Muddy Waters came out with a new report on RINO International this morning. As in ONP, they do an excellent job providing compelling evidence that RINO is fabricating its SEC financial statements. Here is an excerpt of their summary from the first page:
- RINO’s FGD sales (60% to 75% of revenue) are much lower than it claims. We found that many of its customer relationships do not exist.
- Chinese regulatory filings show that RINO’s consolidated 2009 revenue was only $11 million, or 94.2% lower than it reported in the US. We show that the Chinese numbers are credible.
- RINO’s accounting has serious flaws that are clear signs of cooked books.
- RINO’s management is draining cash from the company for its own business and personal uses. The management is in flagrant breach of its VIE agreements, which require it to pay income to RINO (as opposed to taking it).
- RINO’s balance sheet has an astonishingly small amount of tangible assets for a manufacturer. Rather, it is filled with low quality “paper” assets that balance out the inflated earnings, and likely hide leakage.
- RINO is not the industry leader it claims to be in the steel sinter FGD system market. Rather, it is an obscure company in a crowded field, and is best known for its failed projects. Its reported margins are two to three times what they really are. Its technology is sub-par.
- We are not sanguine about management “borrowing” $3.2 million to purchase a luxury home in Orange County, CA the day that RINO closed its $100.0 million financing.
It’s an excellent report and an example of yet another fraud in the U.S.-listed RTO china space.
This article is about how Orient Paper’s top supplier is either non-operating or very small, and is majority-owned by its CEO. I will also discuss certain suspicious share transfers by this supplier in July 2009.
But first, I want to discuss a recent development last week. Last Tuesday, Orient Paper announced that Loeb & Loeb, the law firm it hired to run its internal fraud investigation, hired Deloitte & Touche Financial Advisory Services Limited to “assist” it with its investigation into the issues raised by Muddy Waters, LLC. Per the press release, “Deloitte will provide support to Loeb & Loeb, which is working with the Company’s audit committee, in connection with the independent review of the accounting aspects of the issues raised and the investigation of the relevant financial transactions and customer relationships.”
Deloitte is not performing an audit. It is merely “assisting” and “providing support” to Loeb in the investigation. Much hinges on what Loeb asks Deloitte to do. I’ve previously written that Loeb is not the right firm to be leading the ONP internal investigation. I do believe that Deloitte is an appropriate financial consulting firm to investigate the fraud. But it’s unclear what Loeb will ask of Deloitte, and whether Deloitte will need to sign off on any aspect of the investigation. As a result, I could certainly see a scenario where the investigation finds no wrongdoing, despite compelling evidence that the company is committing fraud.
Now, let’s move to the new evidence that ONP is falsifying its financial statements.
ONP’S Main Supplier is an Empty Shell Primarily Owned by ONP’s Chairman
According to SEC filings, ONP’s largest supplier is Xushui County Dongfang Trading Co. Ltd. (“Xushui Dongfang”). From 2006 to 2008, Xushui Dongfang is listed as ONP’s largest supplier, supplying $14.6m, $15.9m, $28.5m, and $30.7m of goods in 2006, 2007, 2008 and 2009. See the 10Ks for 2009, 2008 and 2007. Note that “Xushui County” is the same county that ONP is based in.
Yet according to third party reports, Xushui Dongfang is an empty shell company with no reported revenue. Here is a third party credit report from Qingdao Inter-Credit Services Pte Co., Ltd. (“Inter-credit”). Inter-credit is a large independent credit agency that provides a variety of credit-related services for clients. It operates out of 12 branches, and has 200 employees, including lawyers, accountants and debt collectors. It compiles independent reports on Chinese companies, using data from AIC filings and other resources – a sample report can be seen on their website here.
For any readers who doubt the authenticity of Inter-credit reports, here are their reports on China Sunergy (CSUN) and Solarfun (SOLF), both of which I believe are more accurately reflecting themselves in their SEC financial statements than CMFO, CSKI or ONP.
Here is Inter-credit’s report on Xushui Dongfang, as well as the Chinese and English translation of the information received from the Xushui AIC office:
- Inter-Credit Report on Xushui Dongfang
- Xushui Dongfang AIC information – Chinese Original
- Xushui Dongfang AIC information – English Translation
The last year in which Xushui Dongfang reported financial results was 2007. In 2007, ONP claims to have purchased $15.9 million in product from Xushui Dongfang (at the then prevailing exchange rate); however, Xushui Dongfang only reported approximately $200,000 in revenue in 2007 according to AIC reports.
Equally as important, Xushui Dongfang’s majority shareholder is none other than ONP’s Chairman and CEO. Liu Zhenyong owns 70% of Xushui Dongfang, while Li Jianjun owns 30%. Zhenyong has contributed approximately $500,000 (RMB 3.5m) of capital to Dongfang, while Jianjun has contributed approximately $220,000 (RMB 1.5m).
Naturally, ONP made no disclosure in its SEC filings that there were any related parties involved in the purchases from its largest supplier. This is likely a violation of SEC regulations.
It’s also an obvious sign of fraud. Xushui Dongfang was likely used to generate fake purchase invoices. By owning Xushui Dongfang, it is likely easier for ONP to generate fake invoices to show the auditors. Because ONP never disclosed the common shareholder, it is unlikely that ONP’s auditors looked into Xushui Dongfang. Thus, it seems that Xushui Dongfang was a vehicle to make ONP appear much larger than it is.
This revelation was first made on July 22, 2010 in the Chinese media when the 21st Century Business Herald (which is considered to be the “Wall Street Journal of China”) published an article on the allegations made by Muddy Waters, LLC. The article was the lead story for the entire newspaper that day – to see a PDF of the newspaper with the article, click here (it’s the article with the headline that contains “AMEX” and “ONP” throughout the text). The article quoted a local tax bureau official as saying that Xushui Dongfang is “just like a shell company.”
And here is the excerpt that discusses Xushui Dongfang:
In the upstream chain, this reporter discovered that a company named “Xushui County Dongfang Trading Co. Ltd” (henceforth termed Dongfang Trading Co. Ltd), according to ONP’s financial report, this company, with a (Chinese) name similar to the Company’s, has been ONP’s largest raw materials supplier since 2006.
In the three years from 2007 through 2009, this company’s supplier share is at levels of 53%, 50% and 37%, respectively.
Information shows that this company was established in 2001, registered at Xushui County AIC, and its main business is waste material collection. In the application information provided in the early stages of start-up, the company registration address contained five houses located in “Xushui County Nan He Shou Ying Village West”, and it also comes with lease contracts signed with the village committee.
This company’s initial registered capital was 500,000 yuan ($60,500 at the time), with two shareholders. The first shareholder was Liu Zhen Yong, the second was Li Chen. Li Chen once was a Director of ONP but resigned from the post in 2009. In ONP’s published documents, his drawn salary from ONP was US$4,826 in 2008 and US$4,093 in 2009. Li Chen now holds 201,164 ONP shares, which is 1.1% of shares offered.
Not long after Dongfang Trading Co. Ltd was registered, the legal representation was transferred from Li Chen to a man named Li Jian Jun and equity rose to 500,000 yuan. From what this reporter understands, Li Jian Jun is a native of Xushui. Also, Dongfang Trading Co. Ltd and the HBOP factory address are in the same place in Nan He Shou Ying Village.
“Dongfang Trading Co. Ltd in the most recent two years almost doesn’t have any revenue,” the aforementioned tax bureau insider informed me, “It’s just like a shell company.”
July Share Purchases
That’s not all.
Xushui Dongfang also somehow owned 4.4% of ONP’s shares prior to June 2009. We have no idea how it received those shares because there is no disclosure relating to it in the SEC filings prior to its sale of shares.
“On June 25, 2009 (the “Closing Date”), Orient Paper, Inc., a Nevada corporation (the “Company” or “Orient Paper”), consummated a Purchase and Sale Agreement with Xushui District Dongfang Trading Limited Company (“Xushui Dongfang”), Barron Partners, LP, Fernando Liu and Golden1177 LP (Barron Partners, LP, Fernando Liu and Golden1177 LP collectively, the “Purchasers”). Under the terms of the agreement, Xushui Dongfang agreed to sell to the Purchasers an aggregate of 2,000,000 shares of the Company’s common stock at $.375 per share, for an aggregate purchase price of $750,000. To facilitate payment and receipt of the purchase price, the Company agreed to pay or cause to be paid $500,000 or the Renminbi (Chinese currency) equivalent to Xushui Dongfang, a company organized under the laws of the People’s Republic of China (the “PRC”). In return, $500,000 of the purchase price would be held in escrow for the benefit of the Company and used to pay the Company’s current and past-due legal fees, investor relations expenses, and auditing fees of a Big 10 accounting firm to be appointed by the Company.”
What? Why did ONP’s largest supplier own 2,000,000 shares of Orient Paper, or about 4.4% of Orient Paper’s share count?
In no previous SEC filing had Orient Paper disclosed the sale or contribution of shares to its largest supplier! Xushui Dongfang was unlikely to have bought the shares on the open market, given that this normally requires regulatory approvals. Foreign equity holdings by PRC nationals and entities require approval by the State Administration of Foreign Exchange (“SAFE”).
But this is beside the point. The question remains: Why does ONP’s largest supplier feature the following?
- It had no revenue in 2008 and 2009, and only $200k of revenue in 2007
- It Is 70% owned by the CEO of ONP.
- It owned 2m shares of ONP prior to July 2009
- Why wasn’t the 70% ownership disclosed in SEC filings? The purchase of products from Xushui Dongfang (keep in mind that Xushui Dongfang comprised 30% to 50% of ONP’s cost of goods sold from 2007 to 2009) was certainly a related party transaction by ONP, and a particularly dubious one at that.
The answer to these questions, in my opinion, is that Xushui Dongfang is a shell company with no underlying business that was used as part of CEO Zhenyong Liu’s efforts to falsify Orient Paper’s SEC financial statements. It likely also aided his efforts to fabricate audit-related supporting documents (ie. invoices) to provide to its auditor.