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Orient Paper: Longs vs. Shorts

Orient Paper's long and short investors spar over the legitimacy of the company's finances and business.

NEW YORK (TheStreet) -- Orient Paper (ONP) shares rallied Friday, retracing most of the week's 50% drop, as long and short investors battled over the legitimacy of the company's financial position and operational viability.

Orient Paper

shares were sliced nearly in half during the first four trading sessions of this week, pressured by a

bearish report from Muddy Waters Research

, whose principals are short the stock and would benefit by a decline in its price.

Two investors with long positions in the stock -- Rick Pearson and Eric Jackson -- came to Orient Paper's defense, contending that Muddy Waters' research was ill-grounded. Pearson and Jackson are both independent investors who contribute commentary to

TheStreet

.

In the firm's inaugural research note, Muddy Waters asserts that Orient Paper is a "fraud" and that it "overstated its 2008 revenue by 27 times." The firm cited financial statements by He Bei Oriental Paper Co. Ltd, which it claims is an operating subsidiary of Orient Paper. Muddy Waters alleges that most of the $31.5 million that Orient Paper raised between October 2009 and May 2010 "has been misappropriated."

Orient Paper responded to the fraud allegations Thursday afternoon, saying that it "categorically denies these allegations and has instructed its legal counsel to contact Muddy Waters and explore all legal options against it for publishing and distributing such a report." Orient Paper claims that Muddy Waters was incorrect in citing financial statements of He Bei Oriental Paper Co. Ltd, and that the company's operating subsidiary is actually named Hebei Baoding Orient Paper Milling Co., Ltd.

"The motivation behind this report is transparent and we look forward to providing our investors and other stakeholders with additional information shortly to further rebut these baseless allegations," Orient Paper CEO Zhenyong Liu said in a statement.

Muddy Waters immediately responded to Orient Paper's rebuttal, arguing that there was no confusion on their part to the name of the company's operating subsidiary. "Our review of our files confirms that we previously studied the correct entity, and thus all of our conclusions in the report are valid," Muddy Waters said in a note.

TheStreet

contributor Rick Pearson came to

the defense of Orient Paper

in an opinion piece Thursday, noting that he visited Orient Paper's facilities in China at the same time the two Muddy Waters researchers were visiting Orient Paperto "pitch a 'paid for' research report -- according to the company -- that would recommend the stock as a strong buy." Muddy Waters

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disputed the allegation

.

"It is my opinion that the purpose of the visit was not to find out information on the company but rather to simply 'check the box' and say that they had visited the company to lend credibility to their report," Pearson wrote. Pearson was long Orient Paper at the time of the article's publication.

Jackson notes that

Orient Paper's founder owns 34% of the stock

and has not sold any stock since the company went public. Jackson concedes that he observed during a March visit to the company's facility in China that Orient Paper's "equipment is older, but I saw no evidence of water damaging the finished product paper." Jackson was long shares of Orient Paper at the time his story was published on

TheStreet

.

At last trade Friday afternoon, Orient Paper shares were up 40.3% to $7.14, although the stock is still below Monday's intraday high of $8.59. At its lowest, the stock hit $4.11 during Thursday's trading session.

Christopher Pruette, an investor who tweets his

trades on Twitter

, said he initially invested in Orient Paper due to the price in relation to underlying growth and added to his position as the stock fell on the Muddy Waters research note.

"

The stock got so cheap I stepped in and got long," Pruette writes in an email to

TheStreet

. "Then I got a link and read the report and its disclosures (first ever 'free' report and significant short position) and tried to keep an open mind. I added as it fell further."

However, Pruette says he began second-guessing his position after viewing "a video of an investor visit

that shows rather antiquated facilities. I closed one-third of my shares for a 25% gain and am digging to find more real data on the situation."

CNBC

stocks commentator

Herb Greenberg wrote

that China has barred the Public Company Accounting Oversight Board (PCAOB) from examining the auditors of most U.S.-listed Chinese companies. This lack of transparency is a risk to investors of many Chinese reverse-merger companies.

On the other hand, traders long Orient Paper argue that the timing of the release of the Muddy Waters research note is suspect. The research firm had doubts about Orient Paper's operations in January, but the research note calling Orient Paper a fraud was not released until nearly six months later.

Among other research firms covering Orient Paper, Roth Capital Partners rates the stock a buy with a $16 price target. Most recently, Roth Capital analyst Mark Tobin China's Ministry of Industry and Information Technology plans to eliminate additional papermaking capacity is a positive development for Orient Paper as it further limits the possibility of oversupply.

Tobin, who operates out of Roth Capital's China office, did not immediately reply to an email seeking comment for this story.

Similarly, Hudson Securities analyst Julie Chen has a buy rating on the stock and a $15 price target. Chen reiterated her rating on the stock after Orient Paper reported first-quarter earnings in May. Chen did not immediately respond to requests for comment on this story.

-- Written by Robert Holmes in Boston

.

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