RatingsDirect publication date: 12- Apr- 2005

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HONG KONG ¡V Standard & Poor's Ratings Services said today that it had assigned its 'B' corporate credit rating to Mandra Forestry Finance Ltd. (Mandra Forestry). At the same time the ratings agency assigned its 'B' issue rating to Mandra Forestry's proposed US$235 million bond issue. The outlook on the corporate credit rating is stable. The proceeds from the issue will be used to acquire up to 270,000 hectares of forest located in Anhui province in mainland China.

Covenants under the bond indenture help mitigate the start-up risks associated with Mandra Forestry. At issuance a portion of the proceeds, equal to 18 months of interest, will be placed in an escrow account. Furthermore, after funding the capitalization of mainland China's wholly-owned foreign enterprises, offshore operating expenses, and working capital, proceeds totaling about US$120 million will be placed in an offshore escrow account to fund the acquisition of additional plantations. Proceeds can only be distributed to acquire plantations once the plantations have been certified by independent consultant JP Management Consulting (Asia Pacific) Pte. Ltd. to ensure that they meet certain parameters, and that all the necessary regulatory approvals have been obtained. Foreign currency risk will be hedged for the first few years of the transaction through a forward currency hedging contract.

Covenants that allow for equity distribution at 50% of accumulated net profit before the bond is repaid, however, could increase the refinancing risk on the bonds. Distributions may be paid 24 months after the bond is issued provided EBITDA to gross interest is 3x and that the total amount distributed does not exceed US$15 million in any one year and US$50 million before the repayment of the bond. Covenants also allow for the use of amounts remaining in the mainland China escrow accounts after all required transfers to the security accounts are applied, and the acquisition of the targeted 270,000 hectares are complete, to fund payments to acquire a further 50,000 hectares. There are no sinking fund provisions on the debt and there is no time limit for asset acquisitions although acquisitions are expected to be completed within a 24-month period.

Mandra Forestry is a start-up company. The company was formed to acquire, grow, and harvest standing timber in commercial forests in Anhui province. Assets acquired by Mandra Forestry will be managed with the assistance of Sino-Forest Corp. (Sino-Forest; BB-/Stable/--) a commercial plantation company that currently operates in southern China.

Mandra Capital Ltd., through its wholly owned subsidiary Mandra Resources Ltd., owns 75% of Mandra Forestry Holdings Ltd., Sino-Forest owns 15%, and Morgan Stanley Dean Witter Equity Funding Inc. owns the remaining 10%. Mandra Forestry Holdings Ltd. owns 100% of its subsidiary Mandra Forestry. Pursuant to the shareholders' agreement Sino-Forest has the right to purchase all outstanding equity in Mandra Forestry Holdings Ltd. at the earlier of the third anniversary of the shareholders' agreement or when Mandra Forestry acquires 300,000 hectares of forest.

The 'B' rating on Mandra Forestry reflects the following risks:
¡E Execution risks associated with the company's acquisition, harvesting, and replanting schedule. At present Mandra Forestry has no operating history. The company will begin acquiring assets only when proceeds from the issue are in hand. Although Mandra Forestry has established a credible business plan, given the magnitude of the operation about to be undertaken it is possible that current assumptions under the business plan may change. Completion of the plantation acquisition, and the harvesting and replanting of trees according to the assumptions in the company's business plan will be important milestones in terms of reducing execution risks.
¡E Regulatory risk as the company does not currently possess the required government permits to own, harvest, and transport timber products. Mandra Forestry expects to secure the required land lease rights, harvesting, and transport licenses from authorities at the county level. The company will also need to secure an increase in its logging quota from the provincial and central governments before it can meet its planned harvest schedule of 3.2 million cubic meters per year beginning in 2006. Undertakings with forestry bureaus at the city level help mitigate some concern in terms of obtaining the required permits, however, it is recognized that regulation in mainland China is fragmented and unpredictable.
¡E High leverage and limited access to further capital could pressure operations in the start-up phase. Mandra Forestry's ratio of debt to capitalization for 2005 is estimated at about 80%. This high level of debt will significantly reduce the company's financial flexibility if acquisition costs increase or product pricing comes in below estimates. Additional debt is restricted to US$25 million, which can be issued at the subsidiary level for working capital purposes.
The main strengths of the transaction include the following:
¡E Strong demand for wood products in mainland China should ensure a ready market for Mandra Forestry's product. This mitigates concerns about the cyclical nature of the industry. In particular, within a 200km radius of the land that is to be acquired there are many small sawmills, plywood factories, medium density fiberboard and particle board plants, and pulp and paper mills.
¡E Sino-Forest's participation as a project manager brings creditable expertise to Mandra Forestry's start-up business plan. The company's participation as the off-taker of timber products also lends certainty to the timely sale of timber products and mitigates concerns about negative working capital associated with slow recovery of accounts receivable. Sino-Forest manages its own accounts receivable so that the outstanding period is 90 days or less. Finally, Sino-Forest's subordinated loan, although small at US$15 million, demonstrates the company's commitment to the Mandra Forestry acquisition.
¡E Undertakings with certain forestry bureaus in Anhui province show regulatory support for the project. The undertakings grant Mandra Forestry scope to negotiate with collectives to acquire plantations in the area. Certain forestry bureaus have also committed to dealing exclusively with Mandra Forestry until the company acquires 270,000 hectares. Mandra Forestry has also been promised assistance in obtaining regulatory licenses and permits, including help in securing an increase in logging quotas required to complete the company's harvesting plan on schedule.
¡E Potential for strong cash flows once the project is executed. The assets to be acquired will be immediately cash generative with standing timber gross margins of about 35%. Assuming the forecast assumptions are met, cash flows should allow Mandra Forestry to support interest payments on the bonds and repay them when due. Forecast assumptions on the price of logs, acquisition costs, and yields are expected to be achievable given strong demand for wood products in the region and limited competition.

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