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Richard Chandler, Sino-Forest, and how $10 million turned into $5 billion

A seemingly minor news item on Thursday gave us the opportunity to write about someone we have wanted to discuss for some time.  The story was that Richard Chandler, a New Zealand-based billionaire, had purchased over 10 percent of Sino-Forest Corporation. Sino-Forest, of course, is the China-based timber company that plunged 83% last month when Muddy Waters published a detailed report alleging fraud.

Sino-Forest’s stock has moved up since the announcement of Chandler’s new stake, so a few astute folks have already taken an interest. However, we are betting most people just said “who is Richard Chandler?” and went on with their day.

That most people do not know who Richard Chandler and his brother Christopher are is not surprising, as they have been extremely secretive since they started investing in 1986. That is except for a single interview they did with Institutional Investor Magazine back in 2006. Since that article was published, the brothers have gone their separate ways and Richard now operates the Mandolin Fund which is the entity that purchased the Sino-Forest stake.

While we have no horse in the race, we have found the Sino-Forest situation to be fascinating. On the day the Muddy Waters report was released, the market had the following set of information: In one corner you had a virtually unknown one-man shop write a report suggesting fraud at Sino-Forest. But in the other corner, the largest shareholder of Sino Forest was John Paulson. Over the last two years, the announcement of a Paulson investment in a company has been enough to cause that stock  to have a pretty good rally. Those facts would have suggested that the market would have shrugged off the Muddy Waters report and continued to coat-tail Paulson. However, the opposite ended up occurring and the stock plunged. Paulson even followed suit – selling out his entire position a few days later.

Ever since Paulson sold his stake, most folks have presumed Sino Forest to be uninvestible. That was until the Chandler purchase.

So who are the Chandler brothers? From the Institutional Investor profile (indented and italicized below) we know:

1. They are dyed-in-the-wool contrarians who aren’t afraid to wade into situations with a lot of hair on them:

“By going into uncharted territory where most investors don’t dare to tread, the Chandler brothers have, in the space of 20 years, grown a family fortune of $10 million into a cool $5 billion — and they’re still in their mid-40s. Along the way they have made waves by being among the first and biggest investors in such emerging markets as Brazil, the Czech Republic and Russia and playing an instrumental — and controversial — role in advocating economic reform and better corporate governance.

Chandlers prefer to operate at a distance from the crowd, steering clear of consensus views. One of Richard’s favorite sayings comes from legendary value investor and Pioneer Investments founder Philip Carret, who said it is essential to “seek facts diligently, advice never.” Explains Richard: “Money managers have to account for their actions to their shareholders, which means they have an undue fear of underperformance. We invest only our own money. Our investment decisions are driven by optimism, not fear.”

2. They are willing to fight for improved corporate governance:

They have waged, directly and by proxy, several bruising governance battles, most notably in Russia, where their militancy helped get the first independent director appointed at state-controlled gas giant Gazprom

“We do have altruistic motives that some investors who are looking for the path of least resistance find hard to understand,” says Chandler, 47. “But we don’t want to be defined by our corporate governance battles. We are value investors with a sense of responsibility, not activists.”

“Russia is really the place where Richard and Christopher’s ability to stomach volatility, their value-spotting talents and their rigorous adherence to principled investment first clearly came together,” says Charles Ryan, chief executive of United Financial Group, the Moscow firm that advised the brothers.

By December 2000, Gazprom had recovered from its lows, but its market cap still stood at just $6.2 billion, leaving Sovereign with a sizable paper loss. Chandler and others familiar with the situation contend that management allies repeatedly offered to buy Sovereign’s stake at a price that would have given them a profit.

“If we were in it simply for the money at Gazprom, we would have just taken the money,” says Chandler. “But it was not about the money. In Russia we believed we could change a culture of fraud by going after the big fish, and that was Gazprom.”

3. Richard is (at least in 2006) a bull on Asia:

“I think Asia is the best place to be for the next 20 years,” says Richard.

4. They are deep value investors:

They consider themselves first and foremost value investors — Richard’s idols include Warren Buffett and Sir John Templeton. Sovereign traditionally buys stocks at P/E ratios of 3 or less

5. They bet infrequently and then bet big:

The brothers also prize scale, believing that the way to achieve outsize returns is to make a few big bets — Sovereign usually holds fewer than ten stocks — rather than manage a diverse portfolio. The Chandlers favor large-cap stocks in big countries. “If you are invested in big companies in big countries, that means there is a ready audience of benchmark-following investors who must buy the asset,” says Richard. “By buying big — going narrow and deep, as opposed to diversifying — you maximize your success.”

“Our talent is to understand the long-term potential of a business,” Richard says. And when they do, the Chandlers will back their hunches 100 percent.

6. They don’t just focus on earnings or easy-to-calculate metrics:

The Chandlers stress the need to be creative in picking stocks and frequently use unconventional methods to value assets. This practice is important in what Richard calls the “delta quadrant” — transition economies or distressed sectors where information is not easily available and standard metrics don’t apply.

7. They are not ignorant of the risks Chinese corporate governance presents:

Richard is cautious about China, however, contending that growth won’t necessarily translate into investment returns because of legal uncertainty and poor corporate governance. “China still has a long way to go to create trust in the Chinese capital markets,” he asserts.

 

So add it all up and Sino-Forest seems like a classic Chandler bet. Will he be right? Only time will tell, but we will be watching with interest. We try to be students of the markets and smart investors and particularly like watching live case studies play out.  Sino-Forest seems like it has the potential to be a great case study.

Two things to consider before rushing out to coat-tail Chandler and buy Sino-Forest stock (which to be super-clear, we are not recommending in any sense of the word).

1. Richard Chandler no longer works with his brother who was his counter-balance. Without a someone to tell him “he is crazy” he may be more likely to trip up:

“I do the analysis and develop the concept,” [Richard] says. “Then I take the concept to Christopher and ask him, ‘Hey, is this crazy or not?’ A sense of value ultimately comes down to being able to project a future and see where a business case really goes in five or ten years. No one I know is better at that than Christopher.”

2. We’ve seen a movie like this before where a previously highly successful investor swoops in to make what seem like bargain purchases only to suffer large losses.

 

Update: So far, this investment is not looking good for Richard Chandler. The Ontario Securities Commission has ordered a trading halt, the CEO has resigned, and Sino Forest’s credit ratings have been slashed.