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Orient Paper: Key Pieces of Evidence for Fraud

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Over the past few weeks, there has been discussion around a wide variety of allegations surrounding Orient Paper. The original Muddy Waters research report was 30 pages long, and they have issued several subsequent pieces of commentary. The company, in turn, has submitted several responses to the Muddy Waters allegations and has hosted a conference call.

There has been a lot of information and keeping track of it has been difficult. The purpose of this article is to highlight the several most compelling pieces of evidence that Orient Paper is a fraud.

As I’ve written in previous articles and blog posts, I believe that Orient Paper is falsifying its financial statements. There is substantial evidence for that, but I’ll focus here on 4 of the most convincing points to me. I’ll exclude certain disputed items like the AIC filings, where the company and Muddy Waters are in disagreement over whose copies are the correct documents.

1. Top 10 Customers

Much of Muddy Waters’ research has focused on direct due diligence that they’ve done on the company’s premises in China. Yet some of the most compelling pieces of evidence that Orient Paper is a fraud comes from incriminating evidence that it has published in its own SEC filings.

One of the best examples of that is in its 2008 and 2009 Top 10 Customers. Here are the two lists, from the SEC filings:

Muddy Waters puts it well:

“ONP’s 2009 top 10 customer list shows that it replaced 80% of the 2008 customers. The strange item is that the minimum level needed to enter the top 10 lists stayed constant at around $2.1 million. In other words, one could reasonably expect that almost all of the companies who did $2.1 million or more in business with ONP in 2008 should do at least as much in 2009. But this was not the case, as eight of the 2008 top 10 customers disappeared. Yet, ONP did not lose any revenue. It grew by 56.5%.

The paper manufacturing business in China is highly competitive. First you have to make the product. Then you then have to sell it. “If you make it, they will come” is no less realistic in China than in the United States. Particularly when the product is highly commoditized – such as paper is.

For a company to lose most of its top 10 customers and not have sales decline requires significant effort by all throughout the organization. To lost most of its top 10 customers and still grow the company at 56.5% is a remote possibility.”

And here is the company’s response:

“Muddy Waters also accuses Orient Paper of churning and burning its top 10 customers and misrepresenting its sales volumes to these customers. Those who have followed Orient Paper and studied the Company’s 10-K and other financial disclosures carefully over the past two years understand the following Company developments. Almost all of the Company’s top 10 customers are printing companies that buy printing/writing paper. The Company traditionally has a large number of small packaging plants buying its corrugating medium paper and very few, if any, of them make to the top 10 list. Within the group of printing/writing paper customers, significant changes in Orient Paper’s product portfolio occurred in 2008 and 2009. In 2008, HBOP started producing writing paper, thanks to the 1760# Fourdrinier Multi-Cylinder Production Line that was placed into service in March. In the Fall of 2009, because of the skyrocketing cost of imported wood pulp, Orient Paper stopped producing high-grade offset printing paper, which requires virgin pulp (rather than recycled paper) as a major raw material. In an effort to push for a lower-priced medium grade offset printing paper, the Company converted the writing paper production line in September 2009 to concentrate on producing more medium grade offset printing paper. As a result of these shifts in product offerings, the top 10 customer lists of 2008 and 2009 had very different compositions. Orient Paper had more white paper sales sold to those customers who switched to the Company’s mainstream medium grade offset printing paper.”

Orient Paper is a paper manufacturer. It operates a commodity business, and Orient Paper doesn’t have any special technology over and above its competitors. As well, while China is a faster growing economy than the United States, it is nevertheless competitive, and paper demand isn’t growing at 50% a year. The Company can’t simply change its product mix, replace 80% of its Top 10 customers and nevertheless grow revenue by more than 50%.

2. The Video

The visual evidence presented by Muddy Waters makes a compelling case that Orient Paper is falsifying its financial statements. While the new digital photo lines provided in subsequent pictures may appear somewhat professional, the main legacy production lines shown in Rick Pearson’s video demonstrate a business far smaller than what the SEC filings indicate.

To best examine the visual evidence, it’s best to look at Competitors’ plants, and then compare those plants with the Muddy Waters facilities:

Competitors’ plants:
– See pages 14-17 of the Muddy Waters report available Here

Orient Paper’s plant:
– see Rick Pearson’s video here
– see additional Muddy Waters pictures here

Based on the videos and pictures, Orient Paper’s main plant is of materially lower quality than that of its competitors. The machines are old, run-down and appear incapable of producing high quality paper. As well, the videos show substantial steam generated in the facility, which conflicts with the company’s claims of producing high quality paper. Once paper is exposed to water, it becomes no longer flat, and cannot be billed as high quality.

3. Muddy Waters’ Claims that the Company’s Top 10 Customers Could Not Have Purchased As Much Product As ONP Claims They Have

In its report, Muddy Waters tried to contact each of the Top 10 customers that Orient Paper lists in its 10K. Five were contacted or otherwise verified, and Muddy Waters lists their phone numbers in its report. Any outside third parties can independently contact them, given that Muddy Waters makes their contact information readily available.

Click here for a table where Muddy Waters documents its diligence on its Top 10 customers.

Based on its findings, Muddy Waters concluded that Orient Paper has fabricated its sales figures to those customers. Five of the customers were too small to be able to buy the volume of paper that Orient Paper claims it purchased from them. For instance, at a company to which Orient Paper alleges selling $3.4m of product, the cleaning woman answered the phone during business hours and was the only employee working. She said that there were only a few employees at the business and all were part-time. Four of the companies within Orient Paper’s Top 10 could not be found, had no website or had no one answering the phones during business hours.

Only 1 of their Top 10 customers, Boading Huatai Printing Co. Ltd, was large enough to theoretically purchase the amount of paper from Orient Paper that ONP claimed.

Here is Orient Paper’s response:

“Muddy Waters has stated that it believes that “all but one of Orient Paper’s top 10 2009 customers are too small (if they even exist) to buy the amount of product that ONP claims they do.” This accusation is false and Orient Paper believes that Muddy Waters’ methodology is inappropriate for establishing substantiation in a fraud case. Business practices in China are different from those in the United States, where many businesses are willing to reply to sensitive trade account confirmation given a properly drafted written confirmation request from the trading partner and the confirmation performed by legitimate third parties, such as auditors. Unsolicited, improperly phrased enquiries are usually met with misleading or inaccurate results. In addition, even in the U.S., auditors who perform written or telephone confirmations must perform additional alternative procedures to get in contact with the relevant parties to be confirmed before any conclusion can be reasonably made. While Muddy Waters claims that they were unable to verify the existence of some of Orient Paper’s customers and made no effort to ask Orient Paper for assistance; many institutional investors; investment banks, such as Roth Capital Partners; and the Company’s auditor, BDO Limited, have all performed due diligence on Orient Paper’s large customers and have confirmed and communicated with their selected sample companies during the last twelve months. Among these parties, Muddy Waters is the only one that claims Orient Paper is providing “false information” about its top 10 customers.”

Orient Paper’s response is basically twofold.

First, it claims that Orient Paper’s customers would lie to Muddy Waters about their size because that is standard procedure in China. I doubt that’s the case.

Second, it claims that a variety of third parties have done the necessary due diligence on Orient Papers’ customers. As I’ve previously written, BDO Limited has demonstrated an inability to do proper due diligence in the past, given that it was the auditor of China Expert Technology, which was a complete hoax. I would not rely on their work. The investment banks working with Orient Paper are third-tier firms that have embraced Chinese RTO smallcaps mainly because the sector generates them a tremendous amount of fees, not because the companies whose offerings they underwrite are real. As for the institutional investors in ONP, I will not make an unwarranted generalization because a variety of funds invest in Chinese RTO smallcaps, and they do so for different reasons and according to different investment theses. But some of the funds that do proper on-the-ground business diligence on Chinese RTO smallcaps like Orient Paper are indeed savvy and have generated outstanding returns from the sector. But their goal isn’t necessarily to avoid frauds.

4. Further Inconsistencies within the SEC filings

In addition to the unlikely 80% turnover within the Top 10 Customers, there are further inconsistencies within Orient Paper’s SEC filings.

First, Orient Paper’s alleged inventory turns are extraordinarily high for a paper company, and when compared with competitors. On page 25 of the Muddy Waters report, we see a comparison of ONP’s inventory turns when compared to competitors. ONP’s 17x 2009 inventory turns is high for any manufacturing business, let alone a paper company in an industry where its listed competitors’ inventory turns are 4.3x, 5.6x, 6.4x and 7.7x.

Second, as an additional blogger wrote in a post last week, if the company grew revenues by 57% and earnings by 45% in 2009, why was its employee count 600 in both years? In fact, an old video on the company’s website (the video doesn’t download properly in many browsers) says that the company had 863 employees. If that’s true, how has revenue grown from $40m in 2007 to $102m in 2009 while employees have actually shrunk 30%?

That blogger highlighted further inconsistencies. How did the company have a 37-member R&D department that only cost them $30,130 in 2008? How do you more than triple sales in 3 years while spending only a collective $655 (six hundred and fifty five dollars) on advertising and promotion in those 2 years?


There is substantial additional evidence that Orient Paper is falsifying its financial statements that I have not touched upon.

The company and Muddy Waters are disputing whether the SAIC financial statements match the SEC financial statements. I also have acquired SAIC documents with the personal seal of ONP chairman Zhengyong Liu, and may post them at a future date. Either mine and Muddy Waters’ documents are false, or the ones recently submitted to the Hebei AIC are falsified.

As well, I have not touched on whether ONP could theoretically purchase a production line for $27m, when Muddy Waters has provided evidence that the most expensive highest capacity 5.6m corrugating medium production line would cost less than $10m.

I have not touched on how the recycled scrap inventory shown in the video and various additional Muddy Waters’ pictures could be worth the amount that ONP values them at in its financial statements.

I have not touched on how ONP can generate the same gross margin as its competitors despite its outdated equipment and far lower economies of scale.

But even without touching on the additional evidence that has been disclosed over the past few weeks, the points highlighted in this article provide compelling evidence that Orient Paper is falsifying its financial statements.

Disclosure: I am short shares of ONP.


Written by chinesecompanyanalyst

July 12, 2010 at 1:02 am

Orient Paper: Not all BDOs are the Same

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In this article, I’m going to discuss why BDO Limited, the Hong Kong branch of the BDO International network of auditors, should not be considered a top tier auditor, and is not comparable with the separate U.S.-based BDO Seidman. Not all BDO member firms are the same.

A glaring red flag among some Chinese RTO (“reverse takeover”) smallcaps is their poor choices for auditors – many firms have hired unheard-of firms to act as their public auditor. In my articles on China Marine Food, I have questioned the quality of the company’s audit firm, ZYCPA, and wondered why a $70mn revenue business would hire an auditor that has only 2 partners and 25 personnel; audits no other exchange-listed public U.S. company; and has its main partner being sued for aiding a HKD$125m fraud of a European investor.

Some RTO Chinese companies have tried to avoid controversy by hiring BDO Limited as their auditor. Investors see “BDO” in the audit firm’s name, and assume that all BDO’s abide by the same strict audit standards as BDO Seidman, the U.S.-based and most well-known BDO member firm. That’s not true.

I’m going to provide several data points that provide evidence that investors should be cautious around companies audited by BDO Limited:

1. BDO Mccabe Lo, the predecessor to BDO Limited, was the auditor of China Expert Technology, an infamous Chinese fraud that blew up in 2007

2. BDO Limited is not inspected by the PCAOB

3. The SAIC and SEC financial statements match for a BDO Seidman-audited firm, Tongxin International, but do not match for two BDO Limited-audited firms, Orient Paper and China-Biotics, Inc.

The BDO International Network

BDO International is a sprawling international network of audit firms that has more than 1,000 offices in more than 100 countries. Like many international auditors, the firm is comprised of individual member firms. The main member firm in the United States is BDO Seidman LLP. The main member firm in Hong Kong is BDO Limited. While both carry the BDO affiliation, they are completely separate audit firms.

BDO Limited was the auditor of China Expert Technology

One of the most illustrious frauds in the U.S.-listed Chinese RTO smallcap space is China Expert Technology (CXTI). CXTI claimed to provide information technology network and infrastructure consulting services to government and corporations. It had stunning financials – from 2003 to 2006, its revenue allegedly grew from $6m to $66m, and its net income grew from $1m to $8m, with smooth revenue and earnings growth in each year.

Then one day, it stopped filings it financial statements. Its CFO quit and its CEO disappeared. Its stock dropped from $7 to 50 cents in two months. The company vanished. The widespread consensus is that the company was a hoax, and that the financial statements were fabricated. Its story has been documented in several places, such as here:

China Expert Technology’s auditor was none other than BDO Limited. Technically, it was BDO McCabe Lo Limited at the time, but the two firms are the same – BDO McCabe Lo Limited changed its name to BDO Limited when it merged with Shu Lun Pan Horwath Hong Kong CPA Limited in May 2009.

The implication for investors currently invested in companies audited by BDO Limited is troubling. If BDO Limited could not detect fraud at a company that appeared to be entirely fabricated, can we rely on it to detect fraud at Orient Paper, a company that at least has some production lines and some semblance of operations? I believe that Orient Paper is falsifying its financial statements, and that the actual underlying company is materially smaller than its SEC financial statements indicate. In contrast, CXTI appeared to be entirely a hoax – essentially, it appears to have been 100% fraudulent whereas ONP may only be 80% fraudulent.

BDO Limited is not inspected by the PCAOB

The PCAOB is the accounting firm’s quasi self regulatory organization – it is comprised of accountants from different PCAOB member firms that do annual inspection audits on other PCAOB member firms. It’s referred to as “the auditor of the auditors” because it double-checks selected audits and provides reports on its findings.

BDO Seidman allows the PCAOB to inspect its books, and its 2009 inspection report is included here.

BDO Limited does not allow the PCAOB to inspect its books, because it is Hong Kong-based whereas the PCAOB is U.S.-based.

Granted, just because BDO Limited is not audited by the PCAOB doesn’t mean that its audit standards are subpar. But when comparing BDO Seidman and BDO Limited, I would be more comfortable with BDO Seidman-audited financial statements because the firm is inspected annually by the PCAOB.

Comparison of SAIC and SEC financial statements for companies audited by BDO Limited vs BDO Seidman

Over the past few months, I and other investors have compared Chinese companies’ SEC filings with the local financial statements that the companies’ main operating subsidiaries must file with the Chinese government. My articles/posts are here, here, here and here. “Waldomushman” has compared CSKI’s and SOLF’s SEC and SAIC financial statements on his website at has done the same for ONP, though it has not yet released its copies of the SAIC financial statements.

In total, comparisons of SEC and SAIC filings have been posted for CSKI, CMFO, LIWA, ONP, YUII, FUQI, and SOLF. For CSKI, CMFO, LIWA and ONP, the numbers don’t match and there is additional evidence that the companies are falsifying their SEC financial statements. For YUII, FUQI and SOLF, the numbers do match (or, more accurately, are in the same ballpark).

In the following, I compare SEC and SAIC financial statements for a BDO Seidman-audited company, Tongxin International, and show how the SEC and SAIC financials match. Then I compare the SEC and SAIC financial statements for a BDO Limited-audited firm, China-Biotics Inc., and show how they don’t match. As Muddy Waters has explained, the ONP numbers don’t match either (ONP disputes whether Muddy Waters has the correct subsidiary, but I believe that Muddy Waters has the correct subsidiary based on their July 2 2010 response to ONP).

First, let’s look at BDO Seidman-audited Tongxin International (TXIC). TXIC is a Chinese auto parts company that was purchased by a SPAC in 2008. Its SAIC financial statements are here:

Click here for TXIC’s SAIC Financial Statements in Chinese

Click here for TXIC’s SAIC Financial Statements in English

Here is a comparison of the SAIC and SEC financial statements for TXIC:

As we can see, the numbers match, for the most part.

Next, let’s look at BDO Limited-audited China-Biotics, Inc. (CHBT)

Click here for CHBT’s SAIC Financial Statements in Chinese

Click here for CHBT’s SAIC Financial Statements in English

Also, here is CHBT’s full 2008 SAIC annual inspection report in Chinese.

Here is a comparison of the SAIC and SEC financial statements for CHBT:

CHBT’s numbers do not match – the SAIC financial statements show a far smaller business than the SEC financials indicate.

In terms of Orient Paper, as Muddywaters has discussed, ONP’s historical SEC and SAIC financials also do not match.

Therefore, our BDO Seidman-audited company has matching financial statements, whereas two BDO Limited-audited companies do not have matching financial statements. This provides evidence for our thesis that investors should remain cautious around firms audited by BDO Limited. BDO Limited is a different firm than BDO Seidman and there is evidence that BDO Limited does not subscribe to the same audit standards as BDO Seidman. Given its history with China Expert Technology, it has demonstrated that it has not been able to prevent frauds in the past. Given that ONP and CHBT do not have matching SEC and SAIC financial statements, and that there are numerous other signs that ONP is falsifying its SEC financial statements, there is evidence that BDO Limited is also not preventing frauds in the present.

Disclosure: short CMFO, ONP and long TXIC

Written by chinesecompanyanalyst

July 12, 2010 at 1:01 am

Posted in Orient Paper

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Orient Paper: Another Fraud

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I have spent much of the past month describing why I believe that China Marine Food Group (CMFO) is falsifying its financial statements. My posts and articles are here, here and here. From my posts, it should be clear that I don’t think CMFO is the only U.S.-listed RTO Chinese company that’s making up its numbers.

Another one is Orient Paper. Over the next few weeks I will explain why I believe this is the case.

Today, I will focus on a research report published by Carson Block and Sean Regan at “Muddy Waters LLC” earlier this week.

You can access it here.

This post will summarize several of Muddy Waters’ allegations. I urge readers to read their entire report, as my brief post does not do it justice.

1. Like CMFO, ONP is using an acquisition to justify a large equity raise that it is likely using for dubious purposes, such as redirecting the funds to personal bank accounts.

On April 12, ONP announced that it had entered into an equipment purchase agreement with Henan Qinyang First Paper Machine Limited to purchase a corrugating medium paper production line with an annual production capacity of 360,000 tons for $27.8m.To fund the acquisition, ONP raised $27m in a secondary equity raise underwritten by Roth Capital Partners.

Muddy Waters wrote this:

“We spoke with the purported seller of the equipment, Qinyang, and four other Chinese papermaking equipment manufacturers. Qinyang told us that its highest capacity 5.6 m corrugating medium production line (the type ONP purports to have purchased) produces only 150,000 tons per year and costs approximately $4.4 million. This stands in stark contrast to ONP’s contention that it is purchasing a single line from Qinyang that will produce 360,000 tons per year for a total price of $27.8 million.”

Qinyang further stated that no Chinese manufacturer makes a 5.6m corrugating medium line that can exceed 200,000 tons per year. Furthermore, the most expensive line was no more than $7.3m. Muddy Waters provides a table showing the companies contacted, their URLs and the rough prices of their highest capacity 5.6m corrugating medium production lines.

No company quoted a price greater than $7.3m.

In my opinion, ONP is either misappropriating 60% of the capital raise and using the remainder to purchase a line, or misappropriating all of the $27m capital raise and purchasing no line.

2. ONP also made a $5m capital raise in October 2009, allegedly to purchase digital photo coating lines owned by He bei Shuang Xing Paper Co. Ltd. But according to Shuang Xing’s audited financial statements with the Chinese government, its fixed assets were worth less than $500k.

With CMFO, we saw a similar instance where the company purchased a company for an amount far more than the target could reasonably be worth. With the case of Shuang Xing, ONP appears to be using the asset purchases as justification to raise equity, which was then likely diverted to personal bank accounts, in my opinion.

3. ONP’s SAIC financial statements show revenue, profit and assets that are far lower than their SEC financial statements, according to Muddy Waters.

In due time, I’ll publish a post independently discussing and providing ONP’s SAIC filings. But I want to mention here that based on Muddy Waters’ research, the SAIC and SEC financial statements don’t match.

The company has claimed that Muddy Waters had acquired the AIC documents for the wrong company. Muddy Waters have refuted that, and has provided evidence demonstrating their case. We’ll discuss this more in future articles.

4. Muddy Waters provide visual evidence comparing ONP’s plants / technology with competitors’ plants.

Here is a video provided by’s Rick Pearson on ONP’s facilities.

In contrast, here are pictures of two competitors’ plants.

Shandong Chenming Paper Holdings Ltd.:

Nine Dragons Paper Holdings Ltd.:

The differences between the Orient Paper plant and the competitors’ facilities are striking. The Orient Paper facilities are old, shoddy and in poor condition, whereas competitors’ machines appear far more professional and new.

There is numerous additional evidence in the Muddy Waters research report that illustrates how Orient Paper is falsifying its financial statements and inflating its assets and operating metrics in its SEC financial statements. In future posts or articles, I will elaborate on some of the financial metrics. I will also explain how the Company’s auditor, BDO Limited, is not the same as BDO Seidman, and how certain Chinese companies have been using auditors within the BDO family to trick investors into mistaking them with the more reputable U.S.-based BDO Seidman.

Disclosure: short CMFO and ONP

Written by chinesecompanyanalyst

July 2, 2010 at 11:41 am