INTERNET: Inflate Gate Scandal Rocks SouFun

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Bottom line: A scandal involving inflated sales reporting by workers at SouFun could cause the company to miss 2015 revenue guidance, and reflects pressures that China Internet firms are facing due to a slowing home economy.

SouFun uncovers inflated sales by employees

Just when it was beginning to claw its way back to favor with investors, real estate services website SouFun (NYSE: SFUN) is being rocked by a scandal after an internal probe revealed that some employees were inflating their new orders. The latest reports say SouFun has verified it fired some workers after uncovering the issue, though there’s no word on the magnitude of the problem.

More broadly speaking, this kind of report highlights the stresses that SouFun and rivals like E-House (NYSE: EJ) are facing due to a sharp slowdown in China’s overheated real estate market. That slowdown has caused prices to stagnate and transaction volumes to also tumble as buyers and sellers wait to see how the market will trend. That’s critical for companies like SouFun, since they depend on transactions for a big part of their business.

The reality is that many of China’s high-growth Internet companies face similar pressures to those SouFun is experiencing. Such companies were typically able to post sales growth of 30 percent or higher on a regular basis for years, and are suddenly having far more difficulty as they get larger and also as China’s economy slows.

As a result, company salespeople are having difficulty reaching their sales targets, and may be resorting to this kind of inflation to please their bosses. E-commerce leader Alibaba became embroiled in a similar scandal 5 years ago involving falsified vendors on its earliest B2B marketplace, Alibaba.com. It ultimately de-listed that company from the Hong Kong stock exchange after its shared foundered in the wake of the crisis, and later listed the entire Alibaba Group last year on the New York Stock Exchange.

According to the latest reports, SouFun fired the employees after conducting an internal probe that found some had falsified their new orders. (Chinese article) Media learned of the action after talking to employees outside the company’s Shanghai office, and SouFun confirmed that some employees were fired from its Beijing and Shanghai offices.

News of this latest scandal is sure to undermine SouFun shares, which have rallied recently after tumbling earlier in the year on concerns about a business slowdown. The stock lost nearly half of its value between a peak in mid June and a late September low, as shares moved in line with a parallel plunge on China’s domestic stock markets. More recently the stock has risen by about a third as China’s stock markets show signs of stabilizing.

Nascent Rally in Jeopardy?

Shares of SouFun and many of its US-listed Chinese peers tumbled during the summertime sell-off in China, prompting some to launch privatization bids on belief that their stock was undervalued. E-House launched such a bid (previous post), but SouFun chose to support its stock by announcing last month that Carlyle and IDG, would team up with company management to invest between $400 million and $700 million in its shares. (previous post)

SouFun was already in the negative headlines in the second half of last year, when it became embroiled in a major dispute over fees it charged to a big real estate agency that was one of its larger customers. (previous post) It later appeared to resolve the dispute, but then abruptly ended the relationship at the end of the year.

That high-profile dispute and now this latest scandal involving false orders highlight the big pressures that SouFun and others are facing as they try to maintain profits and sales growth despite the slowing economy. This latest scandal could cause SouFun to miss earlier revenue guidance for 2015 depending on the magnitude of the problem. But ultimately this kind of probe and corrective action will help the company in the long term, sending the signal that it won’t tolerate this kind of behavior from employees.

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