In March, I traveled with my colleagues to the headquarters of Orient Paper ( ONP) as part of due diligence trip on several Chinese-based, U.S.-listed companies. Coming back from the trip, and after doing more research, I invested in Orient Paper and I wrote several favorable articles on the company, articulating the case for why I thought it was under-valued.

Earlier this week, a new "research" company called Muddy Waters published its first report in which it alleged that Orient Paper is a fraud and assigned a price target of less than $1. They suggested the company had misappropriated private placement funds from investors, cooked the books and prevented them from doing their studious due diligence on site. It's had a disastrous impact on the stock price of ONP. Earlier this week, 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 TheStreet) came out last night with a strong response to the Muddy Waters report.

I wanted to provide some additional comments, as I've spoken with the CFO, Winston Yen, several times in the last week, and one of my colleagues, Chris Lau, visited Orient Paper's headquarters yesterday in China to meet the CEO, Zhenyong Liu, the CFO and other members of the management team.

CEO Zhenyong Liu
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 told me about Muddy Waters is that the firm originally contacted the company last fall asking to write a positive research report about the company for a fee. Winston said they asked for hundreds of thousands of dollars in cash plus an unspecified amount of ONP stock and warrants for their services. ( Editor's note: Muddy Waters, in a press release today, disputes the cash-for-coverage allegation.)

Orient Paper said it declined the offer. They don't believe they should have to pay for an analyst to write about them. Additionally, Liu has always disliked warrants because they are dilutive to shareholders.

Muddy Waters has disclosed that it has been short ONP's stock (and possibly also have owned put options) before the report came out.

Before getting into the allegations, let me say that, whenever I invest in a company, I do so with my own capital. Neither I nor any company I have ever been affiliated with has ever been paid by a company to write about them or promote them. I would never do this. When I went to ONP in March, I did so on my own dime. When I have written about the company, I have always disclosed my long position. As my articles on TheStreet since 2008 show, I write positive and negative pieces about companies.

During my colleague's six-hour meeting at Orient Paper's Chinese office yesterday, he learned that Liu was angry, hurt and shocked that such 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 and owns 34% of the stock, yet has not sold any stock since the company went public. If this company were a fraud, as Muddy Waters alleges, it makes no sense that Liu wouldn't be dumping shares over the last several months. Is he planning to wait another 14 years before selling stock?

Muddy Waters alleges that Orient Paper stole shareholders' money from two recent private placements. Liu categorically denied this accusation and provided a full accounting of where the money was currently in their Chinese and U.S. bank accounts verbally. Orient Paper point out that it also had to submit to due diligence by Roth before the most recent placement was made, and BDO HK Ltd., which spent eight weeks in the spring on-site going through the company's books.

Muddy Waters asserts that ONP's planned capacity expansion to be able to produce 360,000 tons of corrugated paper annually by the end of this year isn't possible. Muddy Waters called the vendor, Qinyang, and a sales rep reportedly told them the largest production line they made produced 200,000 tons of paper a year. The sales rep also apparently told Muddy Waters they didn't sell an off-the-shelf production line that would cost the $20 million ONP had said publicly it would.

Liu told my colleague that this is a custom job and that they're paying Qinyang on a milestone basis. The $20 million will get paid out over the course of the coming year. They presented documents to my colleague confirming this.

Liu and the CFO said that the company's U.S. and Chinese financial statements were consistent and that they planned to released the older statements to investors. In terms of the veracity of their customers, which Muddy Waters also questioned, ONP pointed out that several of the former top 10 customers were no longer in the top 10 now.

Additionally, it is normal for many Chinese companies to not have a Web site or for the people answering the phone to not respond to an American requesting information. Last March, my colleague -- a Chinese national -- tried to call up Fuqi ( FUQI) several times to request a meeting and was repeatedly turned down by lower-level administrative staff.

Many people have asked me about the photos of the plant in the Muddy Waters report. They suggested the plant was old and steamy with broken-down equipment. Liu told us that Muddy Waters visited in January the day after a large snowstorm and low temperatures. The steam appeared when the cold air outside came inside the warm line facilities.
Orient Paper
Orient Paper's new digital photography line opened in March.

When I visited, the lines were all in operation, there was no steam and the machinery was clean. I'm attaching a couple of the photos I took with this article. Certainly it's a smaller plant than Nine Dragons and others, so the equipment is older, but I saw no evidence of water damaging the finished product paper. But this is a small-cap company: it's Orient Paper; not International Paper.

Muddy Waters complained that ONP stored recycled paper outside where it can be exposed to rain and snow before turning it into pulp for making paper. Muddy Waters claimed that valuable inventory would be damaged in the rain/snow. The authors are forgetting the process by which this material gets turned into paper. The recycled paper (waterlogged or not) gets thrown into a pot of steaming hot water and turned into pulp. A little water damage doesn't disrupt the process.

Muddy Waters allegations do not hold up based on the research I've done and what information the company has shared.

I still hold ONP long and more shares yesterday. I stand by my previous articles on the company.

A year from now, I expect to still be investing in undervalued, overlooked Chinese companies like ONP, because my reputation is important. I also expect ONP to be a much bigger company by then (in Wednesday's press release, it confirmed it would have $1.21 in EPS this year; 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 or @ericjackson

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