The billionaire putting principle above profit

When a billionaire investor starts buying shares in a company that appears to be on its last legs, the market sits up and take notice.

The natural reaction is that the billionaire has spotted something everyone else has missed and is preying on an undervalued asset.

But in the last few months, investors in Canada have watched a Singapore-based, New Zealand-born billionaire named Richard Chandler buy into a troubled company for what appears to be a very different reason – to make a point about the importance of corporate governance.

The company in question is Sino-Forest, which is listed in Canada and runs timber plantations in China. Only a few months ago, life was good for Sino-Forest. Its shares peaked at $C25 in March and superstar US investor John Paulson was a prominent member of the share registry.

But then in June everything started to go wrong for the company, thanks to a little known analyst and short seller named Carson Block and his creatively named research firm Muddy Waters.

Block, who specialises in research (and short selling) firms in China, claimed in a report released on June 2 to have discovered that Sino-Forest was a Ponzi scheme.

His report starts explosively: “As Bernard Madoff reminds us, when an established institution commits fraud, the fraud can become stratospheric in size. Sino-Forest Corp. is such an established institutional fraud, becoming massive due to its early start, luck and deft navigation. At nearly $7 billion in enterprise value, it will now end.”

Through analysis and on-the-ground research in China, Block claimed to have found that Sino-Forest had fabricated the existence of a wood-chipping operation and overstated the size of its timber holdings in China.

Initially the company, led by chief executive Allen Chan, strenuously denied Block’s allegations. But the damage had been done. John Paulson sold his stock, regulators launched investigations and the share price started tumbling.

On August 26, Block was vindicated when the Ontario Securities Commission suspended Sino shares from trade and said the company appeared to have “misrepresented some of its revenue and/or exaggerated some of its timber holdings”.

More damningly, the OSC said the company and CEO Chan “appear to be engaging or participating in acts, practices or a course of conduct… which it and/or they know or reasonably ought to know perpetuate a fraud”.

The stock had fallen 67% from June 2 to August 26. But not everyone was selling.

Between July and the time Sino went into a trading halt, Chandler’s Singapore-based Mandolin Fund bought around 48 million shares in Sino-Forest or 19.5% the company, spending around $C195 million in total. Amazingly, Chandler was still buying in the days before the company was put into trading halt, despite the multiple investigations being made into Sino’s business practices and financial statements.

The only explanation Chandler has offered so far was provided to Bloomberg in July by his spokesman Richard Barton.

“Sino-Forest represents an excellent deep-value investment opportunity,” he said simply.

But most commentators have read more into the fact that July was also the month that Chandler’s personal company released a paper called Corporate Governance and National Prosperity.

The 40-page essay outlines Chandler’s long-held belief that investment returns can be generated by forcing investee companies to improve their corporate governance practices.

“As a student at Auckland University in 1982, I wrote a Masters of Commerce thesis entitled Corporate Directorship Practices in New Zealand Listed Public Companies. This academic background, together with over 20 years experience investing in developing economies provide a unique foundation to promote the principles of trust based capital markets which are so essential to accelerating prosperity in our global village,” Chandler writes.

“Investors have an important role in ensuring accountability by company management for their financial and ethical performance. Responsible investors will engage corporate governance issues where they encounter them, as an intrinsic and necessary component of professional investment management.”

Chandler, who was valued last month by Forbes at $US4.2 billion, has been able to drive big investment returns by agitating for improved corporate governance on a number of occasions, particularly in emerging markets such as Brazil, Russia and the Czech Republic.

But Chandler’s biggest corporate governance victory came in South Korea. In early 2003, Chandler and his brother Christopher, then running Sovereign Global Investment, amassed a 14.9% stake in conglomerate SK Corp. The company’s share price had collapsed after a $US1.2 billion fraud scandal that saw chief executive Chey Tae-Won and nine other executives convicted and jailed.

When Chey was released from prison and returned to run SK Group, the Chandler brothers launched a three-year campaign to oust the former CEO and improve the company’s corporate governance.

In the end, the campaign failed and Chey stayed. But improvements to SK Group’s governance practices saw the share price increase five-fold and the brothers make more than $US700 million.

Did Chandler spot a similar opportunity for corporate governance activism at Sino-Forest? Or as his spokesman said, had he just spotted a “deep value” investment opportunity?

The word “deep” is important here – it is a crucial part of Chandler’s investment philosophy, as he said in what is really the only major news interview he has ever given to US magazine Institutional Investor.

“By buying big – going narrow and deep as opposed to diversifying – you maximise your success,” Chandler told the magazine.

Chandler credits his mother with this philosophy.

Richard’s grandfather Edward Chandler came to New Zealand from Chicago in 1903 and started an advertising firm. In 1972, Edward’s son Robert and his wife Marija started a department store in the city of Hamilton, called Chandler House.

The chain, which would go on to spawn a fashion chain under Richard’s management, sold luxury goods, sourced largely by Marija. According to Institutional Investor, she had two rules: never buy anything you’re not sure you can sell to someone and buy as much as you can in a narrow range of sort-after items.

Chandler says his mother become the “master of narrow and deep… With stocks, we do the same. We back out beliefs to the hilt.”

Richard became chief executive of Chandler House in 1982 but he and Christopher decided to sell the business in 1986 and launched an investment business with $US10 million in capital. The pair made their first big bets in Hong Kong real estate and would later make a killing betting on the Japanese economy.

The brothers split their assets in 2007. The Richard Chandler Corporation now invests across the world but retains a focus on the Asian region. The company even recently invested in Australia, grabbing a 14.9% stake in LNG junior Energy World Corporation in mid-July for about $85 million.

The value of Chandler’s stake in Energy World is now up about 40% – a stark contrast to his investment in Sino-Forest.

However, as Chandler told Institutional Investor, he has never been one to back away from his bets – regardless of what the market thinks.

“We are great believers in the idea of having audacious goals, breaking out and doing something out of the ordinary. It’s helped us turn what most people consider a mere profession into a vocation and, beyond that, an art, where we frequently put ourselves in harm’s way.”