Sino-Forest drops off a cliff outright, but adds on hedge; Ares, Superior Energy trade

By Rebecca Melvin

New York, June 3 - Sino-Forest Corp.'s two convertible bond issues were a central focus of Friday's session, plunging outright, but actually expanding on a hedged basis, on the second of a two-day meltdown of the Toronto-listed Chinese commercial forest plantation operator's shares after allegations of fraud that the company denied.

"Those that are involved are preoccupied with Sino-Forest," a New York-based sellside trader said of Friday's session.

Elsewhere, Ares Capital Corp.'s newer 5.125% convertibles due 2016 were said to have traded at 103.75 versus a share price of $17.10 and Superior Energy Services Inc.'s 1.5% exchangeables due 2026 traded at 102.5 versus a share price of $36.65, according to a New York desk analyst.

But there really was not much of anything going on, sources said.

"There is definitely NOT much trading!" one analyst wrote via e-mail.

But for the overall holiday-shortened week, the convertible bond market was fairly resilient as the broader markets saw a considerable shift in sentiments after a raft of economic data came in weaker than expected.

Markets were closed Monday in observance of Memorial Day.

On Tuesday, convertibles started out steady to higher amid a lift in equities, but buoyancy gave way to selling pressure for the remainder of the week. That pushed outright returns lower for the week, but left the convert arb strategy flat to edging up.

The ETF of convertibles securities was down about 0.73% for the week to date and the CVBX convertible bond index was off 0.4%. But the HFRX convertible arbitrage index was up 0.1%

For the year to date, however, the outright CVBX and convert arb HFRX are about even, at plus 2.64% return and plus 2.88% return, respectively.

The convertible ETF has a 2% return for the year to date.

"Convertibles held well relative to other asset classes and continued to catch a bid even in a tumultuous market," Citigroup's converts trading desk reported in commentary Friday.

To blame for the general markets' downdraft were disappointing economic reports including the ISM manufacturing purchasing manager's index on Wednesday and May payrolls data Friday.

On Wednesday, the ISM data showed U.S. manufacturing activity fell, leaving a reading of 53.5 in May from 60 in April and below the 57 that economists had expected.

Private sector hiring for May was torpedoed. May non-farm payrolls data significantly missed estimates that were already revised lower, and the unemployment rate ticked higher to 9.1%.

But the markets started to stabilize on Friday after the ISM non-manufacturing survey of 54.6 was better than the 53.3 expected, and in contrast to Wednesday's disappointing ISM manufacturing survey.

"Moody's did not help sentiment by warning [Thursday] that the U.S. AAA rating would be under negative review if Congress and the President do not make progress on an agreement on the debt ceiling in July," Citigroup's converts trading desk said.

No new issuance was seen during the week, but Forestar (USA) Real Estate Group Inc., a subsidiary of Forestar Group Inc., launched $100 million of new seven-year convertibles that will price in the coming week. Host Hotels & Resorts Inc., on the other hand, announced a partial call for $150 million of its 3.25% exchangeable bonds.

Sino-Forest keeps premium

Sino-Forest's 4.25% convertibles due 2016 were marked at 54 bid at the end of the session Friday, which compared to the C$5.37 close of the shares of the Toronto Stock Exchange. That close was preceded by a tumultuous session in which trades ranged from 30 to 55 for the 4.25% convertibles.

Late in the session, a sellsider said the 4.25% paper was 53 bid, 58 offered versus a share price of C$5.47. That compares to a pre-slide level of well north of par.

On Tuesday, both the 4.25% convertibles due 2016 and the 5% convertibles due 2013 were "wrapped around 116 versus a share price of C$19.88," a New York-based sellside trader said.

Sino-Forest's 5% convertibles due 2013 saw similar whipsaw action. On Friday, the 5% convertibles were marked at 57 bid at the end of the day. That compared to 57 bid, 62 offered versus $5.47 late in the session, and compared to the 116 price on Tuesday.

Nevertheless, the move represented a gain on a hedged basis, depending on holders' percentage of delta, a New York-based sellside analyst said.

"If you were on a 75% delta on the 4.25% convertibles you were up about 12 points dollar neutral," an analyst said.

Nevertheless, a trader was skeptical of that figure, and many players were on a 90% hedge going into the day. But still the paper was 30 points over parity.

The 63% meltdown in shares of the forest plantation operator on Friday came on the heels of a 21% slide on Thursday.

On Tuesday, the shares closed at C$19.27, and on Friday they closed at C$5.37.

The cause of the crisis was linked to a research report put out on Thursday by a firm that claimed Sino-Forest was committing fraud. The research report published by Muddy Waters Research used inflammatory language and declared that the amount of land Sino-Forest reported buying from Lincang City in the Chinese province of Yunnan doesn't match city records, meaning that the company could not have produced as much timber in the areas as it claimed.

Muddy Waters put out a "strong sell" recommendation on the stock, saying the equity was worth no more than C$1.

Sino-Forest said Friday that the allegations in the report were "inaccurate and unfounded." It said the "report" was issued on a website by a short seller which stood to "realize significant gains from a share price decline that it precipitated."

The Sino-Forest statement did not help shares recover, but they leveled out at the bottom in the last hour of trading.

"I'm surprised that they didn't come out with something sooner," a New York-based sellside analyst said regarding the company's statement in response to the allegations.

Mentioned in this article:

Ares Capital Corp. Nasdaq: ARCC

Forestar Group Inc. NYSE: FOR

Host Hotels & Resorts Inc. NYSE: HST

Sino-Forest Corp. Toronto: TRE

Superior Energy Services Inc. NYSE: SPN

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