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China MediaExpress: Two Scenarios

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

BEIJING ( TheStreet) -- Stock prices have often been said to "take the elevator on the way down and the stairs on the way up."

In my last article, I expressed concern that the short attacks against China MediaExpress (CCME) could have a lasting negative impact on the share price, even if their allegations prove to be entirely false. I also mentioned that for the same reason I no longer hold Orient Paper (ONP - Get Report), which was also the subject of short attacks. Shortly after my article, ONP released full-year 2010 guidance causing the share price to rise by around 20%, and I was chided by a few readers for missing the move. However, I think that this move in ONP's share price proves my point exactly.

Despite a surprisingly strong performance for 2010 and very strong prospects for 2011, ONP's share price still sits at $6.27, significantly off its 2010 high of over $15 and a regular trading range (pre-short attack) of $8-$11. The share price has not rebounded to earlier levels due to a lack of investor participation resulting from longs being scared out of the name by shorts.

I continue to share the same concern about CCME; however, I have decided to take a long position in the stock in case there is a meaningful short squeeze. Given the potential for significant short-term volatility, I also have purchased put options to protect my downside.

The initial report by Citron was able to shave a few dollars off the share price, despite the fact that it was really just a compilation of already available information that had been published on various blogs.

Muddy Waters, on the other hand, conducted four to six weeks of on the ground due diligence and has enhanced credibility due to its effectiveness in getting Rino International (RINO.PK) delisted in less than one month. As a result, the Muddy Waters report had a much more significant impact on CCME's share price, driving it as low as $10.31 on Chinese New Year's day. The shorts have also gotten more creative in their attack on CCME, directly confronting Deloitte with a newly created Web site. The longs have gotten creative as well, creating a " "Friends of CCME" Facebook page.

When ONP was first attacked by shorts, the stock fell by around 50% from $8 to $4, but rebuttals by several investors (myself included) drove the share price as high as $7.77 (up nearly 95%) in two days. ONP now sits at $6.27, but is still 22% below its pre short attack levels.

When China Education Alliance (CEU) was attacked by shorts, the share price fell by around 60% in a day, from around $5.50 to $2.31. But when auditor Sherb & Co. announced that it had performed "enhanced audit procedures" on the cash balance, the stock shot up by nearly 50% in two days to a price of around $3.50. CEU now sits at $2.15, a 30% discount to last reported cash per share.

Global Hunter analyst Ping Luo spent more than a week on the ground doing due diligence with management and published her findings last week, reiterating a buy rating on the stock and a $26 price target. The stock rose as much as 20% during the day on decent volume, but only closed up about 12%, which further illustrates my concerns about the long term damage to the stock price.

A report like this should have inspired massive short-covering, as well as rekindling interest from longs, and drove the share price up by at least 40%-50% (similar to ONP and CEU). I bought in early in the day, hoping for the big move, but it is clear that shorts are not covering, which is why I also bought the puts.

My point on CCME is that unlike ONP's 95% jump and CEU's 50% jump, CCME saw only a minimal jump despite a very thorough due diligence effort by a very credible source.

CCME is now facing what I refer to as the "John Dillinger Problem" with short attacks. Bank robber John Dillinger once described his advantage as being that he could rob any bank, anywhere, at any time. The police on the other hand had to guard every bank, everywhere, all the time. As it relates to a short attack, the problem for CCME is that the shorts (i.e., John Dillinger) do not need to be 100% correct on anything; they merely need to attract massive scrutiny to a company in hopes that they are only 10%-20% correct about some sort of fraudulent activity. On the other hand, CCME (i.e., the police) has to be 100% correct about everything or face significant consequences.
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