A speculative litter that got through right under the nose of regulators

Burnt corporate offerings litter HK Exchange

SCMP headline, Feb 5

Under that headline, our reporter listed a number of companies that had chosen the period just before the Lunar New Year, when attention would be elsewhere, to get all their bad news out of the way. The most notable piece of litter was missing from this catalogue, however.

China Forestry Holdings, listed on our exchange only 14 months ago, was suspended from trading on January 26 after the auditors found 'possible irregularities'. This was also two weeks after the chief executive 'entered into a placing agreement' for 119 million shares he held.

But that just makes it ordinary litter. What really turns it into a ripe piece of garbage is that it never was any good anyway, as even the prospectus for the offering made clear.

In the offering document, the company claimed that it made net profits of 339 million yuan (HK$400 million) in 2006, 783 million yuan in 2007 and 5.8 billion yuan in 2008, on the face of it a three-year record of consistent and rising earnings, just what investors want to give them confidence.

Underneath this profit and loss account statement, however, was a note in italics - 'If changes in fair value of plantation assets less costs to sell were not taken into account, we would have had losses for the years to 31 December 2006, 2007 and 2008 ...'

In other words, China Forestry had no cash flow behind its earnings claims. What it had done is assign its forest holdings a value based on a report from an Australian consultant, CFK. This value was much higher than its costs (well, surprise me) and the company then spread the difference into three separate figures, called them profits and retroactively assigned them to the years 2006, 2007 and 2008.

Neat trick, huh?

To drive the insult home, the prospectus also says that the consultant's job in adjusting its valuation for tree cutting since the date of purchase had been 'made easier given the relatively low harvest intensity in our forests'.

Isn't that a gem? Here we have a logging company that admits in its prospectus that it does not do much logging and yet it found people to buy its stock. Yes, scratch your head. How is it possible?

The prospectus also tells us that the consultant did not make an aerial inspection of the forest as the authorities refused to allow overflights. Yours truly put himself through university by working summers as a forest surveyor for the British Columbia Forest Service, and I can tell you from expert opinion that a forest survey without aerial inspection is no forest survey.

Here is another jewel - 'we expect that our gains, and thus our profit in the future, may not be as much as during the Track Record Period if we do not acquire forests at relatively low acquisition costs'.

There were no gains, of course. It was all illusion, as was the three-year 'Track Record Period', but think again of what the company is saying here. It is telling you that it can only make money if it can rip people off when acquiring its assets. This was never really a company at all. It was just a speculation dressed up for a listing.

And now it has showed us that it could not even get past its first audit after listing. There have been 'possible irregularities' and the chief executive has cashed himself out.

So why was this rubbish ever allowed on our exchange in the first place? That's a question for the sponsors, UBS and Cazenove, which are otherwise good names. Yes, Cazenove, blue blood brokers to the gentry, purveyors of fine securities to the queen. They are the investment banks that ticked all the tick boxes on China Forestry, that told the listing committee that everything was OK and that this ripe smelling piece of speculative litter was actually fit for listing.

I don't blame the listing committee directly. The committee is not meant to form an opinion on investment merits. Its job is to make sure that the right questions are asked. When the answers come back signed by purportedly respectable investment bankers, it has to accept them.

So why did you people at UBS and Cazenove put this one through? Did you just get too greedy? Did the possibilities for year-end bonus beckon too strongly for you? Do you take no pride in your standards any longer?

I have a question for the Securities and Futures Commission too. How could you exclude retail investors from the share offering of Rusal, a stock that has seen its share price almost double on the market since June while in the same month passing China Forestry through to prey on these same retail investors?

Protecting people? Is that what you say you do?