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Chris Ridder, CFA
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CFA Charterholder MSc Inventment Managment 2005 Cass Business School City University of London I started trading when I was 20 years old by shorting orange juice futures! And yes the results were not pretty.... Here is my public performance at Marketocracy which the long fund started November of... More
  • Sino-Forest: A Tree Falling in the Forest most likely makes a Fraud sound  0 comments
    Jun 24, 2011 5:45 PM

    I have been following, the David vs. Goliath saga, between Muddy Waters and Sino-Forest (TRE.TO) since reading this article in early June "Making Sense of Sino-Forest". As it states, " If you want to move a stock with a research report, you can hardly hope to do better than Muddy Waters did with its 39-page report claiming that Sino-Forest Corp (OTC:SNOFF) is a Ponzi."

    It is now over three weeks latter, with jabs by both parties have flown back and forth during this time, and so far the battle for the truth of the situation is being won by Muddy Waters. At least by looking at how the market has voted in regards to its stock price:

    The firms largest shareholder, John Paulson's hedge fund, which is best know for making a "killing" shorting subprime mortgages during the financial crisis, has liquidated its entire position. It reported a loss over $450 Million in just this one investment. Some interesting information about why it initially invested was , "Paulson first became interested in Hong Kong-based Sino- Forest in January 2007, following a Bloomberg News story that said CVC Asia Pacific Ltd. and Macquarie Bank Ltd. were considering buying the company, according to the letter. The fund started buying shares after Sino-Forest publicly stated neither firm would make an offer, causing the stock to fall. 'The investment thesis was consistent with the event- driven investment strategy of the Advantage funds, given the possibility of an acquisition or another development such as a re-listing from the Toronto Stock Exchange to a local exchange' " 

    Notice that "The investment thesis was consistent with the event- driven investment strategy" after the stock had fallen because it was not taken over. Now look at Paulson's reasoning giving for exiting Sino-Forest completely, "Paulson & Co. ... said it divested the stake after concluding the stock may be 'depressed for an extended period of time,' even if a special committee investigation were to show that the allegations are unfounded."

    If Paulson's fund is "event-driven" then only the belief that there is a high probability that Sino-Forest is a fraud would cause Paulson to totally liquidate; otherwise, it would be "investing" more capital into the firm at a very depressed price. "It had sold the entire stake as of June 17." The closing price on that date was $3.19 Canadian dollars. Muddy Waters is on record as saying it believes Sino-Forest will trade at zero and The Globe and Mail published a report that lends credence to some of Muddy Water claims.

    Paulson like a good trader cut his loses once he realized he most likely made a very, very large error. The truth is all investors and trader do make errors, his is just public and therefore more embarrassing since the apparent fraud was uncovered by a very small botique shop.

    What can an investor/trader learn from this:

    1) Mistakes and errors happen even to the very successful

    2) Getting out at $3 is better than Zero; or cut the losses of a bad trade the best you can

    3) Muddy Waters had a thesis that "... Harvard-educated Chinese analysts based in New York usually have little more in common with Chinese company managers than you do. As a result, many sub-par Chinese companies find ways to game the system and trade at inflated values." that appears to have beaten Wall Street "Due Diligence"; so don't abandon sound thinking in front of entrenched and powerful "conventional wisdom".

    Sino-Forest closed at $2.68 on Friday on the Toronto exchange. It appears some investors are trying to replicate Paulson's original strategy of "even driven" investments to find alpha. However, I place my subjective probability of this company recovering as to low to commit capital to. I have no position in Sino-Forest, Muddy Waters, or and of the websites linked to; but I do enjoy watching a David vs. Goliath story, even if David is winning again.



    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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