Orient Paper Inc. ONP has been extremely volatile the past few weeks starting with the initial allegations by Muddywaters at the beginning of July 2010. To prove the allegations are baseless, ONP management have released reams of documents and data and followed up with investor and analyst at a conference call and a meeting. Curiously, Muddywaters did not participate in the conference call or the meeting where all of their allegations were disproved in details. Since then, a few other short sellers decided to jump on the bandwagon to distort and talk down the stock for their personal gains. As the result, ONP’s stock price has fluctuated wildly with investors becoming super skittish, not knowing what to believe.
In the morning of Wed 7/28/2010, Theflyonthewall website posted that Roth Capital decided to suspend its rating on Orient Paper pending the results of the company's announced independent third party investigation. As investors have already been super skittish, the news promptly caused the stock to drop down by more than 20% before recovering somewhat at the close. Let’s analyze to see how significant the announcement by Roth Capital is and how it should affect the stock price.
First, Roth Capital’s announcement is understandable since investment banking firms in general do not want to deal with companies tainted with controversies, regardless of whether the controversies are valid or not. It is likely their policy that they simply don't give rating to any company undergoing an investigation, self-imposed or not. ONP management’s attempt to be transparent and to reassure investors by voluntarily ordering their own investigation by retaining a top-tier international law firm and a big-four audit firm thus appears to produce the unintentional effect of admitting wrongdoing. As the result, ONP’s stock tanks by 18.7% at the close of Wed even though Roth Capital only delays the rating to wait for more information, whereas another company suffering from a worse downgrade normally only loses a few percent at the most. This is a good case of “no good deed goes unpunished.” Apparently, any investigation, whether voluntary or not, gives the appearance of trouble and scares off potential investors. ONP’s CEO is learning the hard way that sometimes a small problem should be left alone lest it grows into a big problem.
Second, what is the likelihood that there is even remotely some truth to Muddywaters’s allegations? A careful reading of the abundant data and documents released by ONP indicates that there’s no wrongdoing. However, for anything as complex as running such a big operation as ONP, there's bound to be little discrepancies here and there, and if one looks hard enough, one will find them. These discrepancies, assuming they exist, should be small and inconsequential. It is possible that Roth Capital plans to wait for the voluntary audit committee to work out all of the discrepancies before they resume the rating. Depending on the complexity of the transactions and the priority of the auditors, the audit can last anywhere between a few weeks to a few months, though the timing is almost impossible to predict.
For the nervous investors, there are a few reassuring facts that suggest that ONP is free of fraud:
A. Chairman and CEO Zhenyong Liu has never sold a single share since he founded the company. If there’s fraud, he would have offloaded his shares in anticipation of inevitable exposure. He’s been instead focusing hard on building ONP into one of the most successful paper companies in China and he seems to be doing everything right, from cost cutting to physical expansion to moving to higher margin products, etc.
B. ONP’s Board of Directors consist of several highly respected independent directors who have confirmed, independently of Liu, that all of Muddywaters’s allegations are false and ONP’s revenues and margins are indeed correct and accurate.
C. Reputable institutional investors and analysts, after carefully examining the papers and visiting ONP’s plant, also agree with ONP’s management that ONP’s numbers are accurate.
Thus, with earning release coming in about two weeks, what is the right price for ONP stock? At the current level of $4.36, ONP is absolutely oversold by any account. Even if there are irregularities in ONP’s numbers, ONP is still cheap for any price under $5-6, which is easily 3-4 times below its true intrinsic value. The true intrinsic stock value can be estimated by multiplying ONP’s earning by the average PE 27.85 of the paper and paper product industry, giving $1.05 x 27.85 ~ $30 per share. If a more conservative PE of 15-20 is used, the intrinsic stock value would fall in the range of $16-$21. At the current price, ONP hence is arguably the most misunderstood and undervalued stock in the market today.
Disclosure: Long ONP