Short-seller sets his sights on china inc.

PUBLISHED : Tuesday, 07 June, 2011, 12:00am
UPDATED : Tuesday, 07 June, 2011, 12:00am


He does not have an office and his work experience comprises a short stint as a corporate lawyer before founding a self-storage business in Shanghai. Yet Carson Block, the 35-year-old American short-seller responsible for felling the share price of mainland timber company Sino-Forest has just become one of the most attention-grabbing commentators on corporate China.

Block's research house Muddy Waters, which he concedes does not have any other permanent employees, made headlines worldwide with a June 2 report claiming Sino-Forest, a Toronto-listed company that says it is China's biggest forestry firm, was not publishing accurate accounts.

By the close of trade Friday, Sino-Forest's shares were down 71 per cent. That means Block has scored a big profit from his short sale. Investors who hold Sino-Forest stock believing it would rise, including billionaire US hedge fund manager John Paulson, have lost out. Paulson & Co. is Sino-Forest's largest shareholder. The investment company manages more than US$30 billion of assets and is best known for making spectacularly successful bets during 2008 that US house prices would fall.

Short selling - a bet that a stock price will fall-involves borrowing shares you don't own in the hope of buying them back later at a lower price. It's nothing new but Block's twist on the practice is to publish on his website sensational, yet seemingly well-researched, reports claiming the companies he targets to sell short are frauds.

He focuses on Chinese companies listed in Canada and the US, where many such companies are now under intense regulatory scrutiny. Sino-Forest is the fourth Chinese company Block has singled out since founding Muddy Waters in June 2010. Shares of the other three have fallen between 57 per cent and 95 per cent below their value the day before Block first wrote about them.

The name of Block's firm, according to its website, comes from a Chinese proverb which holds that 'muddy waters make it easy to catch fish'. In other words, says the website, 'opacity creates opportunities to make money ... This way of thinking has been part of Chinese culture for centuries, and it is institutionalised in the modern PRC.'

Sino-Forest, which operates in nine mainland provinces and grows trees, sells timber and trades land, reported US$1.9 billion of sales and a US$395 million net profit for last year.

Muddy Waters' 39-page-report on the company posted Thursday questions those numbers. In part, it relies on his contention that Sino-Forest owns just a tenth of the 200,000 hectares of land in Lincang City, Yunnan that it claims to hold.

Sino-Forest is audited by big four accountant Ernst & Young, while its independent directors include Simon Murray, the chairman of commodities giant Glencore and former Hutchison Whampoa boss.

The forestry firm has denied Block's contentions and responded to Muddy Waters' report yesterday saying it was considering 'legal remedies'. On Friday, Sino-Forest's chief executive Allen Chan called Block a 'shock jock' whose 'approach is transparently self-interested.'

That remark conjured up images of Howard Stern, the frazzled-haired American radio personality, nicknamed the shock jock, who is famous for his risque comments. But Block sports cropped, sandy hair. At a recent lunch in Hong Kong, he was dressed in a maroon button-down plaid shirt with grey check, looking every inch the tanned and scrubbed law school graduate. Block, who spends time in North America and Hong Kong, was carrying what he laughingly called his 'office' - an Apple laptop and a Blackberry. He won't say where he lives, citing 'reasons of personal security'.

He is also coy about whom he employs to assist him, though he says he relies on a network of mainland entrepreneurs to help with his analyses, and also employs law firms and private investigators.

Block's route into the investment world was unconventional. He graduated from Chicago-Kent College of Law in 2005 then worked for US law firm Jones Day in Shanghai between 2005-6. He then founded Lovebox Self Storage in Shanghai - the company's motto is 'get self storage without B.S.' - and co-authored a short book titled Doing Business in China for Dummies. He is also an adjunct faculty member at the Chicago-Kent, which is accredited by the American Bar Association. According to the law college's website, Block has a business administration degree from the University of Southern California.

In its inaugural report last June, Muddy Waters claimed US-listed mainland paper recycling company Orient Paper had 'overstated its 2008 revenue by 27 times.' Orient denied the allegations and appointed independent auditors to review those 2008 accounts. Its stock has fallen 57 per cent since Block's attack.

In November, Muddy Waters claimed Rino International, a Dalian-based company that sells pollution-control equipment and was listed on Nasdaq, was faking its accounts. Rino admitted its accounts were unreliable and its shares are down 95 per cent since Block's research was published. It's now traded over-the-counter, says Nasdaq's website.

On February 3, Muddy Waters claimed China MediaExpress, a Fujian-based, Nasdaq-listed company that operates video screens displaying ads on mainland buses, was inflating revenues. China MediaExpress's auditor, Deloitte, resigned and the stock is languishing 93 per cent below its February 2 price.

Block reckons investors have overlooked red flags at Chinese companies because 'of the investment world's appetite' for China.