Sino Forest completes million private placement ahead of HK IPO

The company raises cash for the second time this year ahead of its Hong Kong listing.

Toronto-listed, integrated woods producer, Sino Forest has completed a private placement ahead of its proposed listing in Hong Kong later this year. The company sold 7.22 million class A subordinate-voting shares late last week at C$2.40 per share versus a spot close of C$2.80. The company raised C$17.328 million ($12.44 million) and will use proceeds to develop its international wood sourcing capabilities.

HSBC led the placement and will sponsor the forthcoming $70 million to $100 million IPO, which is expected to comprise 230,000 hectares of forest plantations in Southern China. Earlier this year, the company also issued a convertible and has seen Fidelity increase its stake to 12.18%.

Company chairman Allan Chan says there are no truly comparable companies listed in Hong Kong, meaning the company's valuation will require plenty of investor education. The two which come closest are CITIC Resources and Pacific Plywood.

However, they are both said to focus more on the downstream manufacturing of wood products, rather than managing plantations. The latter made a HK$36 million profit in the last month and share price closed Friday at HK$0.02. The former lost HK$15 million and its share price stands at HK$0.70.

Chan also says international comparisons will be difficult because while Southeast Asia has plenty of timber companies, not many are plantation managers. Most companies in the regions carry out their logging activity in government reservations, which involve cutting down 'natural' forests.

One banker formerly working for in ING Beijing private equity joint venture says the sector is full of surprises.

"We invested RMB 126 million for a 26% stake in a company called Everbright Timber, a company that processes timber, in 1996," he reflects. "It turned out to be a flop though, because of all the ultra cheap, smuggled timber coming from Malaysia, Burma, Indonesia and Cambodia."

ING Beijing exited last year.

Chan counters that the scale of the smuggling is not that great.

The company originally listed in Canada in the mid-1990s when China fever was at its height, making any China-related stock attractive. That quickly changed after the Asian financial crisis and the company's share price duly went south.

But Chan feels that investment is swinging towards China again, and perhaps surprisingly to some, gives the example of the way the mainland government handled the SARS outbreak as evidence the country is has made great progress in response to international investors. He also points out that Asian emerging market funds find it difficult to invest in a Canada-listed company, while Canadian investors tend to be ignorant of its business.

With the holding company, of which he is one of the founders, keen to retain maximum control, Chan reckons the shares sold will be close the minimum limit imposed the Hong Kong stock exchange main board, around 25-30%.

In Toronto, the company has traded at very low price to earnings multiples. After 1998, the P/E ratio fell to less than three, and now trades around six. The stock price is around C$2.90 after dropping to around C$0.80 in 2002.

He says that discounted cash flow (DCF) is a more appropriate valuation metric than looking at the company's earnings and making a judgement based on the price/earnings figure.

"Ours is a very cyclical business," he comments. "We harvest every five years and reinvest then harvest again five years later. That means we foresee our earnings growing strongly in the future."

Chan believes focusing on the cash flow could result in the company's p/e ratio rising for the IPO, in line with the IPO average band. The Toronto-listed entity has never paid a dividend. Chan says he is contemplating a dividend pay out policy for the Hong Kong unit, but has not yet come to any conclusion.

"If we pay out a dividend in Hong Kong, we would have to pay one in Canada. After all, they have been waiting for ten years!" he says.

The IPO would play an important role in providing cash for the company to fund more tree growth, since he believes the area will continue to grow strongly. However, Chan says the company does not buy the land. It uses the land for its plantations and pays a rent in kind of 30% of the trees to the owner.

"The Pearl River delta is a good place for us to become one of the leading suppliers. It has good logistics and infrastructure, and many companies are moving there," he comments.

The company's net income was $2.7 million in the first quarter of this year, compared to $2.6 million in the same period last year.

Debt levels are 'safe', he says, but he's not especially interested in raising more debt, despite historically low interest rates. Raising the company's profile in the Pearl River delta region is the main objective.

The company has had loans in the past, mainly from European development banks impressed by its foray into environmentally logging. Earlier this year, it also put out a convertible bond of $14 million in a private placement to Taiwanese and Japanese investors.

It was the positive response from Asian investors in the CB, which encouraged Chan to plan a Hong Kong IPO.

Timber is a huge growth industry in China, now the second-largest importer of logs in the world, second to the United States. But China banned logging domestically in 1998 after illegal deforestation caused terrible floods. In addition, certain trading nations like Indonesia have also slammed on the brakes on illegal exports of timber.

That means China is casting around for alternatives, and plantations are one of them. They are more environmentally friendly than natural forests since the latter's ecosystem can be damaged by even moderate felling.

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