Making sense of Sino-Forest

June 4, 2011
39-page report claiming that Sino-Forest Corp is a Ponzi.

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If you want to move a stock with a research report, you can hardly hope to do better than Muddy Waters did with its 39-page report claiming that Sino-Forest Corp is a Ponzi. The report came out on Thursday afternoon; after falling to $14.46 and then being suspended on the Toronto Stock Exchange, it reopened Friday at just $5.

Muddy Waters, of course, reckons Sino-Forest is still a massive short at this levels, with the stock being worthless. But the market clearly thinks highly of the firm’s report, all the same.

I’ve spent a good chunk of this evening reading the report, or trying to — it’s not easy going. Muddy Waters has obviously done a great deal of research into Sino-Forest, and seems to have found some extremely suspicious activity. But there’s large chunks of the report I have a lot of difficulty understanding, and if I was a market participant trying to understand what was going on here, I’d certainly welcome some journalistic help in explaining what exactly Muddy Waters is saying and how credible they are.

In the immediate aftermath of the report’s release, on Thursday afternoon, Alphaville put out a detailed 1,500-word blog post which was further honed and updated over at FT Tilt. The post did a good job of laying out the allegations, and even dug up a juicy new nugget: one of Sino-Forest’s board members is Simon Murray, the chairman of Glencore.

Today, however, the follow-up has been extremely disappointing. Sure, there are lots of basic market reports, saying that the report came out and the stock went down, and giving the formal reaction of the company. Those are necessary. And there’s been a good amount of gloating that the biggest loser here appears to be John Paulson. That’s predictable. But what I haven’t seen is any further insight into the allegations themselves.

Alphaville, again, has been ahead of the curve, giving granular details of Sino-Forest’s response. And some of that response even makes a certain amount of sense: Sino-Forest buys and sells forests in China, so I can see how, in theory, it could sell an entire standing forest without having to cut down or log a single tree. (One section of the Muddy Waters report goes into a lot of detail about how Sino-Forest couldn’t make nearly as much money as it claimed in Yunnan province, since it was physically impossible for that many trees to be felled and transported.)

But is it plausible that Sino-Forest sold a huge forest in Yunnan for $230 million? And if so, who bought it? More generally, how much credibility does the company have, and how compelling is Muddy Waters’s report? Anybody trying to answer such questions is on their own: the press hasn’t helped them at all.

John Hempton, with four short words (“I am in awe”), at least manages to make a clear judgment on whether he thinks Muddy Waters is right that Sino-Forest is a Ponzi. (He does, but he doesn’t go into any detail.) Meanwhile, Reuters has found at least one person who thinks that it isn’t:

Dundee Capital Markets analyst Richard Kelertas put Sino-Forest “under review” pending more information, but said he did not believe the Muddy Water charges.

“To the best of our knowledge we believe that the allegations cited in the short-seller’s ‘research report’ are false and without merit,” he said, noting his conclusions were based on several years of conversations with management.

I’d love to see a lot more detail here. If Kelertas thinks that the Muddy Waters allegations are false, he must have some kind of rebuttal to them — something which at the very least could help frame the debate or raise questions for Muddy Waters to answer. On the Toronto Stock Exchange today, volume in Sino-Forest exceeded $200 million, which means that there’s real money out there buying the stock at these levels.

What’s certain is that in the wake of all this, either Sino-Forest or Muddy Waters is going to lose all credibility: one of them is a multi-million-dollar fraud. Muddy Waters is short Sino-Forest, of course. If Sino-Forest turns out to be a slightly dodgy Chinese forestry company and not a Ponzi scheme, you can be sure that Muddy Waters has been covering its short all day and has banked a huge amount of money by putting out extremely misleading material. On the other hand, if Muddy Waters is right, then Sino-Forest is toast.

Because both companies are talking their book here, there’s a clear need for impartial adjudication, even if it’s just a quick-and-dirty first take on whether the allegations seem plausible. Reuters alone had five reporters, one writer, and one editor working on its report — between them they must have formulated some kind of idea of what’s going on here and whether it makes sense to take Muddy Waters at its word. Because while the market has spoken, it’s not always easy to understand exactly what it’s saying, or whether it’s making any sense. If market reporting is to serve any use at all, it’s to help provide that translation service.


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