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China Forestry has become an example of bad investments in emerging markets
Author:Sino-report    Source:Wall Street Journal    Number of clicks :     Update time:2011-05-17 00:15
Sino-report News Center May 2011

HONG KONG—A Chinese forestry company that won backing from big-name private-equity funds has become a new poster child for what can go wrong with an emerging-market investment.
The latest results for China Forestry Holdings Co. Ltd., which attracted early investments from the U.S.'s Carlyle Group and Switzerland-based Partners Group, include a US$417 million loss.
The company also reported that its former chief executive officer was arrested by Chinese authorities on Feb. 24 on allegations he embezzled 30 million yuan (US$4.6 million) from the company, and noted that a chief financial officer and other senior staff are no longer with the company and it hasn't been able to contact them.
Carlyle paid US$55 million to acquire a stake now amounting to nearly 11% of China Forestry, which advertises itself as one of China's largest private plantation-forest operators, in two separate transactions beginning in January 2008. In June 2009, Partners Group invested US$30 million and now owns a 5.5% stake. China Forestry later raised US$216 million in a December 2009 listing on the Hong Kong stock exchange.
Just over a year later, troubles at the company began spilling out. Auditors KPMG informed China Forestry's board of irregularities in the books, leading to a suspension in the trading of its shares in January. Li Han Chun, CEO at the time, soon was fired.
Aside from the embezzlement allegations, the company says Mr. Li, who has been detained by the public security bureau in Guizhou province, absconded with some of its financial records. Hong Kong's Securities and Futures Commission won a court order to freeze Mr. Li's assets after he sold China Forestry shares two weeks before the trading suspension, which is still in place.
Mr. Li couldn't be contacted, nor could his legal status be determined.
In earnings released Friday, China Forestry reported a loss for 2010 of 2.71 billion yuan after drastically lowering the value of its plantation holdings, the company's chief asset. The company said it couldn't ensure that its financial statements were accurate, though, because, among other things, "most of the former key accounting personnel have left without notice."
Before China Forestry's shares were suspended, both Carlyle and Partners Group had made money on their investments, which are small in comparison with their outlays in more developed markets. They could still end up winners if the company recovers from its troubles.
The extent of China Forestry's problems, nonetheless, underscores the risk that potential fraud and poor corporate governance pose for private-equity and other investors in emerging markets, where regulatory and other standards often don't match those of developed markets.
"There are an increasing number of transactions in China, where it can be difficult to assess businesses," said Scott Jalowayski, a lawyer at Ropes & Gray LLP in Hong Kong. "Even careful and disciplined investors can run into problems with deals," he said, adding that private-equity firms can sometimes turn around poor investments and make them successful.
In addition, private-equity companies are often under pressure to deploy funds even when there is a dearth of good deals, industry observers say.
Michael Cheung, vice president at China Forestry, said in a statement that the company is making a number of changes, including the adoption of enhanced, centralized financial reporting and the hiring of new management to oversee the process.
Chairman Li Kwok Cheong "is determined to step up internal control to improve the management of the company to take advantage of the growing opportunities in the market," Mr. Cheung wrote.
An investigation by an independent board committee found that China Forestry's former management team provided its auditor with false bank statements, inconsistent insurance-policy documentation and falsified logging permits for about 100,000 cubic meters of wood. Most of the group's sales from 2010 were conducted in cash, the committee said, and Mr. Li, the former CEO, kept more than one set of books, so that "actual cash movement was concealed from the board."
"The big unanswered question is: was the cash there and stolen, or was it never there in the first place," said hedge-fund manager and financial commentator John Hempton. "One implies fraud from inception and no real business, and the other implies a real business that was run by people who stole from it," said Mr. Hempton.
He said he holds positions in more than a dozen Chinese companies he believes are involved in fraud but wouldn't disclose individual positions.
Another question involves regulation—whether China Forestry, whose initial public offering was underwritten by Standard Chartered PLC's Cazenove Asia Ltd. and UBS AG, should have been allowed to list. Hong Kong's regulators have complained about poor work done by certain banks and other financial sponsors in screening companies that come to market.
David Webb, a shareholder activist, said that some of the blame must rest with the regulators themselves.
"It remains unclear whether the alleged fraud was going on at the IPO stage, but so long as prospectus liability law in Hong Kong remains as weak as it is, there isn't much incentive to do the sponsorship and auditing job any better," he said.
Representatives for KPMG, UBS and Standard Chartered declined to comment, as did those for Hong Kong Exchanges & Clearing Ltd. and the Securities and Futures Commission.

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