A Sino-Panel factory is seen in Gaoyao, Southern China on June 28, 2011.Adam Dean/The Globe and Mail
As Sino-Forest Corp. bonds continue their slide, one analyst is arguing debt investors may only get back pennies on the dollar should the company end up in default.
The company's notes are now trading for less than 30 cents on the dollar, down from closer to 31 cents on Wednesday and from 49 cents last Thursday, the day before the Ontario Securities Commission (OSC) levelled allegations of fraud at the company.
When bonds trade at such distressed levels, it usually signals that investors are concerned the company won't be able to pay them back at maturity. Instead, the focus is on trying to understand how much cash bondholders would get back in a restructuring, and whether that makes the company's debt worth buying.
That's a murky process because of the nature of the allegations from the OSC, which said last week that there appears to be evidence that the company's timber assets have been "exaggerated." There are concerns that even if the assets are there, a large portion of Sino-Forest's cash holdings might not be available to pay bondholders.
Volume in the bonds this week has been light, traders say, suggesting that even at these prices, the debt isn't drawing much interest from funds that specialize in distressed debt. Even buyers that are used to messy situations are leery because of the uncertainty about what they would get back should Sino-Forest end up in a restructuring.
Nomura Securities analyst Annisa Lee took a shot at answering the question and came up with an answer that will be troubling to holders of both Sino-Forest bonds and stock.
After looking at the company's cash holdings and how fast it burns through money, and trying to find a way to get a handle on its forestry assets, she values the bonds at 17 cents on the dollar in her base-case scenario – and just 1 cent in her downside case.
That's bad news for bondholders, but even worse for shareholders because it suggests the company's remaining equity value would be completely wiped out.
The stock is now halted in both the U.S. and Canada following the OSC's cease-trade order. It last changed hands in the U.S. at $1.38 (U.S.) on Friday, giving the company a market value of $338-million.
Sino-Forest had long-term debts of $1.9-billion and cash of close to $900-million as of the second quarter, which ended June 30.
Ms. Lee believes the money is there, given that the company posted bank statements to its website. But a good chunk of that cash – $287-million – is in China and subject to foreign-exchange controls. That raises questions about whether bondholders could get to it.
The cash hoard is dwindling. The company has used some to pay back bonds and make interest payments since the second quarter.
What's more, in an average quarter lately, the company uses about $100-million or more of cash in its business, Ms. Lee said. With no access to capital markets, the company will be hard pressed to raise new money.
Ms. Lee tried to understand the company's forestry holdings by estimating what the company has spent on them, which she pegged at $1.2-billion, rather than using the $3.5-billion valuation the company puts on them.
Bondholders might not be able to get to all those assets either because of the company's complicated structure and many subsidiaries. Ms. Lee estimates that the bondholders would be able to access half at best, or about $600-million.
Ms. Lee estimates that bondholders would get a recovery of 30 cents on the dollar, but it might take years. For that reason, she puts the current value of the bonds at 17 cents.
The downside case, she said, if nothing goes right for bondholders, is a recovery of 2 cents on the dollar. In that case, the bonds are only worth 1 cent today.