Eco Investor April 2017

Core Securities

MD and Short Seller Action at Quintis

Drama unfolded at newly rebranded Quintis with the founder and managing director Frank Wilson resigning to join a possible takeover consortium only days after TFS Corporation changed its name to Quintis and a short seller hit the stock and drove the price to a three year low of 97.5 cents.

Mr Wilson resigned only hours after he and Quintis issued a detailed rebuttal of a report by Californian based short seller Glaucus Research Group that was highly critical of the company and valued it at nil.

Mr Wilson said his potential partner is an unnamed international corporation that is looking to propose a change of control transaction, suggesting that this group sees a lot more value in Quintis than does Glaucus.

Mr Wilson holds 13 per cent of Quintis' equity worth over $61 million at $1.25 per share and a lot more at recent higher prices, so presumably he would only be interested in partnering with it if the price is going to be attractive.

Mr Wilson said he may also potentially explore the takeover opportunity with other third parties. Although no offer may eventuate, Quintis has retained legal and financial advisers in case it has to assess any proposals.

Chairman Dalton Gooding said "It is important to recognize Mr Wilson's achievements in establishing Quintis as the world's largest grower of premium Indian Sandalwood with assets that are extremely valuable to Quintis and its shareholders." He also said the fundamentals of the business remain strong, and the company has a very experienced senior management team extremely capable of fulfilling the duties previously done by Mr Wilson.

Under normal circumstances a possible takeover would throw a mighty spanner in a short seller's strategy and buoy a company's share price. That may be, or partly be, the case here as the timing of Quintis' rebuttal and Mr Wilson's announcement make it hard to know which factor contributed most to the quick rebound in Quintis' share price.

Over four days the share price fell from $1.45 to 97.5cents, then quickly rebounded to $1.10 and the company called a trading halt to release more information and rebut the short seller. It jumped to $1.27 after the rebuttal and Mr Wilson's resignation, but has since drifted down again to below $1.10.

Daily volume during the short selling jumped from the usual circa 0.1 million to 11.4 million on 23 March and 9.9 million on 24 March before the trading halt. Since Quintis' rebuttal and Mr Wilson resignation, volumes have remained high.

With so much going on and so quickly, Quintis appointed deputy chairman Julius Matthys as interim chief executive. Mr Matthys is an experienced senior executive and just as importantly Mr Gooding said "Julius has a comprehensive understanding of Quintis, our business strategy and operations, having served on the Board from 2003 to 2005 and from 2011 onwards. His proven track record and vast international business experience will be of considerable value as we expand the distribution of our wood and oil products to global markets.

"Julius will commence as Interim CEO with effect from Monday 3 April 2017 beginning with a review of Quintis' operations and outlook. He will perform the Interim CEO role while the board assesses the Company's requirements for a permanent CEO."

Meanwhile, trading volumes remain high and there is the short seller and the issues raised to settle.

In response to Glaucus' critical research note and an ASX inquiry, Quintis said the note was self-serving and biased and has "substantial and egregious inaccuracies littered throughout".

Quintis said its sandalwood business is backed by "some of the largest and most respected institutional investors in the world, investments they made after undertaking considerable due diligence". It argued it has a strong track record of meeting its financial guidance, and reaffirmed its guidance that 2016-17 cash earnings (EBITDA) will rise by at least 25 per cent.

The day of its ASX response and just before the trading halt, Mr Wilson made a show of his confidence by buying 50,000 shares on market at $1.185 per share, a total of $59,250.

In giving Quintis a value of nil, Glaucus made a point of its unashamed biased. "We are short sellers. We are biased. So are long investors. So is TFS. So are the banks that raised money for the Company. If you are invested (either long or short) in TFS, so are you. Just because we are biased does not mean that we are wrong."

The report compares Quintis to failed managed investment schemes. It says it is "one of the last remaining publicly-listed agricultural Managed Investment Schemes ("MIS")... We believe that TFS will likely follow Timbercorp and Great Southern into ignominy and failure. In our opinion, TFS's model resembles such collapsed agricultural MIS companies and their Ponzi-like structure: TFS does not generate significant cash from sales of its sandalwood, which for the most part has yet to be harvested. Instead, TFS is reliant on raising capital to plant new vintages, operate its business, make payments on its ballooning debts and pay off earlier investors. Interest payments reached 50% of cash EBITDA in FY 2016, and total borrowing has increased by another AU$ 65 million so far in FY 2017. Without access to the capital markets, TFS's financial statements indicate it will struggle to service its debts, let alone repay them.

"We believe that once investors scrutinize TFS's misleading forecasts, dubious marketing materials and questionable customers, TFS will lose the confidence of the capital markets it requires to survive. Thus, we value TFS's shares at AU$ 0.00."

As can be seen, Glaucus has a dramatic way of trying to dent investor confidence.

The Glaucus report is 39 pages. Its main points are that:

1. That Quintis' business model is based on "Serial Capital Raising on Dubious Promises of Future Profits". It says "the Company has raised AU$ 1.4 billion in gross financing to date, with no end in sight."

2. It accuses Quintis of ‘Ponzi-Like Marketing Materials' and examples a German institutional bank, Jaederberg & Cie, "which characterizes itself as an asset partner of TFS" and which "offered project level investments in TFS's vintages from as early as 2010. "Inexplicably, JC's marketing materials promise that investors in TFS's plantations will be paid cash dividends starting two years after the initial investment, with a full payback of the initial investment promised within seven years of the investment date. There is no possibility that any of such payments can come from the harvesting of sandalwood, because the trees are not ready to be harvested until at least 15 years after planting."

3. It questions whether Quintis has a "Phantom Chinese Buyer?". "In September 2016, TFS announced that it completed its first shipment under a "five-year agreement to supply 150 tonnes per annum of processed heartwood to China." It argues that Quintis' "exclusive distributor in China is an obscure firm named Shanghai Richer Link", which is too small to be capable of purchasing so much sandalwood.

4. It accuses Quintis of "Forecasted Cash Flows Based on Ludicrous Assumptions" and of having "used the long production cycle and esoteric sandalwood market to propagate ridiculously favorable assumptions to investors regarding the future profitability of its plantations." It says Quintis has "Dubious Yield and Survivability Assumptions" for its trees and that by buying the sandalwood itself it "Artificially Inflates the Price of Sandalwood and Prevents Market Price Discovery".

5. It accuses Quintis of having a high level of "Officer and Director Turnover". It says "eight officers or directors have resigned since late 2011. Many have done so after a brief tenure of two years or less." The actual number is four. The other four served for between 4.7 and 14.7 years.

There seems to be a lot of criticism in the Glaucus report and investors are right to wonder how much is convenient propaganda and how much, if any, has substance?

The statement from Quintis when the trading halt was lifted was designed to shore up investor confidence as well as refute the criticisms.

For the first time Quintis named its largest clients. Among the top five are international companies" Galdema, an international dermatology company with a 20 year contract for oil; Lush Cosmetics, a UK retailer with nearly 1,000 stores around the world and a five year contact for oil; Young Living, which Quintis says is the world's leading essential oils company and which has a five year contact for oil; and Medinext General Trading with a two year contract for wood.

Glaucus may have had a point about Shanghai Richer Link. It is in the top five list but has not put in an order for 2017. So Quintis is in negotiations with alternative buyers. Quintis said that at 150 tonnes of product per annum, the inaugural contract with Shanghai Richer Link was a small percentage of the predicted China market identified by McKinsey, which for timber alone was circa 5,300 to 6,400 tonnes by 2025.

In February Quintis said that total product sales for 2016-17 are expected to be in the range of $45 million to $55 million. It believes that its ability to achieve this is not dependent on further sales to Shanghai Richer Link as any wood not sold to it will be sold to other customers.

Quintis said that outside the big five it has other customers but who have not entered long-term contracts. These include IFF in Europe and Paspaley in Australia.

Most of the contracts and sales are at US$4,500 or above per kilogram of oil and equivalent pricing for wood.

Quintis is confident of further sales. It refers to a 2016 study by McKinsey & Co, not mentioned by Glaucus, that says Quintis is likely to have a substantial market share of the global trade of legal Indian Sandalwood (Album) by 2025, and that there is significant latent demand for Indian Sandalwood (Album) due to the unavailability of a legal and sustainable product.

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On the issue of MIS schemes, Quintis said it is proud to be the last remaining major manager of forestry MIS schemes in Australia, but it has "moved well beyond that model by diversifying its plantation investors and selling Sandalwood oil and wood products. In FY16, only 10.3 per cent of total revenues and other income was derived from MIS schemes (from plantation sales and ongoing plantation management fees). Only 5.7 per cent of Quintis' new plantation sales in FY16 were derived from MIS investors."

Quintis said it survived the fall-out in the MIS sector 8 to 9 years ago "principally because Indian Sandalwood (Album) is a rare and valuable product which has become increasingly scarce due to high levels of deforestation and a lack of commercial plantations. This imbalance between supply and demand attracted investment into Quintis's plantations from some of the world's largest and most reputable institutions."

Its global institutional investors include one of the world's largest sovereign wealth funds, an Ivy League university endowment fund, the Church Commissioners for England, and US based GMO LLC.

On oil pricing, Quintis says Glaucus confuses higher value Indian sandalwood oil with other much lower value varieties of sandalwood oil.

In regard to the marketing materials from German company Jäderberg & Cie, Quintis said it has not been involved in the production of prospectuses and marketing materials. With the publication of the Glaucus opinion piece, Quintis contacted Jäderberg & Cie, and the company "categorically denied any impropriety and advised Quintis that its retail prospectuses have been approved by the German financial supervisory authority (BaFin)".

On Yield and Survivability Assumptions, Quintis responds that it has "achieved approximately a three-fold improvement in yield from its first to its third harvest" and that it expects to double yield from its third to its fifteenth harvest due to improvements in silvicultural practices.

Survival rates have improved from an initial less than 30 per cent in 1999 to about 70 per cent in the third plantations that were harvested in 2016. 98 per cent survival was achieved in 2015.

Quintis' scathing view is that "Glaucus's opinion is not a research "note" that complies with ASIC Regulatory Guide 79 regarding Research Reports."

The short selling drama took away from Quintis' rebranding from a tree grower to a global brand based on what it calls a super ingredient. The ingredient name is Sandalwood Album and the full brand name is Quintis Sandalwood Album.

Watching trees grow is normally not this exciting. The drama has probably done more to raise Quintis' profile than the rebranding ever could. Depending on Mr Wilson and his potential partner, more action may be on its way. (ASX: QIN)






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