Much of the information that Muddy Waters LLC has put out on Orient Paper Company (NYSEMKT:ONP) and claimed as "factual information" has required us to go on good faith that we can trust Muddy Waters and their intentions. This information includes, amongst others, a transcript of a phone conversation they had with the paper machinery manufacturer, Henan Qinyang, as well as the phone calls they made to ONP's top ten client list. If this were a well respected research firm that has been in business for several years with a sparkling reputation, we would be much more inclined to believe that word. However, that same word from an unknown requires much more of a leap of faith. I personally find that leap of faith in Muddy Waters very hard to make, considering the contradictary statements and misleading information that they have put in writing, as well as the general lack of character that they appear to display.
Oh What a Tangled Web We Weave...
Let’s take a look at the original intent of the visit to ONP as stated by Carson Block in his July 2nd rebuttal, which he states was on behalf of his father’s company, W.A.B. Capital, to accomplish due diligence. The first point I’ll bring up is what W.A.B. Capital states on their own web site in their FAQ’s section (http://www.growthequities.com/wab_faqs.html):
“How extensively does W.A.B. Capital research a potential corporate client?
W.A.B. Capital’s research process takes several weeks. The first step is to thoroughly review a company’s SEC filings, press releases, and product / service information. Next, we hold an initial teleconference with the management to answer higher-level questions that we have relating to the company’s business and finances. Both parties then decide whether they would like to move forward.
If we move forward, W.A.B. Capital will visit the company at its place of business. In a day-long meeting, we will ask about and discuss almost every facet of the company in detail. Following the meeting, we will ask to be put in touch with suppliers, customers, and other important parties with whom the company does business. At the conclusion of the process, we will propose an agreement with the company.”
Now take a look at Carson Block’s own words from Muddy Waters’ July 2nd rebuttal (http://www.thestreet.com/stock-market-news/10798398/muddy-waters-research-responds.html):
“On January 3rd, Sean and I were at Hong Qiao Airport in Shanghai for a number of hours due to the snow in Beijing. This was the first opportunity either of us had to look through the 10-K and recent 10-Qs. As we went through the documents, my jaw dropped a number of times. There were so many red flags, a number of which we covered in our report. By the time we finished our reading, we were convinced the stock was a short. “
This statement by Carson Block says quite a lot. First, note that W.A.B. Capital says “the research process takes several weeks. Part of the first step is to thoroughly review a company’s SEC filings.” So on January 3rd, in the airport one day before their intended visit to ONP, this is the first time they even took a look at the 10-K and recent 10-Q’s? According to W.A.B. Capital, they thoroughly review a company’s SEC filings, press releases, and product/service information, as well as hold a teleconference with management to answer high-level questions before they even arrange a visit.
Since the visit to ONP was already arranged, this leads us to one of two conclusions:
1. W.A.B. Capital had already thoroughly reviewed these reports and didn’t see all the jaw-dropping red flags that Carson Block and Sean Regan saw in eight hours in an airport.
2. This is really the first time these reports were looked at by anyone from W.A.B. Capital, which means W.A.B. Capital is misleading about how thorough their research process is.
So which one is it? Is Carson Block saying that his father’s company is incompetent in their research, or is he saying that his father’s company is misleading? Or is there a third option, where Carson Block is the one misleading everyone else?
…When First We Practice to Deceive
Carson Block makes the statement in his July 2nd rebuttal that, although no offer was ever tendered, compensation of 20,000 shares was deemed appropriate for W.A.B. Capital’s services. He also states that “Certainly that would have been an easier path to getting paid than we took with Muddy Waters, LLC.”
Easier path? Debatable.
W.A.B. Capital still needed to provide their services to ONP in exchange for these shares. These services, in addition to the research coverage, also includes “road shows and concerted exposure efforts”, according to W.A.B. Capital’s own web site. For Carson Block, he still had to fulfill his obligation to W.A.B. Capital, which they state as “In a day-long meeting, we will ask about and discuss almost every facet of the company in detail. Following the meeting, we will ask to be put in touch with suppliers, customers, and other important parties with whom the company does business.”
Carson claims that he told his father, before even visiting the factory, that ONP was not a buy. So the “day-long meeting” where “we will ask about and discuss almost every facet of the company in detail,” suspiciously turned into a 90 minute tour of the factory and a question and answer session where Carson Block admits to not asking many questions. Apparently, when you are building a case for fraud, probing questions are no longer necessary. As far as the follow up research of being “put in touch with suppliers, customers, and other important parties with whom the company does business,” that was apparently going to be done either way.
So Easier Path? Maybe. More lucrative path?…
At the time of discussion of the 20,000 shares compensation in late 2009, the stock price for ONP at it’s highest in November was about $10 a share. So at the time of discussion, the shares would have a value of $200,000. Obviously the favorable review of ONP by W.A.B. Capital would have the intent of bringing in institutional investors and driving the price of the stock up. So even at triple the stock price, or a generous $30 a share, the compensation would amount to $600,000. However, this wasn’t going directly into Carson Block’s pocket. This was the potential take of all of W.A.B. Capital. “My father of course had in mind that I would conduct the due diligence. He offered me a portion of any economics on the deal.”
Carson Block was going to receive a portion of the economics. How large of a portion? Well, W.A.B. Capital still needed to cover its own costs. It has two offices, one in California and one in China. It has to take ONP on a road show. It has employees. It has expenses. It also employed the use of an outside consultant, Sean Regan, for his factory expertise. “When he had a project with his father, he asked me to consult for them as a factory expert. Basically they would pay my expenses, fly me up and we would take a look. As he was a good friend, I was more than happy to help Carson out.” So either Sean Regan is being paid for his services by W.A.B. Capital, or he just does favors for his friend Carson Block, in which case it would also be a lot more lucrative for Sean Regan to take the Muddy Waters path.
So how much compensation was Carson Block and Sean Regan poised to receive from W.A.B. Capital? Even half of the 20,000 shares would seem like a generous amount for a consulting job.
The Muddy Waters path, which would include shorting the stock, and then potentially buying a long position at a much cheaper price, would appear to be the path to a vastly more lucrative return.
So Where is Your Character?
Carson Block was well aware of Rick Pearson’s excitement about ONP. In his July 2nd rebuttal, Carson states that Rick Pearson was, during the factory tour and in the car ride back, exclaiming “They’re printing money!” Carson himself says, “I was in a state of prolonged surprised that he could be so exuberant about this company.”
But why was Carson Block so conflicted about telling Rick what he thought of ONP in the car ride back? Was he afraid to burst his exuberant bubble? He claims in the rebuttal that “I felt the company was a sham and I wanted to help Rick out by telling him so; but, to do so was illogical.”
Apparently, to Carson Block, helping Rick Pearson out means letting him go home and invest his money and reputation in ONP while you go home and accuse it of fraud. If Carson had genuinely wanted to help Rick Pearson out, he would have had a professional discussion as to how he felt about ONP during that car ride. If Rick, in his own professional opinion, chose to ignore Carson’s insight, then it would be at his own peril and he would deserve what was coming to him. But for Carson to never say anything while claiming he “wanted to help Rick out,” it really brings into question Carson Block’s character and motives.
Or maybe it was just illogical…
Tell me, is that the type of character you want to base your Leap of Faith on?
Disclosure: Long ONP