidence. “While management indicated that the company will slow its acquisitions, we would not be surprised if cash burn continues in 2Q.”

Both Lee and Muddy Waters put in question reliability of Sino-Forest’s first quarter results since they were not audited by the company’s auditor Ernst & Young.

During Tuesday’s conference call, Sino-Forest said that the company has tasked three of its independent directors to examine the Muddy Waters’ allegations. The company says it will take two to three months for the committee to provide a complete report on the findings.

Muddy Waters says their experience with much smaller companies suggests that Sino-Forest's timeline is aggressive.