Carson Block looks south as Sino-Forest success hits short-sellers

Short-seller Carson Block is looking to other emerging markets and searching for his first long-only investment in China after suggesting that finding potentially fraudulent firms to short has become problematic in a more wary market.

While he argues that fraud is as prevalent as ever among Chinese small and micro-cap companies, he suspects many firms have been restating their filings with the State Administration for Industry & Commerce (SAIC), making it harder to catch them out.

“Since short-sellers have become pretty aggressive in exposing Chinese companies that they believe are frauds, we suspect some Chinese companies have gone back into their SAIC filings and restated them,” he says.

“While I wouldn’t say the number of potentially fraudulent companies has decreased greatly, investor interest in these companies has. Given the awareness in the US markets of the problems that we’ve had in the micro-cap world, some [companies] delisted and others are trading at very, very low price levels.”

Block was speaking to AsianInvestor from the airport on his way back to the west coast of America after touching down from an exploratory visit to Brazil. He is expanding his short-selling search to Latin America to target indiscriminate investment chasing questionable companies.

“It seems similar to China,” he says. “You’ve heard tales of lots of Americans getting off the plane not knowing what’s going on and throwing money at stuff. You never want to be one of those guys.”

Block, founder and only permanent staff member of research firm Muddy Waters, was the short-seller who first targeted Chinese timber company Sino-Forest Corporation, which is listed in Toronto, Canada.

In a well documented chain of events, Muddy Waters published research on June 2 alleging that Sino-Forest had committed fraud, was a Ponzi scheme and had overstated its timber holdings by nearly $900 million. It is a claim the company has denied.

The report triggered a precipitous decline in Sino Forest’s share price and prompted the Ontario Securities Commission (OSC) to tentatively back Block’s claims. Sino-Forest’s chairman and CEO, Allen Chan, has since stepped down.

“It’s a positive for shareholders that [Chan] does step down,” says Block.

Block, who still has a short position in Sino-Forest, has praised the commission for preventing worse damage. The OSC has frozen Sino-Forest shares at C$4.81, a 75% slump from the C$19.27 they were at before the Muddy Waters report. Sino-Forest’s bonds are still trading, at distressed levels of less than 30 cents on the dollar.

The commission has also stated that Sino-Forest and certain officers “appear to have misrepresented some of its revenue and/or exaggerated some of its timber holdings” and appear to be participating in acts “they know or ought to know perpetuate a fraud”.

While the extent of the alleged fraud remains unclear, such a pronouncement is still an endorsement for Muddy Waters, although Block resists the temptation to crow about this apparent vindication.

A number of investors are now suing Sino-Forest, noting that the company had raised close to $3 billion in debt and stock offerings. The firm’s big-name backers include John Paulson, whose hedge fund Paulson & Co held 34.7 million shares in the firm before dumping them at an estimated loss of $720 million.

New Zealand billionaire Richard Chandler then became Sino-Forest’s biggest shareholder with an 18% stake, and he continued to buy shares he clearly felt were undervalued right up until they were frozen.

Block points out that a large company such as Sino-Forest was easier for him to target because, with 120 related entities and 16 years as a public company, it just could not cover its paper trail. “With the volume of filings and long track record it becomes harder to manage the scrubbing process,” he points out.

Nevertheless, Muddy Waters, which last published research on June 28, is still looking at an undisclosed number of listed Chinese companies to short. “We’re looking at some companies that are problematic and may turn out to be committing fraud,” says Block.

But these days Block is also searching for a long-only investment to pursue. Given the difficulty in shorting Chinese companies, which can prove expensive and difficult to execute, he believes he would make more money on a single long-only investment than on all his shorts together, although he declines to disclose the amount.

“There are potentially some babies that have been thrown out with the bathwater, and that’s what we have our eyes on,” he says. “We would like to sweep the streets more, and then we can start talking about the longs.”