110623_cs sino-forst now what

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THIS REPORT IS NOT RESEARCH AND IS INTENDED FOR QUALIFIED INSTITUTIONAL BUYERS ONLY

Sector Strategist

Charles Chang

+852 2101 6036

[email protected]

PLEASE REFER TO THE DISCLAIMER SECTION FOR IMPORTANT DISCLAIMERS AND CONTACT YOUR CREDIT SUISSE

REPRESENTATIVE FOR MORE INFORMATION.

Asia CREDIT OVERVIEW China H

23 June 2011 [email protected](+852 2101 603

Sino-Forest: now what?

Paulsons exit from Sino-Forest (SNF) stock drove SNFs bonds to new lows. Current prices (11s: 85, 14s: 46/44% YTM, 17s:

40/26%) suggest that the market continues to expect the 11s to be paid, but is now differentiating less between the 14s and 17s,

possibly due to heightened doubts on SNFs prospects thereafter. Released bank statements showing USD1b of cash make the

11s look the least at risk, but the upside vs. downside appears overly lopsided. As for the 14s, a small long could make sense,

as the 6 point price differential vs. the 17s provides little justification for the latter, particularly since the 14s have seen stronger

technicals and could face less uncertainty in a going-concern scenario (see below), which still seem to be the rational base case.

On data points, the past week saw both positives and negatives. On the positives, (1) 1Q11 results came in on time, (2) no

conclusive evidence against SNF emerged, (3) more documents were released and remain largely uncontested, and (4)management appears engaged (working with PWC, fighting allegations) and duly cautious (capex to slow). On the negatives, (a)

the AI issues were not fully addressed, (b) no buy back of bonds or stocks for now, (c) the Globearticles added to ongoing

doubts and (d) Paulsons exit likely impacted sentiment. The positives could support liquidity and help rule-out flight-with-cash

scenarios, while the negatives could keep suspicions high and technicals weak.

As for allegations, Muddy Waters (MW) has provided little new evidence, nor has it contested most of the evidence provided by

SNF, some of which showed a number of MWs charges to be erroneous (e.g. transport standing timber, overlooked Yunnan

acquisitions, key named sub not a sub). As a result, MWs thesis that SNF is a Ponzi scheme seem to remain unproven and

poorly supported. The Globehas done better investigative work, but its articles appeared inconclusive on the questions raised,

many of which were later addressed by SNF. Despite this, questions on SNFs customers and assets remain at the forefront,

where they seem likely to stay until key milestones are met. Having released 1Q results and paid the 16s CB coupon, these now

include (1) coupon payments on the 14s (7/26), 13s CB (8/1) and 17s (10/21), (2) redemption of the 11s (8/17), (3) release of

PWCs findings (2-3 months), and (4) any buyback of shares or bonds (likelihood uncertain).

Tactical approachGiven the above, trading the bonds in small longs/shorts continues to look more sensible than going outright large, as significant

uncertainties and technical risks remain, and most could find themselves unable to stomach the whole ride. Regardless of the

actual motivation, Paulsons exit points to the risk that prior holders could decide that their positions were either unlikely to

recover or take too long to recover, and that it is not worth the volatility and the reputational impact. Indeed, much of the bonds

seem likely to change hands to those better suited for such trades, a process that could drive technical pressures in both

upswings (orderly exit) and downswings (capitulation, some after Paulsons exit).

Assets, liabilities and downsideAs of end March, SNFs key reported assets total USD4.9b, comprising 1.1b cash (767.5m offshore, 320.6m onshore), 3.1b

forestry assets (at 12/31/10, per Poyrys latest report), 448m AR and 211m prepaid costs (plantations, logs). Key offshore

liabilities total 1.9b (11s: 88m, 14s: 400m, 17s: 600m, 13 CBs: 345m, 16 CBs: 460m) while key onshore liabilities total 732m,

including 155m bank debt, 505m AP, 11m taxes and 61m admin that could accrue in a 6 month wind-down. If SNFs forests

could be liquidated at 30% less reported value, and other assets at 80% less, the resulting total could exceed liabilities, and

economic value (proxy for downside on the bonds) could be 69%. If only cash and forests backed by released documents

(c.25% of total forests) are included, the downside could be 33%, which could imply a wide trading range for the bonds.

Corporate CredSector Strateg


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CHTREE some similarities and differencesEvolution of the SNF situation shares some similarities with China Forestry (CFH), which saw a CEO share sale (1/13) followed

by a share suspension (1/26), accounting irregularities (1/31), a Board committee investigation (1/31) and an SFC investigation

(on the CEO, 2/9). Announcement of cash holdings and a conference call (3/2) pushed the bonds from the 50s to the high

70s/low 80s, where they settled after the release (on 4/29, delayed from 3/31) of results from its internal investigation, which

included a re-audit by KPMG and a re-valuation of its forests by its valuer.

Allegations that CFH was a sham proliferated during the three-month investigation period (1/31 to 4/29) presumably

encouraged by short-sellers. The charges focused on (1) illegality (logging > quota), (2) improbability (forest reported > village),

(3) unverified assets (forest not bought/certificates not real) and (4) non-existence (locals not aware of company). In SNFs case,

(1) and (2) were employed by MW, while the Globe focused on (3), with (4) largely absent, as MW/Globehave verified SNFs

presence on the ground with various agents and counterparties. Ultimately, none of CFHs accusers seemed able to prove that it

was a fraud, and associated charges fizzled out after 4/29, even though the re-audit and re-valuation were heavily qualified.

Indeed, the market seems to have taken comfort in the fact that CFH was re-examined by credible parties, and that the alleged

perpetrators (CEO, CFO, CRO) were removed.

What could come after the milestonesWe may not see as clean a break in SNF as we did in CFH, as SNFs accusers seem to be targeting the company, not particular

individuals, and as the AI issues (not in CFH) could remain outstanding post the PWC report. Nevertheless, SNF could follow a

similar path, with the report providing comfort and allowing various charges to fade into the background thereafter. That said,

technical pressures could continue (although they could become less potent), as short sellers could follow SNF for some time

(they are less able to for CFH, as its stock remains suspended). While SNF could operate as a going concern in this scenario, it

could be blocked from the markets for years, and may need to rely more on existing inventory (866.6k ha, c.107k cbm). At FY10

volumes (17.6m cbm), this implies c.6 years of sales, with c.USD840m of cash generated p.a. (see table below), which could

leave 200m-400m p.a. for forest acquisitions (1Q11: 475m). It is worth nothing, however, that this episode could incur material

costs (e.g. fees, any lost lawsuits). This could result in meaningful ongoing outlays, as could the adoption of dividend payments,

which may be needed to entice shareholders. These items could be a drain on free cash, and could shorten inventory life,

implying greater uncertainties for the 2017 bonds.


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Sino-Forest - Financial Summary

USDm 12/04 12/05 12/06 12/07 12/08 12/09 12/10 *3/11

Total assets 756 895 1,207 1,837 2,604 3,964 5,729 5,869

Cash (unrestricted) 201 108 153 329 441 1,102 1,223 1,055

Cash (restricted) + cash equiv 24 30 19 22 46 70 32 33

Work in progress/inventory 3 8 15 47 43 46 62 3,354

Other fixed assets 426 594 841 1,253 1,717 2,261 3,236 369

Interest in/loans to assoc. 0 16 16 23 22 38 0 0

Other assets 102 139 164 164 335 447 1,176 1,058

Short-term debt 29 41 71 55 72 104 242 243

Long-term debt 300 300 450 453 714 925 1,660 2,055

Total debt 329 341 521 509 787 1,029 1,901 2,298Net debt 103 203 350 158 300 -143 646 1,210

Other liabilities 55 86 108 142 218 270 578 566

Total equity 372 468 578 1,187 1,599 2,665 3,250 3,005

Total debt/op. EBITDA 3.9 2.9 3.7 2.3 2.5 2.7 3.3 3.8

Net debt/op. EBITDA 1.2 1.7 2.5 0.7 1.0 -0.4 1.1 2.0

Op. EBITDA/gross interest 5.3 4.0 3.8 5.1 6.0 5.3 4.6 4.3

Op. EBITDA/net interest 5.8 4.7 4.6 7.8 8.0 6.1 5.0 4.5

Net debt/tangible equity 28% 43% 60% 13% 19% -5% 21% 44%

Total debt/total capital 54% 47% 52% 35% 37% 30% 43% 50%

Cash/ST debts 7.1 2.6 2.2 5.9 6.1 10.6 5.1 4.3

Current debt/total debt 9% 12% 14% 11% 9% 10% 13% 11%

Revenues 331 493 555 714 896 1,238 1,924 339Operating EBITDA 84 117 142 224 313 376 585 88

Gross interest 16 29 37 44 52 71 128 44

FFO 118 228 307 459 543 825 1,173 55

Net debt decrease (increase) -7 99 147 -192 142 -443 789 1,210

Gross margin 31% 28% 31% 34% 41% 36% 35% 34%

Operating margin 22% 23% 24% 28% 35% 30% 30% 25%

Op. EBITDA margin 25% 24% 26% 31% 35% 30% 30% 26%

Net margin 16% 17% 20% 21% 26% 23% 20% -7%

Cash flow and net debt

Net cash gen. by op. 128 225 326 528 522 836 922 246

Net finance charges paid -9 -29 -36 -42 -39 -52 -82 -35

Post internal financing CF 119 196 290 486 483 784 840 211

Capital expenditure -171 -301 -423 -693 -701 -1,093 -1,406 -382

Fixed asset sales 0 0 0 1 0 0 0 0

Business acquisitions 0 0 0 1 2 0 -2 0

Net cash from investments 0 0 0 0 0 0 0 2

Other inflow/(outflow) 0 0 0 0 -1 24 1 0

Net CF flow pre-financing -52 -105 -133 -206 -221 -285 -562 -169

Shares issued for cash/debt (equity i 68 0 1 390 2 652 12 0

Other non-debt, non-repayable sourc -6 -1 -3 4 -31 -53 -3 0

Debt decrease/(increase) from forex 0 1 1 5 2 0 2 1

Other non-cash items that dec./(inc.) -3 6 -12 -1 91 129 -238 -396

Net debt decrease/(increase) 7 -99 -147 192 -158 443 -789 -564

Opening net debt 110 103 203 350 158 300 -143 646

Closing net debt - ,

Source: Company reports, Credit Suisse. *3ME.


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