SouFun Dividend Yield Is Likely Deceiving

Apr.23.13 | About: SouFun Holdings (SFUN)

I believe that there is risk to the SouFun (NYSE:SFUN) dividend and therefore the stock may be poised to fall when investors get disappointed.

Investors everywhere have been searching for yield. The ads on Seeking Alpha for dividend funds and much recent press has been focused on investors hungry for cash flows to escape low interest rates. This has produced some exuberance in prices of equities or partnership interests that pay large dividends. When investors get surprised or disappointed because they just look at the dividend yield on Yahoo or blindly follow analyst forecasts without digging into them, people can wind up long a stock that has paid good dividends in the past, but will not pay them on a go forward basis. The most egregious example I have ever seen of this type of inefficiency was Whiting (NYSE:WHX) which was covered on Seeking Alpha here. The circumstances were very different from the following write-up, but it boils down to blind buying for yield.

I have been closely following the recent controversy surrounding SouFun. Glaucus did some very good research and highlighted some very serious corporate governance problems. Their most recent report on Seeking Alpha is available here.

In my opinion the dividend yield appears to be holding the stock up, so I decided to dig into the dividend. SouFun's dividend is paid by pledging onshore deposits against offshore loans. This is due to China's capital controls and is a creative choice by the company to circumvent PRC government policy. As a result the true capital usage of the dividend is a bit unclear since the amount pledged is always in excess of the amount paid. In addition, because SouFun operates primarily as a Variable Interest Entity ("VIE"), the cash would need to make its way from the VIE to the wholly owned subsidiary onshore. This will result in VAT as well as EIT charges of up to 25% depending on which entity is used and whether or not that entity has received a special tax status. SouFun does not disclose the mechanism by which it actually plans to repay the loans. Further, when the cash is then moved outside of China via dividend or capital reduction, SAFE will charge an additional 15%-25% as part of the PRC's capital controls policy. All in, the total cash cost associated with getting cash from the VIE to the offshore entity to repay the loans could be as high as 40%.

I also noticed in SouFun's response, available here, that the commentary on the dividend is non-recurring and that the company seeks to retain at least 150mm dollars in cash at any one time. Given the recent purchase of the BaoAn facility for 110mm dollars, it would appear that the company will just not have enough cash at the moment to pay the dividend, or at least not in the amount previously discussed. The company ended 2012 with 118mm dollars, and so by its own guidance, with a fully diluted share could of 82.4 million shares outstanding, it would need at least 123 million dollars of free cash flow in order to pay the dividend. May calculations are as follows:

150mm minimum need vs 118mm on hand = 32 mm shortfall

Dividend require 111% cash pledge onshore so amount needed for $1 per share div is:

1.11 * 82.4 = 91.4mm

Total need is therefore 91.4 + 32 = 123.4mm dollars. This is notably before any additional charges that should be baked in by the government. If the company were truly disciplined, it would explain to shareholders the various charges using different entities and show exactly how the cash will make it offshore and what charges could be incurred. On my numbers, the true cost of a dividend could wind up being 140% of paid amount or 115mm dollars. This is likely why the company has not instituted a formal dividend policy. That and to give them the flexibility to blow hundreds of millions of dollars on property speculation according to Glaucus.

Here's the problem we have to deal with now: how on Earth is there going to be a similar sized dividend this quarter? The company previously declared dividends in August and December. December 2012 came and went with no event, mainly because it decided to buy BaoAn instead for 110mm dollars. In order to meet the cash need to pay a dividend in August, the company would have to generate a minimum of 123mm dollars in less than six months. Is this possible? Well, the company doesn't produce a cash flow statement in its quarterlies, so we will have to look at Net Income for guidance. The best quarter it has ever had was 4Q12, where net income got to 55mm, a far cry from what is needed to pay a dividend. At the pace of the fourth quarter of last year, and assuming no acquisitions at all, SouFun will not be able to pay a dividend equivalent to previous sizes at least until year end.

I also decided to take a look at analyst forecasts, and I think it is very interesting that Ravi Sarathy of Citi, who has been the most accurate on the stock, is not forecasting a dividend this year. This is in direct contrast to GS, who just initiated with a new analyst covering the stock and is forecasting $1 per share dividends every year. The GS analyst is Fei Fang, an analyst that finished his undergraduate degree only in 2009 according to LinkedIn. His lack of experience may show, and I am wary of getting too excited about his forecasts.

My view is that the company is on a property buying spree (potentially from related parties according to Glaucus), and investors who lazily follow Yahoo! Finance or listen to inexperienced analysts will be disappointed when they do not get a dividend this year. I expect the result to not include a dividend of any meaningful size and most certainly less than previous dividends. When that happens, yield seeking investors are likely to be disappointed and sell the stock.

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.