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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.



) -- 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


, 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.


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.

In the case of ONP, I continue to believe that the shorts got it wrong, but it doesn't matter because the share-price damage and loss of investor interest have happened. In the case of RINO, I also have no doubt that there were significant shortcomings and overstatements by the shorts in their research. But the end result was that due to the multiple areas where they were in fact, correct, RINO was promptly deslisted and now trades at a price of around $2.13. Immediately prior to the short attack, Rino traded at $18, and there were multiple Wall Street analysts with share-price targets on Rino as high as $40.

On Friday,


fired what was likely his last shot in the battle , and it was not particularly effective. Notably, the report inaccurately states that CCME's 10-K is due out in 10 days, which is incorrect. The share price traded in a narrow range of $13.92-$14.83 and actually closed up on the day. Muddy Waters has stated that it intends to fire another bullet, writing a follow-up piece in response to Global Hunter, and this may well have a more negative effect on the stock. Muddy Waters claims that it is speaking to both the


and to Deloitte with transcripts and audio recordings, which directly contradict the findings of Global Hunter.

While the shorts continue to fire their bullets, the only nuclear bomb that remains in this battle is the sign-off by Deloitte on CCME's upcoming 10-K, which is tentatively due out on March 15 -- just over three weeks away. The nuclear bomb is going to severely wreck someone's portfolio, but it remains to be seen whether the victims will be the longs or the shorts. Thus I see two likely scenarios.

Scenario 1

: Deloitte signs off without issue. The shorts will cover, the longs will rush in and the stock should rise 30-40% in one to two days, putting it back around $20. Given the damage to the stock caused by the short attacks, I expect that from a price of $18-$20, CCME will continue to "take the stairs" on the way up and take some time to recover previous highs and/or reach the Global Hunter target of $26. In this case, I would be happy to be patient for a while and hold.

Scenario 2

: Deloitte finds issues with CCME's 10-K. That could include "revenue recognition," "contract validity" or "earnings management." Regardless of what they are called, any of these issues would be viewed as "fraud." Given the work done by Global Hunter, I believe we can discredit many of the shorts' claims that CCME is an empty shell conducting no business, and I also believe that even in the event of a meaningful restatement, the Muddy Waters price target of around $5 is too low.

However, I also observe that Global Hunter was only able to verify around 50% of CCME's revenue, which still leaves a significant potential for restatement. In the event of a restatement, the stock probably trades at $7-$9, where it was in September. The reason I bought shorter-dated puts is that the facts will all be out in the open in about three weeks and puts represent a cheap insurance policy against a downward move of as much as 50%.

As for my trade, I paid $14.23 for the stock, around $2 for the puts. Therefore, the per share pay off profile (post-put expiration) looks like this:

As the table illustrates, this is not a home run trade in either direction, but rather a low-risk way to bet on a short squeeze.

The simple fact is that no one knows what the results of the audit will be. Contrary to their reports, it is my belief that the shorts are really only betting on a 10%-20% restatement to drive the stock down to around $7, at which time they will cover. The longs on the other hand are betting on a 100% clean report, which will also drive the shorts to cover, but which should drive the price to as high as $20.

Disclosure: The author holds a long position in CCME common stock and CCME put options.

The author can be reached for comments at


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.

Rick Pearson is a Beijing-based private investor focusing on U.S.-listed China small-cap stocks. Until 2005, Pearson was a director at Deutsche Bank, spending nine years in equity capital markets in New York, Hong Kong and London. Previously, he spent time working in venture capital in Beijing. Mr. Pearson graduated magna cum laude with a degree in finance from the University of Southern California and studied Mandarin for six years. He has frequently lived, worked and traveled in China since 1992.