|Theres little money, yet, growing on MFFs trees in China|
Behind the drop is the delay in the acquisition of plantation lands in Chinas Anhui province that has set back the companys business plan by some nine months, according to Standard and Poors credit analyst Mary Ellen Olson, prompting S&P in March to issue a negative outlook on its initial B rating.
Were obviously concerned about their ability to repay the bonds, says Olson. Theyll start to feel the heat about six months before the first [interest] payment and well be taking a much closer look at them then.
The first interest payment on the notes not covered by an escrow account is due on May 15 2007, at which point the company must also meet certain covenants, including minimum acquired acreage of 140,000 hectares. According to S&P, as at March 31, Mandra had acquired just 17,231 hectares. S&P is now doubtful whether MFFs cashflow can increase enough to make interest payments.
Weve asked management directly if theyre in violation of any covenants, says Olson, their answer was no.
MFF is the financing arm of Mandra Forestry Holdings (MFH) a company established by Zhang Song-yi, a Chinese entrepreneur and formerly a managing director of Morgan Stanley. Zhang remains an advisory director of Morgan Stanley, Hong Kong. He controls 75% of MFH.
Canadian-listed Sino-Forest Corporation an operator of commercial forestry plantations in China, advanced a subordinated loan to MFH of $15 million in exchange for a 15% stake. Sino-Forest also has an option to buy out the rest of the shareholders in specified circumstances.
Morgan Stanley owns the remaining 10% of MFF and was the sole sponsor, earning a 3% fund-raising fee and a corporate finance fee of $10 million. The latter fee was exchanged for a 10% stake in MFF. Morgan Stanley did not invest in the notes.
According to S&P, Zhang negotiated the acquisition of forestry assets with government in Anhui province, China. Investors are puzzled by the failure to meet acquisition targets, particularly given Zhangs relationships.
More than 90% of commitments to purchase forestry rights have failed, says a hedge fund manager. No one expects 100% success, Id be prepared for 50%, but not wholesale failure.
MFH blames initial management appointed by Sino-Forest, which has now been replaced. Following an internal audit, most signed preliminary contracts for land were cancelled. Zhang says the company has acquired more than 50,000 hectares of land in the two months since new management took over and started to work closely with another local government. He remains confident. Were trading strictly within our covenants, he says, and Im very comfortable with the 140,000 target outlined in the document. Id like to get to that as soon as possible.
Sensitive to investor concerns, the company and Morgan Stanley recently held a site visit. Now they claim investors are comfortable with progress made on the new business plan. But not all are satisfied. Theyve been making acquisitions, thats good, says one institution that attended the presentation, but theres been no information on the quality of the land and they refused to allow investors to appoint our own independent assessor.
That is not true, Zhang says. The plantations were buying have to meet strict criteria in the bond documents, he says. Independent consultant Jaakko Poyry Consulting has confirmed they are all within those parameters.
Zhang says the governments incentive is driven solely by economic considerations. He vehemently rebuts any suggestion of wrongdoing. The key officials are all supportive, he says, and we have no interest in taking over land where the farmers are not supportive. These are vast areas. If farmers choose to stop you planting, theres not much you can do.
Zhang insists that all investors will remain whole on interest and principal, although he admits that the delays will affect MFHs equity value, perhaps by as much as 30%. That in turn will reduce investors overall return, since the notes were issued with warrants in MFH.
Meantime, there is little investors can do but grumble. The notes hardly trade and finding a price is difficult.
Although the company might yet make good on its promise, the difficulties with investors suggest that such an intricate start-up transaction is better suited to the private market. One competitor seems to think so. Some of the recent Morgan Stanley [high-yield] deals have been bold, says the debt head of one US bank. Its the type of deal that wed have done as a structured loan and we usually participate as a lender.
Morgan Stanley has done much to push Asian high-yield debt. The Mandra deal seems to sit at the very edge of its envelope.
Morgan Stanley officials declined to comment.