Sino-Forest: Day 4

June 7th, 2011 by Potato

I keep following it thinking I’ll dive back in, but I haven’t yet, and likely won’t until after the results are released next week at the earliest.

I liken it to when you’re afraid there might be a spider in the shower: before you get in you shake the towel and have a scan around, and it looks clear, so you get in. Once in, I might have ignored banging at the door or the water turning cold, since I wasn’t afraid of the Psycho or broken hot water tank scenario, but if I so much as see a black hair that might resemble a spider leg poking out of the drain, I’m running out of there screaming.

So before I bought Sino-Forest, fraud was my biggest fear, and I didn’t allay it by obtaining first-hand concrete knowledge, which would have given me the confidence to see something like this as a buying opportunity. Instead, I relied on weak heuristics and an analyst report that claimed the governance was good.

Then the MW report hit, alleging fraud, and it all fell apart: exactly what I was afraid of. MW had a good hit rate (~3 for 4) with these Chinese RTOs, and I had heard of them before this broke, so I wasn’t about to just dismiss them as a short-seller with dreams of market manipulation.

On the other hand, MW is the noisy kid brother of the cottage industry that is exposing RTO frauds. I don’t want to just attack the source, since that’s not a strong foundation for investing, but he strikes me as someone more interested in market manipulation than justice. His reports haven’t seemed as thorough or solid as say John Hempton’s*, and so far the frauds have been low-hanging fruit. Sino-Forest, if it is a fraud, is a step up. His best part of the analysis (both playing to his strengths and making SF look bad) was the one about how impossible it was to harvest all those trees Sino-Forest sold… but that was smacked down with the first release that said it was a sale of standing timber. I’m not sure tracing related party transactions and capital flows into and out of the country is really his forte. Then the paper reports that he spouts off about having all this other evidence on the analysts’ conference call he hosted, yet he hasn’t released it. Maybe waiting for another Chinese holiday for maximum impact.

I still don’t know what to think. The company has released some documents (though it took a few days). The bank statements look real enough, complete with hand-written notations (presumably linking transactions to entries in the ledger/accounting system). But we’ve learned with other frauds that the companies can and do fake bank statements: you have to get an auditor to go down to the bank and confirm with the bank that the money is there as specified.

Various analysts have said they’ve physically gone over to view the operations, but Poyry might have had the same problem: they can say there are trees there, but who owns them? Plus other, much smaller, less well-executed [alleged] frauds have put up the potemkin factories for analyst visits before, only for private investigators to find the sites empty or idle weeks later.

Fraud is insidious. It’s quite difficult to prove something isn’t a fraud, particularly when there is so much suspicion after all the recent cases, and from halfway around the world with a massive language and cultural barrier. You can’t believe anything the company says without 3rd party verification, and the balance sheets become useless — if it was a matter of pine beetles or wildfires, banks not lending or demand drying up that hammered the share price to a third of book value, I’d probably be buying like crazy. But book value is unreliable if there’s a chance it’s all a lie anyway.

I forget his name, but one talking head on BNN put it [approximately] thusly: “What else were they going to say? It’s like they went to I’ve been targetted by a short seller dot com and printed off the fill-in-the-blanks press release.” The company’s been doing the dance, and releasing some of the documents is a bit better than par, but it’s still not fundamentally different than the dance that an actual fraud would do. That’s partly because there isn’t much more for them to do. Offering the analyst tour in July and specifying that the analysts could pick the locations was a good step at helping to remove the potemkin element. The Dundee analysts’ comments after the close today were also heartening.

So I’m not buying yet, but I keep turning it over in my head, and think I might if there was some good 3rd party evidence of authenticity: an auditor in a bank branch verifying cash, or signing off on the annual report, or maybe a supplier of eucalyptus seeds/seedlings confirming that SF is indeed buying sufficient quantities to do the planting they claim they are. I feel close to having the confidence to buy in again.

Plus I have to bear in mind that my bias is to want to believe. After all, I bought in and lost money, so deep down inside, I want to be vindicated on that prior decision and have this one come out fine in the end. That forces the rational part of me to be extra careful before buying back in.

* - Though John did say that he “was in awe” of MW’s report, but that may just be because of the size. And he hasn’t commented at all since Sino-Forest started posting responses. With MW I read and I think and wonder if he’s wrong. If it was John Hempton alleging fraud, I would be out and gone and never look back: his track record at research and alleging fraud is too good to bother trying to second guess to find value.

One Response to “Sino-Forest: Day 4”

  1. Rob Campbell Says:

    Another financial blogger writing about Sino Forest this week. I came here from Mark Goodfield’s The Blunt Bean Counter I like the personal approach both you guys take in your writing. But I notice very few financial bloggers put pictures in their posts? Any stock that falls from such high valuation to such a low price must have been over valued in my opinion. Maybe though if there was fraud, there will be a movie story here worth making. I can see it now… Opening shot is an aerial view over muddy hills and a cast of thousands planting trees in China…