Orient Paper: Inconsistent Record Keeping Raises Red Flags

| About: Orient Paper (ONP)

By now Orient Paper (NYSEMKT:ONP) is quite famously known for the allegation raised by Muddy Waters Research that it defrauded investors of its revenue and assets.

Back in April, Eric Jackson promoted this company after his visit to China. I took a serious look at this paper making company but decided that it was not going to double or triple as Eric suggested. Instead, it did not appear cheap compared to its Chinese peers. I offered my opinion in the comments, and Eric suggested that because it was a smaller company the growth profile would be different.

Muddy Waters Research’s report revealed another risk for companies like Orient Paper: It is not wise to base an investment decision purely on the balance sheet, income statement, and cash flow statement provided by the company. Given that fact, what can investors do to protect themselves if they cannot go to China to kick the tires? Well, reading Orient Paper’s SEC filings more carefully may help.

Several issues can be found just by reading its SEC filings alone.

1. Inconsistent G&A Spending

Compared to its reported revenue, Orient Paper’s G&A spending is disproportionally low. In 2008, only $327k was spent on revenue of $65ma, which amounted to 0.5%. If you think this number is odd enough, then the Q4 G&A number is even odder. If you look up their quarterly reports for 2008, the first three quarters show the G&A cost at $221kb, $203kc, and $231kd respectively, which leaves the fourth quarter G&A cost a negative $327k. There is no explanation in the 10-K for this abnormality.

FY 2008











a. 2008 10-K, Page F-4

b. 2008 Q1 10-Q, Page F-3

c. 2008 Q2 10-Q, Page F-3

d. 2008 Q3 10-Q, Page F-3

2. Inconsistent Cost of Sales

In 2008 and 2009, Orient Paper reported COGS (Cost of Goods Sold) of $53ma and $82mb respectively, and it specifically noted that raw materials accounted for 70% of COGS and coal 10%c, so raw materials plus coal consumed in 2008 and 2009 are roughly $42m and $66m respectively.

There is another way to calculate the raw materials and coal consumed. Orient Paper reported 50%d and 37%e of its purchase were from Xushui County Dongfang Trading Company, its biggest supplier, for the above two years. It also provided the numbers, $28mf and $31mg respectively. Backing out from these two numbers, we should have $57m and $83m raw materials and coal purchase for 2008 and 2009.

The gaps between the accrual method above and the cash method below, $15m and $17m, have to be explained by inventory increase if they were both true. The following table shows that this is not the case.






Purchase calculated by COGS



Purchase amount from Biggest Supplier



Biggest Supplier Percent



Purchase calculated by Biggest Supplier



Gap between two methods



Inventory increase



Unexplained Gap



a & b. 2009 10-K, Page F-5

c. 2009 10-K, Page 31 Top

d, e, f, & g. 2009 10-K, Page 10

h & i. 2009 10-K, Page F-7

3. Inconsistent Sales Volume

Orient Paper claims that its top customer of 2009, Hebei Tianpurun Printing Company, purchased $5.3m of goods from it (2009 10-K, Page 9). However, Tianpurun’s website (screenshot below) indicated that its revenue was about 3000 Wan RMB, or $4.4m USD, and they made 236 Wan RMB, or $0.8m USD in net income and tax.

The above issues look like mistakes caused by a lack of attention to make sure that the numbers management was fabricating were consistent or reasonable. They also represent the sorts of clues that an investor may catch before falling for a potential fraud. In particular, the first two do not require that the investor understand Chinese.

Some may still think that it is too difficult to compare numbers and find the red flags. In that case, here are still some easier inconsistencies you can find.

First, nearly all the press releases on its official website have the current CFO’s information, including the ones released before he was appointed in May 2009. This suggests that the press releases might be artworks. A screenshot of a March 31, 2008 press release is shown below, and the link is here.

Second, if you search “XXX” in this SEC filing, you will find 15 matches. No, the “XXX” don’t refer to pornos – it was just an amazingly lousy job.

I suggest readers also read Muddy Waters’ original report and the company’s response to get an independent opinion on ONP. Video and photo evidence has been abundant since the controversy first began.

A brave Chinese business journalist picked up this story, visited the local government office, and called trade experts and the CEO. His original finding is the cover story on this official newspaper site. Google Translate should help you understand the content.

Lastly, I side with Muddy Waters: ONP has more likely than not committed fraud. Yes, reading all the SEC filings is a tedious job for sure. But if done properly, it reveals inconsistencies for fraudulent companies.

Disclosure: Author is short ONP