In March, I traveled with my colleagues to the headquarters of
as part of due diligence trip on several Chinese-based,U.S.-listed companies. Coming back from the trip, and after doing moreresearch, I invested in Orient Paper and I wrote several favorablearticles on the company, articulating the case for why I thought it wasunder-valued.
Earlier this week, a new "research" company called Muddy Waterspublished its
in which it alleged that Orient Paper is afraud and assigned a price target of less than $1. They suggested the company hadmisappropriated private placement funds from investors, cooked the booksand prevented them from doing their studious due diligence on site.It's had a disastrous impact on the stock price of ONP. Earlier thisweek, before the report came out, the stock was trading at close to $9.Yesterday, at the height of panicked selling, the stock touched $4.11.
Rick Pearson (a fellow contributing writer on
) cameout last night with a
to the Muddy Waters report.
I wanted to provide some additional comments, as I've spoken withthe CFO, Winston Yen, several times in the last week, and one of mycolleagues, Chris Lau, visited Orient Paper's headquarters yesterday inChina to meet the CEO, Zhenyong Liu, the CFO and other members of themanagement team.
The writer (left) with CEO Zhenyong Liu (center) and my colleauge Chris Lau.
One of the first and most remarkable things Orient Paper's CFO toldme about Muddy Waters is that the firm originally contacted the companylast fall asking to write a positive research report about the companyfor a fee. Winston said they asked for hundreds of thousands of dollarsin cash plus an unspecified amount of ONP stock and warrants for theirservices. (
: Muddy Waters, in a
today, disputes thecash-for-coverage allegation.)
Orient Paper said it declined the offer. They don't believe theyshould have to pay for an analyst to write about them. Additionally,Liu has always disliked warrants because they are dilutive toshareholders.
Muddy Waters has disclosed that it has been short ONP's stock (andpossibly also have owned put options) before the report came out.
Before getting into the allegations, let me say that, whenever Iinvest in a company, I do so with my own capital. Neither I nor anycompany I have ever been affiliated with has ever been paid by a companyto write about them or promote them. I would never do this. When Iwent to ONP in March, I did so on my own dime. When I have writtenabout the company, I have always disclosed my long position. As myarticles on
since 2008 show, I write positive andnegative pieces about companies.
During my colleague's six-hour meeting at Orient Paper's Chineseoffice yesterday, he learned that Liu was angry, hurt and shocked thatsuch allegations could be made on a Web site and result in a nearly 50%drop in the stock over a few days. Liu founded the company in 1996 andowns 34% of the stock, yet has not sold any stock since the company wentpublic. If this company were a fraud, as Muddy Waters alleges, it makesno sense that Liu wouldn't be dumping shares over the last severalmonths. Is he planning to wait another 14 years before selling stock?
Muddy Waters alleges that Orient Paper stole shareholders' moneyfrom two recent private placements. Liu categorically denied thisaccusation and provided a full accounting of where the money wascurrently in their Chinese and U.S. bank accounts verbally. OrientPaper point out that it also had to submit to due diligence by Rothbefore the most recent placement was made, and
BDO HK Ltd.
, whichspent eight weeks in the spring on-site going through the company'sbooks.
Muddy Waters asserts that ONP's planned capacity expansion to beable to produce 360,000 tons of corrugated paper annually by the end ofthis year isn't possible. Muddy Waters called the vendor,
, and a sales rep reportedly told them the largestproduction line they made produced 200,000 tons of paper a year. Thesales rep also apparently told Muddy Waters they didn't sell anoff-the-shelf production line that would cost the $20 million ONP hadsaid publicly it would.
Liu told my colleague that this is a custom job and that they're paying Qinyangon a milestone basis. The $20 million will get paid out over the courseof the coming year. They presented documents to my colleague confirming this.
Liu and the CFO said that the company's U.S. and Chinese financialstatements were consistent and that they planned to released the olderstatements to investors. In terms of the veracity of their customers,which Muddy Waters also questioned, ONP pointed out that several of theformer top 10 customers were no longer in the top 10 now.
Additionally, it is normal for many Chinese companies to not have aWeb site or for the people answering the phone to not respond to anAmerican requesting information. Last March, my colleague -- a Chinesenational -- tried to call up
several times to request a meeting and was repeatedlyturned down by lower-level administrative staff.
Many people have asked me about the photos of the plant in the MuddyWaters report. They suggested the plant was old and steamy withbroken-down equipment. Liu told us that Muddy Waters visited in Januarythe day after a large snowstorm and low temperatures. The steamappeared when the cold air outside came inside the warm line facilities.
Orient Paper's new digital photography line opened in March.
When I visited, the lines were all in operation, there was no steamand the machinery was clean. I'm attaching a couple of the photos Itook with this article. Certainly it's a smaller plant than NineDragons and others, so the equipment is older, but I saw no evidence ofwater damaging the finished product paper. But this is a small-capcompany: it's Orient Paper; not
Muddy Waters complained that ONP stored recycled paper outside whereit can be exposed to rain and snow before turning it into pulp formaking paper. Muddy Waters claimed that valuable inventory would bedamaged in the rain/snow. The authors are forgetting the process bywhich this material gets turned into paper. The recycled paper(waterlogged or not) gets thrown into a pot of steaming hot water andturned into pulp. A little water damage doesn't disrupt the process.
Muddy Waters allegations do not hold up based on the research I'vedone and what information the company has shared.
I still hold ONP long and more shares yesterday. I stand by myprevious articles on the company.
A year from now, I expect to still be investing in undervalued,overlooked Chinese companies like ONP, because my reputation isimportant. I also expect ONP to be a much bigger company by then (inWednesday's press release, it confirmed it would have $1.21 in EPS thisyear; both analysts covering the stock have current EPS targets of$1.05).
At the time of publication, Jackson was long ONP
At the time of publication, Eric Jackson was long Orient Paper.
Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd. You can follow Jackson on Twitter at www.twitter.com/ericjackson or @ericjackson