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Photos supplied by Sino-Forest. Photo of one of their Gaoyao Particle Board operation in the city of Gaoyao, province is Guangdong and country is China .


As shares in Sino-Forest Corp. continue their slide, the spotlight now turns to the company's bonds.

Fitch Ratings downgraded the company's debt on Tuesday to double-B-minus from double-B-plus and placed its long-term outlook under negative review. The news shocked bondholders, who started selling, driving down the prices on Sino-Forest's latest $600-million bond offering to around 40 cents on the dollar.

While shareholders have been taken on a wild ride since Muddy Waters Research released its critical report on June 2, bondholders had felt relatively protected. Sino-Forest's most recent bond issue slumped to 60 cents on the dollar after the report was released, but then held steady around that level.

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The stability reflected the fact that bondholders have a better claim on assets in the event of a bankruptcy than shareholders. But investors were shaken Tuesday as hedge fund Paulson & Co., which had been Sino-Forest's largest shareholder, disclosed it had sold its entire stake, and another Canadian investment bank suspended its research coverage of the forestry firm.

Sino-Forest's bondholders must now decide whether they have enough confidence to stick it out until an independent review of the Muddy Waters allegations by the accounting firm PricewaterhouseCoopers is released in two to three months. Sino-Forest says it has about $1.1-billion in cash sitting in its banks. On $2.1-billion in debt, that translates into 52 cents on the dollar.

However, Fitch expressed doubts about whether Sino-Forest can readily access the cash. The downgrade was "primarily driven by the fact that the company does not currently have direct access to the profits of its main operating subsidiaries due to complexities in its corporate structure," Fitch said in a report.

On Sino-Forest's latest quarterly earnings conference call, management said that about 90 per cent of its timber sales are conducted by its British Virgin Island (BVI) subsidiaries. Under Chinese law, these holding companies are barred from receiving any local currency because they are offshore corporations. For that reason, if any timber sold is owned by a BVI subsidiary, the money never leaves China and is reinvested to buy more assets.

"Under this business model, any restriction in access to international capital markets over the medium term is a major concern for Fitch, as without access to the BVI cash flows, the company would potentially need to rely on external refinancing for offshore debt maturities," the report said.

It is not clear why this issue is now a problem. Sino-Forest's corporate structure has been in place for some time.

As the company's bonds slumped, shares in Sino-Forest fell below $2 on Tuesday, closing at $1.99. At its lowest point, the stock price hit $1.30, as the market digested the news of Paulson & Co. selling its 34.7 million shares. Paulson would not elaborate on its sale, other than to say that there is too much uncertainty around the company.

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Uncertainty also prompted RBC Dominion Securities to suspend its equity research coverage on Sino-Forest, a day after Dundee Securities did the same thing.

The investment bank provided only a short statement, which said it "has temporarily suspended research coverage of Sino-Forest pending the release of information by the independent committee formed by Sino-Forest's board of directors to review allegations made by Muddy Waters LLC, or pending the release of information by other independent and credible sources."

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About the Author
Reporter and Streetwise columnist

Tim Kiladze is a business reporter with The Globe and Mail. Before crossing over to journalism, he worked in equity capital markets at National Bank Financial and in fixed-income sales and trading at RBC Dominion Securities. Tim graduated from Columbia University's Graduate School of Journalism and also earned a Bachelor in Commerce in finance from McGill University. More

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