Orient Paper: Much More Upside Ahead

| About: Orient Paper (ONP)

Over the last few months, investors of Orient Paper (NYSEMKT:ONP) have endured a tremendous amount of drama on a very emotional ride. But now that the investors stand on the threshold of a critical stage in the company’s evolution, savvy investors will recognize that the upside of ONP is phenomenal.

If this were a cautionary tale, it’s fair to say the story began with an attack by a two person outfit with no record, called Muddy Waters. Proving that small Chinese companies were vulnerable to just about any attack, no matter how flimsy, the stock plummeted 50% and after some ups and downs, settled at a base of around $4.50.

The stock shot up over 75% over the last couple of weeks from its low and is close to $7 now. Yes, it has had a nice run up and investors are realizing that ONP has done far more than any other small Chinese company to disprove allegations levied against it. But prior to the report the stock was trading around $8-$10 with a high of $15.15 in January 2010--certainly there is plenty of room to grow from here.

Fighting against investors’ mistrust stemming from little more than McCarthy-like scare tactics, ONP management took the extraordinary step of hiring a national law firm with an impeccable record who enlisted the services of Deloitte to assist in investigating the numerous claims made by Muddy Waters. Demonstrating their confidence in the results of the investigation and making it clear that they want investors to know what is happening, ONP management recently issued a press release stating that the results will be given to the board of directors within a period of three weeks, which would be prior to November 16, 2010.

From "Orient Paper Updates Investors on Investigation" (click here):

We believe we have conducted a detailed and thorough independent investigation over the last three months and are pleased to announce it has entered its final stage," said Mr. Drew Bernstein, Chairman of Orient Paper's Audit Committee. "We continue to work with Loeb & Loeb and Deloitte to complete the rest of the investigation on schedule and look forward to providing the results to the Board of Directors.

Now that the 2010 Q3 earnings have been released, there has been a huge overreaction. Unfortunately, Orient Paper did not give any insight into the investigation and it has not finished as expected, but they continue to re-iterate their positivity to releasing the results, which is always a positive sign. The only negative is that investors are going to have to wait just a little bit longer, but there is still no reason that ONP will not head above $10 based on positive results.

There are still many positives to take away from the results and even the press release (see here):

  • Even with the setback, they delivered $23 million in revenue.
  • Selling price of the Corrugating medium paper rose 16%.
  • 5% of revenue was from Digital photo paper which has just started selling in March 2010.
  • Revenue for the first 9 months in 2010 are up 23.9% compared to the first 9 months of 2009.
  • $22.8 million in cash and cash equivalents.
  • "We are in the final stages of completing the independent investigation," said Mr. Drew Bernstein.
  • "Our new 360,000 tons per year corrugating medium paper production line is expected to begin production in the first quarter of 2011."

In regards to the reduced revenue compared to 2010 Q3, this issue was explained in the 2010 Q2 press release:

In connection with the government's approval of our new corrugating medium paper production line, the Baoding City Environmental Protection Agency requires that we replace two of our four steam boilers with new more energy- efficient models. We removed the two old boilers in July 2010. Our production in the third quarter may be lower until the new boilers are installed and inspected possibly in the fourth quarter. As a result of all of the above mentioned factors, we now expect fiscal year 2010 adjusted net income of $16.2 million compared to our previously provided guidance of $18.0 million.

Read more here.

So there should have been no surprise that this quarter and even the second half of 2010 was not going to be that strong. So the issues in regards to the plant and the boilers was already stated.

The main factor for the stock and its investors going forward are the results of the investigation. In the meantime, because so many of the arguments made by Muddy Waters and others are so porous and weak, over the last few months many people have handily rebutted these claims.

Here are several articles that have exposed the distortions and untruths of the allegations and the short attacks:

Many of the claims were immediately and persuasively rebutted by ONP as well, but the board of directors took it one step further. They did the best possible thing by bearing the expense of hiring Loeb & Loeb as independent investigators who in turn hired Deloitte to assist in the audit portion of the investigation. In taking this measure, ONP has demonstrated its confidence, professionalism and willingness to be scrutinized by real professionals with reputations that mean something.

Let me underscore the significance of this point. Up until now, ONP and other small cap Chinese companies have been vulnerable to any argument (no matter whether they were substantiated) and by any individual (regardless of whether the person had ANY credentials or whether that person would even identify him/herself). Although the expense of the investigation will definitely be felt this quarter, ONP is taking the credibility question off of the table. These are the actions of a company that has nothing to hide. These are the actions of a company that should be evaluated on its fundamentals and potential and that alone.

The fact that ONP has stated that it is “pleased” to present the audit results to the board and that its auditor BDO has not revised a single figure of its prior audits (notwithstanding its participating in the Deloitte investigation) makes it no secret that the results of the audit are positive. This gets to my main point. We stand at a brief, but important period of time where numerous catalysts of the stock will soon be triggered. Many China small cap stocks have been struggling and have just started coming off of their lows, but the clarity issue and questions of the validity of these companies are still in of the forefront of investors’ minds. What ONP is doing is giving itself validity, clarity and transparency, and management has given every indication that the results will be positive through their efforts.

Here is a list of catalysts to push the stock above $10 in the near term(less than 3 months and $15 (3-6 months, if not sooner) :

  1. The results of the investigation – this is obvious as it will clear the air, but it does so much more because it eliminates all credibility concerns, which will give the stock a higher multiple compared to other China Small Caps. This brings the focus back to ONP’s fundamentals. And based on these fundamentals, one recent analyst initiated research on the company with a target price of $16.70 per share for 2011 (see here).
  2. Update on the new equipment – this is big for the future of the stock and the company as the new equipment and expansion is what is going to drive the stock long term and will allow this company to grow substantially starting in 2011. The new production line, which we expect will be operational in the coming months, will effectively more than double the productivity of the company. We have already seen in videos, plans for the site and the land where the production facilities are being built.
  3. Re-initiation of coverage –Roth Capital suspended, but did not cancel its coverage, pending the results of the investigation. Once ONP is cleared of wrongdoing, coverage should be re-initiated with a price target above $15, perhaps even well above $15 given recent developments with the new production line.
  4. Institutional buying – While ONP is undervalued and provides assurances to its investors on its integrity, many institutions will jump on board due to the upside, but most importantly, less worry due to the clarity. In fact, institutional investments have already started to increase. Transparency and clarity are extremely important and will be an advantage that almost no other China Small Cap has.
  5. Professional analysis– many positive articles, including those written by professional media outlets, written about ONP and its future and on the flip side, many articles, that have already started to emerge, about the distortion tactics by firms like Muddy Waters.
  6. Continued Growth – There has been a lot going on with ONP and they have been heavily burdened and distracted from their core mission since June 30, 2010. They have certainly incurred expenses to clear up concerns investors have because of allegations, and while this has been costly, it should be viewed as a valuable investment in the company’s future. Even if ONP hits $0.90 EPS for full year 2010, that still gives ONP a P/E of about 7.6 based on the closing price today. Given the expected growth for 2011 and clarity of being a valid growing company provides ONP the right to be valued highly.

There are other catalysts that can have an effect on the price of the stock, but these will help get ONP going in a forward motion for some time to come. Obviously, everything is going to start with the results of the investigation which I believe will come out very positive for ONP and its investors

I know many investors have been very patient (or perhaps impatient!) waiting for these results, but in the long run, the many catalysts that will continue to push this stock upward. Investors should be cautioned not to expect results of the audit immediately as everything is still going to have to be evaluated by the board of directors and they will have to put everything in place to ensure that the investors are going to get the best response possible and nothing is left undone. That the audit committee and the board are taking their time, being thorough and coordinating a communications strategy is a sign of professionalism and nothing less. It still may be a little bit more time before we get the complete details, but any update by management, Loeb & Loeb, Deloitte, ONP board of directors, would be appreciated.

Regardless of any short decline in the stock, just remember the potential for this stock and the catalysts that are a hair away from being triggered. There may be more of a downturn as the conference call is here and there is not much more for Orient Paper to state, but a positive outlook and any other specifics would be an added bonus. The results of the investigation are saving grace and this will go back up with positive results.

Any drop presents a buying opportunity as Orient Paper is a fast growing company that is going to be rapidly expanding and producing in 2011, but the best part is that all of the concerns will be resolved while eliminating future concerns. And that, especially for a small Chinese company, is priceless.

Disclosure: No position but by the end of the month I plan to get back in long-term.

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