We believe that the founder and Chairman of SOUFUN HOLDINGS LTD. ("SFUN", "SouFun" or the "Company"), which owns and operates a real estate website in China, has diverted resources from the Company for personal use through a series of questionable transactions involving high-priced New York real estate and charities of dubious authenticity. SouFun's VIE structure demands that shareholders have full faith in the integrity of the Chairman because it is he, ultimately, who owns and controls the operating business in China. We believe that SouFun's Chairman has irrevocably broken the trust of shareholders, rendering, in our view, the Company's shares only as valuable as the Chairman's apparent respect for his fiduciary duties. Please view our full report, available here.
I. The Arden House - An Iconic American Mansion
On November 18, 2011, the New York real estate market was abuzz over the $6.5 million sale of an iconic gilded age mansion, the Arden House, a 100,000 square foot palace with 97 guest rooms built by railroad tycoon E.H. Harriman in 1909. The Arden House is an American icon, located 40 miles from Manhattan and donated by the Harriman family to Columbia University in 1950 to serve as the home of a prestigious foreign policy study group.
The Arden House's buyer of record was a New York based not-for-profit named the Research Center on Natural Conservation, Inc. ("RCNC"). According to public records, available by application to the Secretary of State of the State of New York, RCNC is controlled by SouFun's founder and Chairman, Vincent Tianquan Mo ("Chairman Mo") and his wife Jing Cao (an excerpt of the certificate of incorporation is included below). The couple formed the charity four weeks before the purchase of the landmark property.
There is evidence to suggest that Company resources are used to operate (and possibly were used to purchase) the Arden House, even though the not-for-profit is ostensibly privately owned and controlled by the Chairman and his wife.
Sellers Claim that the Arden House was Sold to SouFun
In an article published at the time of the transaction, the real estate brokers for the sellers, Colliers International, told reporters that in the process of marketing the property they approached SouFun because the Company had recently purchased the AIG building at 72 Wall Street. "I thought this would be a perfect adjunct, as this property has 97 guest rooms and various amenities on it," said Richard Warshauer of Colliers International. The article then states that "SouFun first toyed with the idea of buying the land through an established non-profit. The company ultimately started the Research Center on Natural Conservation as its own non-profit."
Another media account of the transaction states that "Richard Warshauer, senior managing director of Colliers International, who helped OSI broker the deal, said the Research Institute is part of SouFun Holdings Inc., a large China-based real estate company." There is certainly corroborating evidence to support this narrative that the Company formed RCNC to purchase the gilded age mansion with Company money.
Property Registered to SouFun's US Headquarters
Most notably, the deed to the Arden House, a copy of which is included on the next page, states that the registered address of the property's owner is none other than the 16th floor of the AIG building at 72 Wall Street, the building that SouFun purchased in 2011.
Below is a screen shot from a property report, available on a website administered by the county of Orange in New York (click here), in which the Arden House is located. The property report, like the deed, clearly states that the owner of Arden House is located at SouFun's New York headquarters and not the registered address of RCNC (which, according to public records available by searching here is 260 Middle Neck Road in Great Neck, NY).
The above property report, like the deed, clearly states that the registered owner of the Arden House abides at SouFun's New York headquarters and not the registered address of the charity.
SouFun Employee Administers the Property
Multiple data points show that Company resources are used in the operation and administration of the property. First, the contact email on the Arden House website is the Company email address for SouFun's employee and authorized representative in the United States, Yukui Hou: firstname.lastname@example.org.
Company filings (excerpted below) list Yukui Hou as SouFun's authorized representative in the United States and lists him as holding power of attorney for the Company's US subsidiary, Best Work Holdings (New York) LLC. Note that the SouFun employee lists his Company email address on the Arden House website.
Our investigator visited the property. At the house, our investigator encountered SouFun employee Yukui Hou, the same person who is listed on the contact page of the property website. Yukui Hou gave our investigator his SouFun email address.
Where is the Charity?
The Arden House is listed on the national register of historic landmarks and a deed restriction limited the sale of the property to a not-for-profit organization. Yet records indicate that RCNC has not been granted tax-exempt status by the IRS, it was set up immediately before the purchase of the Arden House and we found no evidence of any bona fide charitable (or other) operations.
The IRS database of tax exempt organizations, which permits potential donors to verify whether a purported charity has been granted tax-exempt status, does not list RCNC on any of the following lists:
- Organizations eligible to receive tax-deductible contributions (Pub. 78 data).
- Organizations whose federal tax exemption was automatically revoked for not filing a Form 990-series return or notice for three consecutive years.
- Form 990-N (e-Postcard) filers and filings.
The IRS makes its list of tax-exempt organizations available to the public, so that taxpayers may "rely on this list in determining deductibility of contributions." The database is updated monthly, so if RCNC, which was formed in September 2011, was eligible to receive tax-exempt donations, it should appear on the list. [Note: The application for tax-exempt status may be delayed pending approval by the IRS. RCNC may also still be preparing to file for tax-exempt status.]
Moreover, we could find no evidence that RCNC is an operating charity. It has no website (which we could find) and no records exist online (to our knowledge) of any charitable work, conferences, seminars or other activities.
RCNC's Articles of Incorporation state that the purpose of the non-profit is to:
"create, form and establish an organization to research innovative natural conservation methods; to hold, conduct and organize meetings, discussions and forums to consider community opinion or contemporary issues pertaining to the preservation of the environment…[and] to study the effects of global warming on the environment in the future."
We can find no evidence that RCNC has conducted, since inception, any of the activities mandated by its charter. We expect serious repercussions and public outcry if (as it appears) the Chairman established a sham charity to circumvent a conservation easement protecting the land, the house and its surrounding trees.
Off-Balance Sheet Purchase?
We believe that the evidence supports a simple narrative: sellers approached SouFun to buy the Arden House, so management set up a cosmetic charity to purchase the property, which is registered to SouFun's NY offices and administered by the Company's US employee through his Company email address. To boot, the charity appears to be a façade as it does not appear to be currently eligible to receive tax-exempt donations. Nor is there any evidence of bona fide charitable operations.
If Company funds were used to purchase and operate the Arden House, the $6.5 million purchase should appear on the Company's books in Q4 of 2011. SouFun's balance sheet reflects prior purchases such as the AIG and Hainan purchases (both discussed below). Yet looking at changes in PP&E in the 20-F filings for 2011 and 2012, there does not appear to be any room to account for the $6.5 million cash purchase of a house. This would imply that if SouFun funds were used to purchase the Arden House, the asset is being kept off the books.
But even if SouFun can prove that RCNC purchased the Arden House with charitable donations from wealthy individuals (and no Company funds were misappropriated to buy the mansion), there is ample evidence to support the notion that Company resources are being used to operate the property, despite the fact that the Arden House is privately owned and controlled by the Chairman and his wife. This is a clear violation of Chairman Mo's fiduciary duties.
II. No Training at 72 Wall Street?
In 2011, the Company purchased another New York landmark, the AIG building at 72 Wall Street, for $60.7 million. According to the Company, it bought the building to serve as a training facility. Yet almost two years after the purchase, the building appears dilapidated and empty and according to on-site interviews, is barely in use.
Missing Charitable Donations
In conjunction with the purchase of the property, the Chairman established a New York based not-for-profit in May 2011, Wall Street Global Training Center ("WSGTC"), to run high-priced training courses at 72 Wall St. for Company-employees visiting from China.
Publicly available IRS records suggest that either Chairman Mo made false statements to the IRS about funds received by WSGTC or that the Company made false statements in its SEC filings about the amount donated to WSGTC by SouFun. Chairman Mo can pick his poison: the IRS or SEC, but we believe that either he or the Company made false statements to a government agency.
SouFun's 2011 Annual Report states that:
Wall Street Global Training Center, Inc., a New York not-for-profit corporation, provided training services to us in 2011. Mr. Mo, Shan Li and Quan Zhou are directors of Wall Street Global Training Center, Inc. ...In 2011, we paid Wall Street Global Training Center, Inc. training service fees of approximately US$0.5 million. In addition, we also prepaid service fees of US$1.6 million for future services.
Even though SouFun claims to have paid over $2 million to WSGTC in 2011, the following IRS record, which any investor or regulator can access through the IRS website, states unequivocally that WSGTC received less than $50,000 in 2011.
The IRS defines 'gross receipts' as "the total amounts the organization received from all sources during its annual accounting period, without subtracting any costs or expenses." SouFun claims to have contributed over $2 million to WSGTC in 2011. Yet Chairman Mo's charity reported to the IRS that its gross receipts were less than $50,000 in 2011.
Tax returns are filed with the IRS under penalty of perjury, and tax fraud is a felony punishable by incarceration, but Chairman Mo might find such penalties preferable to the consequences if it is shown that he is involved in diverting public-Company funds (which were ear marked for charity no less) for personal use.
Empty Chairs at Empty Tables
In an effort to corroborate whether the Company was running a training program at its 72 Wall Street offices, as it claims in its filings, we had consultants visit the property on two separate occasions and ask for Wall Street Global Training Center by name.
On both occasions, doormen at 72 Wall St. told such consultants that they had never heard of Wall Street Global Training Center and that we must have the wrong address. The doorman also said that he was not aware of any training facility or training center in the building.
According to the Company's SEC filings, SouFun prepaid $1.6 million to WSGTC so that at least 300 employees could attend training sessions (of at least one week in duration) at 72 Wall St. in 2012. Yet according to our conversations with a doorman at 72 Wall St., the building was barely in use, he had not seen anywhere close to that number of people, and there was no training facility on the premises. The doorman told our consultant that 72 Wall St was in such disrepair (elevators were broken) that it could not possibly host a training program.
We encourage any investor or regulator to visit the building. The property appears empty and a big 'AIG' sign still remains prominently displayed over the front desk. When our consultants visited the site, they saw what appeared to be construction materials strewn throughout the lobby.
We believe that these accounts corroborate WSGTC's IRS records and indicate that SouFun did not donate $2 million to WSGTC to conduct training courses at 72 Wall St. So where did the money go? We will leave it up to regulators with full investigative powers to find out, but we believe that the evidence points to a simple narrative: the funds were misappropriated by Chairman Mo.
Wasteful or Corrupt?
Ultimately, the purchase of 72 Wall St. is inherently suspicious. Why does SouFun, which operates exclusively in China, need 325,000 square feet of New York's priciest real estate to train employees who live 7,000 miles from the training facility? SEC filings state that SouFun's US subsidiaries "do not conduct any substantive operations of their own. No provision for United States income tax has been made in the financial statements as the subsidiaries in the United States have no assessable income for the three years ended December 31, 2012." If the Company does not have any meaningful US operations, why would it need a training center in the US?
Moreover, if the Company wanted to set up a training center for Chinese employees, why would it need to purchase some of the most expensive real estate in the world? The AIG building at 72 Wall St. is located next to the New York headquarters of Deutsche Bank (60 Wall St.) in the heart of downtown Manhattan.
AIG used 72 Wall St. as a training center. AIG at its height was the 29th largest public company in the world with 116,000 employees (an estimated half of which were located in the US). By comparison, SouFun has only 7,700 employees, all of whom are located in China. Why would it need the same amount of space to train employees as a company with 15 times as many people?
So why would the Company purchase some of the world's most expensive real estate and then let the building sit idle more than 20 months after its acquisition in July 2011? At best, it looks like a giant waste of shareholder capital. At worst, the training center is simply a fig leaf disguising the fact that public funds were used to purchase expensive real estate which is now being used for some other nefarious purpose.
III. The Vulnerable VIE
In our full report, available here, we have uncovered what we believe to be multiple examples in which SouFun's Chairman Mo has either diverted Company resources for personal use or presided over wasteful spending that is ultimately destructive of shareholder value and not germane to SouFun's core business. In our view, regulators will likely take such claims very seriously, particularly to determine whether Company resources were diverted to purchase or operate the Arden House and to determine why Chairman Mo's Wall Street Global Training Center reported less than $50,000 in gross receipts when the Company claims it paid the not-for-profit $2 million in 2011.
China bars foreigners from owning companies operating in sectors such as defense or technology, which the government deems sensitive. In order to attract foreign capital, companies such as SouFun have adopted a Variable Interest Entity (a "VIE") structure in which an offshore holding company (owned by foreign investors) forms a new subsidiary in China (a "WFOE") which has a contractual right to the economic benefits of the PRC-based operating entity (the VIE). The VIE is owned by PRC individuals, in SouFun's case, 80% by Chairman Mo and 20% by his nephew, Richard Jiangong Dai. Chairman Mo and his nephew are the authorized signatories for the operating business in China.
The key risk in a VIE structure is that shareholders do not have any ownership interest in the operating business - rather they have a call option to transfer control of the operating business to its foreign owners in the event of a dispute with the Chairman - a contractual right which may be unenforceable given that Chinese law does not permit foreign entities to own PRC-based Internet companies. Even if, in a perfect world, such a right was enforceable under Chinese law, shareholders can only enforce it by prevailing in a Chinese court against rich and powerful Chinese citizens who own the operating business - which seems highly unlikely.
SouFun's VIE structure therefore demands that shareholders have full faith in the integrity of the Chairman because it is he, ultimately, who controls the assets and the business. We are not aware of any foreign shareholder successfully exercising such an option to take control over an operating PRC business. By comparison, the capital markets are littered with cautionary tales of investors burned by unethical leadership in China: after management is caught breaking rules, they simply abscond with the operating business, leaving US investors with few viable remedies.
Investors must therefore trust leadership completely. We believe that SouFun's Chairman has irrevocably broken the trust of shareholders, rendering, in our view, the Company's shares as valuable as the Chairman's apparent respect for his fiduciary duties.
 Per the Company's FY 2012 20-F, the Company booked $1.6 million in payments to WSGTC as expenses in 2012. But we know from the Company's FY 2011 20-F that it prepaid the $1.6 million in FY 2011, meaning that it should appear on the charity's gross receipts in its FY 2011 IRS tax returns.
We are short SFUN. THIS RESEARCH REPORT EXPRESSES OUR OPINIONS. Use Glaucus Research Group California, LLC's research opinions at your own risk. You should do your own research and due diligence before making any investment decision with respect to the securities covered herein. This is not investment advice nor should it be construed as such. We are short SFUN and therefore stand to realize significant gains in the event that the price of the stock declines. Please refer to our full disclaimer in our report, available here.
Disclosure: I am short SFUN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: We are short SFUN. THIS RESEARCH REPORT EXPRESSES OUR OPINIONS. Use Glaucus Research Group California, LLC’s research opinions at your own risk. You should do your own research and due diligence before making any investment decision with respect to the securities covered herein. This is not investment advice nor should it be construed as such. We are short SFUN and therefore stand to realize significant gains in the event that the price of the stock declines. Please refer to our full disclaimer in our report at glaucusresearch.com.