Thursday, November 24, 2011

Iron Ore Outlook 2011-2016

During September to October, iron ore collapsed from $180 to under $130. Recently it has fluctuated at $140. How is the outlook in five years?

I expect demand in iron ore will keep growing, but iron ore prices will drop into the range of $90-$120 because of overcapacity.

A detailed analysis report is HERE.

Wednesday, September 14, 2011

Is Silvercorp Another Chinese Fraud?

Silvercorp Metals Inc. (TSX: SVM), a Chinese silver producer, was accused of fraud by an anonymous letter dated August 29, 2011 addressed to the OSC, the Company's auditor and various media. September 13, 2011, Silvercorp was hit by a second round attack, which is an 8-page long report (see here) published on a short-seller's research website, Silvercorp has responded quickly to deny all allegations on September 2 and 14 respectively (see here).

Is Silvercorp another Chinese fraud like Sino-Forest?

My short answer is: No.

Revenues can be inflated, assets can be exaggerated, but the records of cash activities and tax payments are hard to cook.


According to Brad Humphrey, an analyst from Raymond James:

"...since 2004 the company has raised just over $200 mln, paid some $40 mln in dividends, ~$30 mln in share buybacks, spent more than $175 mln acquiring, developing, expanding and exploring (both in China and Canada) and still have roughly $220 mln in the bank."

It's clear that the Company has been a cash cow.


According numerous copies of tax remittance forms and verification letters from China tax authorities published on Sivercorp website, the company's major operating subsidiary Henan Found has paid USD$106 million of taxes for the period 2006 to June 2011. The published annual tax payments are in line with the reported annual revenues of the Company and its subsidiaries'.

If you have doubts about the reliability of documents published by the Company, you can easily verify them with your own online research. For example, according to the State Tax Bureau of Henan Province, Henan Found paid taxes of RMB145.82 million in 2009 and ranked No.50 largest taxpayer in Henan (see here).

Review of Alfredlittle's Allegations

1. Production

Alfredlittle's investigators spent two weeks counting the number of 30 tonne capacity trucks delivering ore to SVM’s two mills and then calculated the actual production. The problem here is that in China a 30 tonne capacity truck would be loaded with 40 tons, 50 tons or more, as truck overloading is just a day to day business there. Please see here a serious report regarding truck overloading, and here are some funny vehicle pictures including overloaded trucks.

The Alfredlittle Report also cited the designed production on the mining permit and the tonnage reported to the local Land and Resources Bureau to question SVM's reported production in filings. In China the designed production on the mining permit is determined at the time when the permit was approved, and usually will not be updated till expiry or renewal of the permit. It is a universal phenomenon in China that the actual production of a mine is bigger than the designed production on the permit, and the miner intends to align the number with the permit or industry norms when reporting to certain government departments.

2. Quality

The questions raised by Alfredlittle did bring doubts with regard to the quality of SVM's mineral reserves, however, they are not convincing evidence.

According to Alfredlittle, the quality of the Ying mine ore in the local L&R bureau records is much lower than it in SVM's 43-101 reports. SVM has already responded that the government record is outdated (2005). Does the government have updated record? Probably it has, but the record is not accessible to the public. Chinese government has built a system to keep the documents of current mineral reserves confidential. From a government website (
here ) we can see that the government has documents regarding the reserves of SVM's two subsidiaries, Henan Found and Henan Huawei, but the documents have been protected.

Alfredlittle's investigators sent two samples fell from the trucks at the mine site to a local lab and the results showed significantly lower silver grade than it in SVM's 43-101 reports. Two samples certainly do not represent the quality of the whole mine. Due to the uneven distribution of silver in different site and different depth, if Alfredlittle intended to keep going with site sampling, a more appropriate method would be to randomly collect samples form those trucks during a time span of at least several months.

In my opinion, the cash SVM has made and the taxes the Company has paid surely have demonstrated the quality of its ore, if not the whole, at least the ore that the Company has dug out in the past several years.

3. Auction Sale of 5% Henan Found

Auctions of state-owned mining assets are always tricky in China. It's not uncommon that the appraisal, the buyer and the final price are often fixed in such auctions.

4. Questionable Acquisition of Yangtze Gold Inc.

As Alfredlittle report hints that SVM might have overpaid in the acquisition of Yangtze Gold Inc, it is ironic that Larry H.P. Lang (Lang Xianping), a well-known Chinese economist and lecturer, accused foreign companies including Silvercorp of taking over Chinese mining assets cheaply in one of his books. The book, titled "Production Chain Plots III: The Truth of New Imperialism Acquiring Chinese Enterprises', is available for reading online, and here is the part about Sivercorp taking over Henan Found and Yangtze Gold Inc.

When SVM acquired Yangtze Gold Inc, SVM clearly stated that Yangtze Gold was controlled by SVM's CEO Rui Feng and his relative (see here the news release in 2008).

Was the CDN$62 million a fair price? The independent directors and the auditor of the Company should have the answer. And, investors will see the answer very soon, as GC Project, one mine owned by Yangtze Gold, will achieve a 700 tonne per day mining capacity and a 1,500 tonne per day milling capacity by the end of fiscal 2012.

Friday, July 8, 2011

Can Paulson sue Sino-Forest and its Directors and Auditors for his loss?

According to a news report titled "Sino-Forest On The Ropes, Battered By Short-Seller", after Sino-Forest's shares were pummelled by a report from short seller Muddy Waters who alleged the Company was a fraud, Paulson & Co sold off its entire holdings in Sino-Forest and took a $574 million loss.

Can Paulson sue Sino-Forest and its directors and auditors for his loss?

Lawyers will probably say that it depends. Sino-Forest has hired PwC to investigate the allegations. On one hand, if the investigation results showed Sino-Forest as a fraud, Paulson certainly could launch litigations. But the Company's assets probably were not enough for its debts; directors would say they were duped by the management, and the auditors would state that an audit is not designed to detect fraud. On the other hand, if the Company was vindicated by PwC 's investigation, Paulson probably would not be able to sue the Company.

But my answer to the question is YES. Paulson can sue Sino-Forest and its directors and auditors right now without considering Muddy Waters' allegations or PwC's investigation results, because there are numerous material misstatements and misrepresentations in Sino-Forest' financial statements.

1. Overstated cash flows from operating activities by $4 billion for the period of 2003 to 2010

Cash flows from operating are one of the most important factors for investors to make investment decisions. Sino-Forest has unscrupulously overstated cash flows from operating in every year since 2003. According to the financial statements, the aggregate cash flows from operating activities for the period of 2003 to 2010 were $3.3 billion, which should be negative $0.7 billion and was overstated by $4 billion.

During the period 2003 to 2010, the company generated $4.3 billion of revenues from its standing timber business, and correspondingly about $4 billion operating cash flows have been reported in its consolidated statements of cash flows by using indirect method.

But these $4 billion cash flows never occurred. The Company has applied a business model of BVI (British Virgin Island) companies + AIs (Authorized Intermediaries) for its standing timber business since 2003. According to the explanation of the model by CEO Allen Chan, BVI companies have never received real cash from the standing timber transactions. The following is taken from Mr. Chan’s remarks in the Company's Q1 2011 conference call scripts:

"Fourth, the AI pay the proceeds from the timber sales to the end users to a Sino-Forest designated purchasing agent rather than direct back to the BVI company. The AI pays under the terms of the contract, but since the BVI subsidiary cannot hold a bank account in China, cash is no exchanged.

In the fifth step, the purchasing agent utilizing the money from the AI, purchases more parcels whose ownership is transferred to the BVI company. Sino-Forest directs the AI to use the proceeds from the sales, which is a receivable to Sino-Forest, to purchase new plantation assets through an agent on behalf of Sino-Forest that had been already been identified by Sino-Forest."

It’s very clear that on the Sino-Forest’ accounting perspective the process of standing timber business is as follows:

Standing timber ---- accounts receivables from AIs ---- more standing timbers

There was no cash ever flown into Sino-forest in this process, so the company overstated its cash flows from operating by $4 billion for the period of 2003 to 2010.

2. Serious non-compliance with Chinese tax laws

Under Chinese tax laws, a foreign company doing business inside China has mandatory obligations to pay income tax. Sino-Forest started selling standing timber inside China through its BVI companies in 2003, but these BVI companies have never filed or paid income taxes in China. According to Sino-Forest’s financial statements and applicable tax laws, as of December 31, 2010, the unpaid tax and interest on tax overdue for its standing timber business amounted to $0.51 billion; and the Company also was facing $0.14 – 1.4 billion of penalties. This non-compliance with Chinese tax laws is so serious that all assets in China owned by Sino-Forest could be seized by the Chinese government for unpaid tax and penalties.

Sino-Forest is listed on TSX. According to Canadian Audit Standard 250 “Considerations of Laws and Regulations in an Audit of Financial Statements”, compliance with laws is the responsibility of management, but the auditor has responsibility of obtaining sufficient appropriate audit evidence regarding compliance with tax laws.

There have been two laws governing income tax on foreign companies in China. Before 2008, it was Income Tax Law of the People’s Republic of China on Enterprises with Foreign Investment and Foreign Enterprise, plus related rules of implementing, explanations and circulars (Thereinafter “the Old Law”). The tax rates on foreign companies under the Old Law ranged from 15% to 30%.

Starting from 2008, all companies except for local proprietorship and partnership have been under the Enterprise Income Tax Law of the People’s Republic of China, plus rules of implementing, explanations and circulars (Therein after “the New Law”). The tax rate under the New Law is 25% for all companies except for withholding tax rate for foreign companies and preferential tax rates for certified hi-tech and small size low-profit companies.

Both the Old Law and the New Law mandate a foreign company to pay income tax when doing business in China. According to regulations of tax collection, the daily interest on tax overdue is 0.05% and the penalty is 50% - 500% of the total overdue.

There are two ways for a foreign company to pay income tax. One way is registration. A foreign company, by itself or through its local organization such as an office or a representative, registers with local SAIC and tax bureau, and then remits advance tax instalments monthly or quarterly and makes annual tax filing within 5 months after year ending.

The other way is withholding, which usually applies to dividends, interest income, royalties, rentals, and consulting fees, etc. This way, a foreign company does not need to register with SAIC or tax bureau. When a client makes a payment to the foreign company, or redirects a payment to a third party on behalf of the foreign company, the client must withhold 20% of the payment and remit it to a local tax bureau on behalf of the foreign company within 5 days under the Old Law, or 7 days under the New Law, and then send a copy of tax remittance to the foreign company.

Whether it is registration or withholding, the foreign company will definitely receive a copy of tax filings or tax remittance and will then clearly know how much income tax the company has paid. According to Sino-Forest’s financial statements and new releases, the Company’s BVI companies that have sold standing timber since 2003 have never paid income tax in China. In footnotes to its financial statements, the Company stated that its AIs should withhold and remit incomes taxes on behalf of the Company, but apparently the AIs have never done so because even the CFO of the Company does not know whether the AIs have ever paid taxes for the Company or not according to his answers to tax related questions at Q1 2010 conference call.

According to the segment information in Sino-Forest’s financial statements, during 2003 to 2010, its standing timber business generated $4,316 million of revenues and about $1,930 million of net income. Even using possibly lowest tax rates, as of December 31, 2010, the corresponding unpaid tax and interest on tax overdue amounted to $426 million and $85 million respectively, and the penalties ranged from $136 million to $1,360 million.

3. Understated tax expenses and overstated net income by $263 million during 2006 to 2010

Based on segment information in Sino-Forest’s financial statements, the Company generated $1, 768 million of net income before tax during 2006 to 2010, and recorded $139 million of tax expenses. Under the applicable tax laws, even using possibly lowest tax rates, the tax expenses should be $402 million, therefore, the company understated tax expenses by $263 million and consequently overstated overall net income by $263 million.

4. Numerous material inconsistencies and irregularities

Since the Company started to sell standing timber in 2002, there have been numerous numbers and statements in Sino-forest’s filings and releases, which were inconsistent, or contradictory, or even unbalanced, here are some examples:

Example 1: No justification for the business model of BVI companies + AIs

In Q1 2011 conference call scripts, Allen Chan, CEO of Sino-Forest, explained why they used BVI companies + AIs for standing timber business as follows:

“In the 1990s, an international company operating in China would have to use an offshore subsidiary to help it conduct business in the country. In those days, we could not form the Wholly Foreign Owned Enterprise or WFOE for short, on-shore.”

But Sino-Forest did own four WFOEs when it started to use the model of BVI companies + AIs in 2003. These four WFOEs were: Jiamin WFOE, Jiasu WFOE, SFR WFOE, and Jiafeng WFOE.

Actually, Sino-Forest started its standing timber business before 2003. According to its 2002 annual report, the Company sold 8,100 hectares of standing timber during the year; however, there was no mention of AIs’ and BVI companies’ involvement in standing timber business at all in the report.

Also, before 2008 all WFOEs in China were able to enjoy multiple years of tax-exemption (tax holidays), but there have never been tax holidays for foreign companies, therefore, from the tax advantage point of view, Sino-Forest should use WFOEs instead of BVI companies. If it was for the reason of AIs, the Company certainly should use a model of WFOEs + AIs instead of BVI Companies + AIs.

Example 2: The issue of harvesting permits has been omitted since 2005

According to Forest Law of the People's Republic of China, the land of all forests is owned by the government, and is not tradable. The use right of the land of a forest and the ownership of trees (plantation) in the forest can be traded together or separately. To cut down any trees in a forest, the owner of the plantation should apply for a harvesting permit (logging permit) from the local government (local forestry bureau or its agents).

Without harvesting permit, the standing timber alone in a forest in China is not marketable. A harvesting permit stipulates how many trees and what trees with what size in what area can be cut down, therefore, without a harvesting permit, the two sides of a standing timber transaction cannot determine the volume and the market value of the timber.

Harvesting permits are also an effective method for the standing timber seller to control the risk of uncollectable accounts receivable, especially when a large area of plantation is sold, as usually a harvesting permit will be issued for each small parcel of forest.

When Sino-Forest first started selling standing timber in large volume, the Company actually applied and controlled harvesting permits. In both 2003 and 2004 annual reports, there was the following related content:

“In addition to instituting these instalment payments, we also seek to control our credit risk from sales of standing timber by not releasing the logging permits to the buyer until we have received substantially the amount outstanding under the sales contract.”

But since 2005, harvesting permits (logging permits) have never been mentioned in the Company’s annual reports.

Have its auditors checked the harvesting permits of the standing timbers it sold? Maybe.

Example 3: Hiding income taxes payable from being seen in balance sheets

Before 2005, in Sino-Forest’s financial statements tax provisions were recorded in Income taxes payable in balance sheets.

In 2005 financial statements, the Company adopted an innovative accounting practice – hiding the majority of Income taxes payable into Accounts payable and accrued liabilities. In 2004 balance sheet, the taxes payable balance was $18.5 million, but in 2005/2004 comparative balance sheets in 2005 financial statements, the$18.5 million was changed into near $0.5 million, and $18 million was moved from Income taxes payable to Accounts payable and accrued liabilities.

Since then, the majority of income taxes payable were hidden into Accounts payable and accrued liabilities in every year’s financial statements. To know how much income taxes were unpaid, investors have to look into the footnotes. But even reading through the related footnotes, investors would still be in the dark, because the footnotes only tell part of the story. The following is from 2010 footnotes:

“As at December 31, 2010, this provision is $156,941,000 [2009 – $98,863,000], which amount relates to the profits of the Authorized Sales Activities earned by the BVI Subsidiaries during 2010 and in the three preceding years including discontinued operations, and is included in accounts payable and accrued liabilities.”

As it stated that the $157 million of tax provision was for 2007 to 2010, how much was it for the years before 2007? How much was the total balance? It appears the Company just does not want to show it to investors.

Example 4: Unbalanced tax liability balances

As there were no future tax assets reported in Sino-Forest’s financial statements and tax payments usually should not be negative, in any given period the tax expenses per income statements should be equal or larger than the increase in tax liabilities per balance sheets. But according the financial statements, the tax expenses were much less than the increase in tax liabilities for the period 2007 to 2010.

During 2007 to 2010, the total tax expenses per income statements were $140 million, but the tax liabilities in balance sheets increased $230 million from December 31, 2006 to December 31, 2010. The $90 million of increase in tax liabilities over total tax expenses means either the $157 million of tax provision for 2007 to 2010 was substantially understated or the financial statements for the period were not balanced.

Example 5: Misinterpreting tax regulations to understate tax expenses

Note 18 in the 2010 financial statements stated the following:

“The PRC tax authorities issued Circular 19 in February 2010 (the “Circular”) stating that the deemed profit percentage for certain activities should be a minimum of 15%. The activities subject to this minimum percentage appear to include sales of plantation fibre. The Company has been assessing the effect of the Circular on the BVI Subsidiaries and monitoring its interpretation and its application by the PRC tax authorities. Based upon the Company’s analysis to date, the Company has recorded income tax based on a deemed profit rate of 15% for 2010.”

The above statement by Sino-Forest is totally a misinterpretation of the Circular 19. The online version of the origin Circular is as follows:

The Circular 19 clearly stated that the tax authorities will determine a foreign company’s income taxes first based on its accounting records and books. Only when it is difficult to determine income taxes because of incomplete or improperly recorded records and books, the tax authorities would designate a profit rate, which ranges from 15% to 50% for different industries, to the total revenue to determine the income taxes.

Sino-Forest is an established public company, and its accounting records and books are certainly well recorded and kept. The statement by Sino-Forest regarding the Circular 19 appears to me that Sino-Forest intends to hide or destroy its well recorded accounting books in an attempt to make Chinese tax authorities designate a much-lower-than-actual profit rate when determining income taxes on the Company’s standing timber business.

DISCLAIMER: I do not guarantee the accuracy, completeness and reliability of this article. In no event I shall be liable for any kinds of damages resulting from the use of this article.

Tuesday, June 14, 2011

Sino-Forest continues telling stories

As expected, the Q1 results of Sino-Forest showed the Company has kept growing fast. CEO and Chairman Allen Chan continued telling beautiful stories about the company's achievements and future, but the subsequent diving in its share price has indicated that many investors see these beautiful stories as mirage.

Before this morning, I saw a likely fraud. After listening to today's conference call, I see the writting on the wall: most standing timber transactions were fabricated.

Why? Two points probably suffice.

1. Mr. Chan stated again that Sino-Forest sells standing trees and thus no issue of quota limitation. But the business model, which he talked in detail, clearly shows the buyers CUT down trees and sell them to end users. Therefore, the quota limitation issue still stands firmly.

2. Mr. Chan said that standing trees are sold to AIs (Authorized Intermediaries), and AIs will pay taxes including corporate income taxes for Sino-Forest's BVI companies. Unless Sino-Forest has organized a massive tax evasion scheme participated by Chinese officials in taxation, there is NO way for the Company to transfer its subsidiaries' tax obligation to the so called AIs.

Apparently the question now is not whether there is a fraud, is how big the fraud is.

Stories are ending!

Friday, June 10, 2011

Review of Muddy Waters Report on Sino-Forest

Since Muddy Waters (MW) issued a report on June 2 accusing Sino-Forest (TRE) of institutional fraud, TRE stock price has been pummelled. Some analysts have stood out to defend for TRE, and an analyst at Dundee Capital announced that MW research is a pile of crap.

I have looked into this pile of crap in detail, and here I’d like to share my review.

I saw the following specific allegations in MW report. For each allegation, I will put what MW said, what Sino-Forest said, and my opinions with analysis.

1. Yunnan $231.1 million standing timber sale is unreasonable


The $231.1 million sale of timber in Lincang city, Yunnan province is largely fabricated, because such amount exceeds the applicable harvesting quotas by six times, and transporting the harvested logs would have required over 50,000 trucks driving on two-lane roads winding through the mountains from this remote region, which is far beyond belief (and likely road capacity).


The revenue was very clearly disclosed in MD&A filed for Q1 and Q2 of 2010 as the revenue resulting from the sale of the standing timber - there is no cutting or transport involved.

Opinion: The sale is questionable.

In TRE 2010 Annual Information Form (AIF) there is the following regarding standing timber sales.

“Pursuant to the sales contract, the buyer is required to harvest the standing timber within 18 months from the date of the contract.”

Accordingly, the buyer needs to cut down the trees in 18 months, therefore, we might need to further check with local forestry regulator about 2011–2012 harvesting quotas, and ask locals about or go there to observe the harvesting activities. Over $200 million of trees in one city to be cut down in 18 months, probably you can see legions of Chinese scattered everywhere chopping down trees there.

2. Raised $3.05 billion in total, only $1.2 billion injected onshore


Sino-Forest has raised a total $3.05 billion from the capital markets, but only a maximum of $1.2 Billion of cash has been injected onshore according to the SAIC filings.

Opinion: SAIC filings do not support the allegation.

SAIC filings record the registered and actually injected capital by foreign investors, but injecting cash to subsidiaries in China does not necessarily to go through capital. For example, TRE and any of its offshore BVI companies can lend money to any of TRE’s subsidiaries in China, and SAIC does not regulate and record this lending.

The exchange from foreign currency to Chinese currency RMB must be approved or registered with another government department, SAFE, so to check how much funds were actually injected onshore, we need to look into SAFE records, not SAIC filings.

3. During 1994-1997, the revenues from its Leizhou EJV were fabricated


TRE breached its commitment to contribute equity capital to the EJV, Leizhou Eucalyptus Resources Development Co. Ltd, and fabricated its revenues by the EJV.

Appendix A5: Letter by Leizhou Forestry Bureau (JV partner) dated Feb 27, 2008 says TRE injected only $1 million and the EJV had never had actual operations till letter date due to lack of Cash.

The $12.4 million TRE stated that Leizhou Forestry owed to TRE resulted from EJV cessation in 1999 was fabricated.


1996 Annual Report

In 1996, wood chip production in the Leizhou EJV accounted for approximately 35.8% of total production. Leizhou EJV: 212,500 BDMT, all products exported.

An initial capital contribution of $1,000,000 was made in 1994. No further capital contribution was made in 1996.

1997 Annual Report:

TRE entered into an agreement to cease EJV operations. As settlement, Leizhou Forestry Bureau owed TRE $12.4 million, which would be paid with standing timber

Opinion: Revenues generated by the EJV during 1994-1997 are questionable; no evidence shows the $12.4 million settlement was fabricated.

No hard evidence pointed out that the $12.4 settlement was fabricated, as the arguments regarding the EJV operation cessation from TRE side could be another story.

The focus here should be the revenues generated from Leizhou EJV, as Leizhou Forestry Bureau stated in its letter that the EJV had never produced actually till 1997. Though the letter is one side’s story in a divorce, it is a formal government document, and there wasn’t any motivation for the Leizhou Forestry Bureau to lie about the production, because a successful EJV in 1990s would be a huge achievement for the local officials.

As TRE 1996 and 1997 annual reports indicated that all products from Leizhou EJV were exported, export records with customs or foreign exchange records with SAFE during that period would be able to validate the revenues.

4. Standing Trees transactions through offshore BVI companies are fake


The transactions are artificial and the traded trees are phantom trees. Business confidentiality, VAT tax, income tax, etc, are excuses to cover the fraud. Under Chinese laws, TRE offshore BVI companies cannot do businesses inside China directly, and there is no way to escape VAT tax.

Opinion: No hard evidence

It’s true that a foreign company must establish a local company to do business in China, and escaping VAT tax can lead to life imprisonment.

A foreign company can invest in to and divest out of China, can export to and import goods from China, but cannot buy and sell goods inside China without going through its subsidiaries there.

However, there is at least one way for a foreign company to sell standing trees in China without paying VAT and income taxes, though it is in the grey area and could bring trouble in the future. The loophole here is to change the standing timber into capital of a company and then sell the ownership to the buyer. An example is as follows:

Suppose a scenario: A foreign company has set up a subsidiary, company A, in China, which bought $100 million value of trees. And the foreign company also has two offshore BVI companies B and C. Now a Chinese buyer is willing to purchase the trees at $200 million.

Transaction process: A takes the timber as capital valuated at $100 million to register a wholly owned subsidiary company X inside China –-- A transfers it ownership in X valuated at $100 million to B –-- B transfers its ownership in X valuated at $200 million to C –-- C transfers its ownership in X valuated at $200 million to the Chinese buyer.

In this process, since B and C are registered in BVI, in which capital appreciation incurred, therefore no VAT and income tax incurred inside China.

5. Sino-Forest’s timber holdings in Yunnan is overstated


The timber holding is overstated significantly according to government reports related to master agreements, forest rights issuances and their corresponding value.

Opinion: No hard evidence with regard to master agreements and valuation; the standing trees TRE actually purchased and sold are questionable.

Master agreements are similar to framework agreements, and are subject to changes even after government approval; therefore, it’s reasonable that there is difference between government documents and TRE filings.

It’s impossible to accurately calculate TRE’s forest value by using the numbers in the government reports. What support the valuation of those forests in the government reports? When was the valuation date? What difference between TRE’s forests and the average forests in the area?

The numbers in Chinese government documents related to local achievements and resources, such as forestry resources and foreign investment received are usually equal or larger than actual numbers. Accordingly, the numbers in government documents indicate that TRE’s investment and standing timber sales might be quite different from its annual reports. Further verifications with local government and forestry farmers are needed.

6. Dodgy timber agents

(MW described 3 agents; here I am taking one of them, because of similar allegations)


Bo Hu is a tiny company established one month before signing the master agreement with TRE. Bo Hu is registered in Guangdong, so its selling forest in Guangxi to TRE is questionable.

Opinion: Being small and new is ok, but the agent’s jurisdiction brings question.

In China, it is common that one large mountain is divided into numerous pieces and every local household gets one piece. This is actually the reality in my hometown, a city in Hunan, China. When the standing timber in the mountain is to sell to one buyer, a new company, of course, pretty tiny, would be registered by households collectively, and all households would sign an agreement with the new company, and then the new company would sign a master agreement with the buyer. This small new company certainly would be registered locally. In the case of TRE and Bo Hu, it is questionable that Bo Hu was registered in Guangdong but sold trees in Guangxi to TRE.

Also, Bo Hu did not actually own the trees, so the agreements between Bo Hu and actual plantation rights owners should be verified.

7. Stealing money and other allegations

Opinion: No hard evidence, but there were questionable cash transfers.

Though the numbers in audited financial statements a company submitted to SAIC are usually different from the company’s consolidated financial statements, the SAIC audit reports indicated the existence of unusual cash transfers between TRE’s agents and its subsidiaries.

Tuesday, June 7, 2011

Need to go China to investigate Sino-Forest? (2.)

Look into Sino-Forest's trees in Hunan, China

The two Chinese provinces in which Sino-Forest owns the most standing timbers are Yunnan and Hunan. Muddy Waters has already sent investigators to Yunnan and then displayed tons of findings in its report. Before flying to Hunan or hiring a local investigator there, we may do some cross-checking by just using Internet.

According the Company's 2010 Annual Information Form (2010 AIF), which you can download from, Sino-Forest signed master agreements with Hongjiang City Forestry Technology Integrated Development Services Company (Hongjiang Forestry Services) to acquire approximately 400,000 hectares of non-state owned plantation trees for between RMB10.4 billion to RMB12.5 billion over 14 years in Hunan Province. The plantations under this agreement include mature trees with an estimated yield of 100 to 120 cubic meters per hectare, or an aggregate 40 million to 48 million cubic meters of wood fibre.

When Sino-Forest signed an agreement of intent with the local government in Hunan in 2006 to acquire forests, the Hunan Forestry Bureau put the news on its website, which said that Sino-Panel planned to invest RMB 2 billion to acquire 150,000 hectares with 7 million cubic meters of wood fiber.

What differences do we have here?

First, the investment. According to the government news report, RMB2 billion for 150,000 hectares, thus 400,000 hectares should be around RMB5.3 billion, but Sino-Forest's 2010 AIF stated RMB 10.4 to 12.5 billion. Could the government want to shrink the numbers? Unlikely. Foreign investments are a key performance indicator to Chinese officials, the local governments always try to exaggerate the numbers.

Second, the cubic meters of wood fiber. The Forestry Bureau reported 7 million cubic meters on 150,000 hectares, thus 400, 000 hectares should have about 19 million cubic meters of wood fiber, but Sino-Forest said 40 to 48 million cubic meters. I really wish those natural trees could grow so fast during the period from 2006 to 2010.

Where are those forests specifically? The Sino-Forest's 2006 AIF, which you can download it from Sedar, clearly stated 100,000 hectares of the 400,000 hectares under the master agreements were in Hongjiang city, but an article dated on October 14, 2011 on Hunan Forestry Bureau, might challenge these 100, 000 hectares. The article indicated that the total forest area in Hongjiang city was 2,301,600 mu, which equals to 153,440 hectares. The end of article also said that 4 towns were full of bamboos. This means the city agreed to sell almost every tree in the whole Hongjiang city except the bamboos and some trees in peasants' yards to Sino-Forest. The article also mentioned that over 90% of all forests in Hongjiang were rented and operated by peasant households.

The other 300,000 hectares might also be questionable. The 2006 AIF clearly stated that Sino-Forest entered into a master agreement with Hongjiang City Forestry Technology Integrated Development Services Company, a state-owned enterprise, to acquire 300, 000 hectares in cities other than Hongjiang. All state-owned entities in China are controlled by government. If the entity's name started with China, it is controlled by the central government, if the name started with a city, it is controlled by the city, so Hongjiang City Forestry Service is appearently controlled by Hongjiang city. It is very rare that one city's state-owned forestry service company has rights to sell forests in other cities' turf.

Sunday, June 5, 2011

Need to go China to investigate Sino-Forest? (1)

On June 2, 2011, Muddy Waters published a research report on Sino-Forest Corporation (TRE.TO) accusing Sino-Forest of institutional fraud. The report also mentioned that one of the reasons why auditors and analysts had not questioned this massive fraud is that they did not go to China. Do we really need to go to China to investigate Sino-Forest? Can we smell something fishy by just browsing its website and taking a look into its financial statements? Let's have a try.

First, let's go to Sino-Forest website, Click Operations/Map of Operations, you will see all operations are inside China. Doing business in China, do you need a web in Chinese? Absolutely, every company is doing that. I searched every corner on every page of Sino-Forest's website, there is not a single icon or button leading to a Chinese version web.

I also searched Sino-Forest's Chinese name ε˜‰ζ±‰ζž—δΈš in Baidu, but no Chinese website of Sino-Forest has been found. However, I did find its flooring division's website,, which has both Chinese and English web pages but no links leading to Sino-Forest's website. The English text on Sinomaple introduces Sino-Forest as "Sino-Forest Group was founded in 1994 with registered capital of 2 billion US dollars...." Probably they need to change "billion" into "million", since Sino-Forest was pretty small when it started its business in 1994.

It seems to me that the website structure of Sino-Forest and its flooring division was designed to prevent cross-check by both Chinese and North American Investors. On the China side, the Chinese have no idea what Sino-Forest really is. On the North America side, investors have no idea what Sino-Forest has really been doing in China.

Now let's take a look at Sino-Forest's financial financial statements in recent years, which were audited by Ernst & Young. I have found two interesting issues as follows.

1. Unreasonable gross margin on standing timber, especially in 2008

Based on the segmented information in its financial statements, I calculated Sino-Forest' gross margin rates for its plantation fiber (standing timber) through 2006 to 2010 were: 50%, 45%, 59%, 45% and 47%. As financial crisis erupted in 2008, Sino-Forest's 59% gross margin on standing timber looks especially conspicuous and is certainly worth a closer look.

The gross margin of 59% is unreasonable because 80% of standing timber that sold in 2008 was added in 2006 or after according to Sino-Forest's financial statements. Sino-Forest's 2005 balance sheet showed that its 2005 year-ending timber holdings were $513.4 million, and its segmented information for 2006 and 2007 indicated that the depletion of timber holdings during 2006 to 2007 was $462.5 million ($177.7 for 2006 and $284.8 for 2007), so in the beginning of 2008 there were only $50.9 million of timber holdings which were purchased or planted before 2006. As the depletion of timber holdings for standing timber segment for 2008 was $281.9 million, $231 ($281.9-50.9) of it were purchased or planted in 2006 or after. Sino-Forest was able to buy forests in 2006 and then flipped them out at doubled price in 2008, it seems money does grow on trees in China.

2. Questionable timber holdings

Sino-Forest's 2007 year-ending timber holdings were $1,174.2 million, it's 2008 segmented information indicated that in 2008 the depletion of timber holdings was $284.5 million ($281.9 for plantation fiber and $2.6 for manufacturing), and in 2008 the additions to timber holdings was $672.9 millions, therefore the 2008 year-ending timber holding should equal to $1,562.6 ($1,174.2-284.5+672.9). However, its 2008 balance sheet showed $1,653.3 million of timber holdings, and there was no explanation for the difference of $90 million.

Similar issues of inconsistency connected with timber holdings and capital assets existed in other fiscal years.