Grizzly Research, or Grizzly, released a short-selling report on narrow-moat PDD Holdings, or PDD, leading to a 5% stock price drop on Sept. 7.
We Maintain PDD's Fair Value Estimates
We think the conclusion that PDD is a dying company lacks merit. PDD continued to outperform Alibaba Group (09988, BABA) and JD.com (09618, JD) in its second-quarter revenue and bottom line by a wide margin. We keep our fair value estimate at US$ 117.
We believe PDD is the best positioned amid value-for-money consumption trends given its strong network of merchants providing such products and consumers’ identification with PDD as such a platform. That said, we think the short report may negatively affect sentiment and share price in the near term. We recommend waiting for a pullback to buy the shares.
Grizzly claimed PDD’s Chinese e-commerce Pinduoduo and overseas e-commerce Temu apps have major security concerns. We have not seen major regulatory action against PDD, and consumers continue to embrace PDD’s apps after Google Play suspended the Pinduoduo app over security concerns on March 21.
Furthermore, we continue to see both apps in Apple’s App Store. Should there be major concerns by regulators and consumers, we think PDD will improve the security standard of its apps to match its peers.
Over the long run, PDD’s provision of value-for-money products will continue to attract consumers.
PDD's Strong Growth Absorbs Subsidiary Temu's Loss
PDD continued to deliver strong top- and bottom-line growth in the second quarter despite the expansion of loss-making Temu. We don’t see the need for Temu to sell data of western country customers to make a profit as suggested by Grizzly. We believe PDD could terminate or sell Temu if it underperforms.
Grizzly highlights corporate governance concerns for PDD that we think are valid, including limited disclosure, potential conflict of interests on the provision of an interest-free loan to its executives to acquire Shanghai Fufeitong, a payment service company that provides payment services to PDD, and why the firm did not purchase Shanghai Fufeitong directly.
We agree that competition in the low-price goods segment will be fierce given it is widely adopted by Chinese e-commerce companies. However, we disagree with Grizzly Research that PDD is losing its battle with Alibaba and JD as regulatory crackdown on Alibaba comes to an end and JD ramps up its efforts to regain market share.
Grizzly Research claims that Temu is an unmaintainable business. We note that Temu’s loss is absorbed by Pinduoduo’s successful domestic operations. PDD was able to beat Refinitive consensus estimates in the first and second quarter this year despite Temu’s expansion. In addition, we believe PDD can just shut down or sell Temu’s business if Temu is not performing and continue to focus on its profitable domestic business. Hence, the Temu business will not drag on PDD’s business in the long term.
We have seen Pinduoduo being unprofitable since its launch in 2015 to 2020, but subsequently became profitable. We think as customer scale develops, order size increases, and customer stickiness becomes strong, Temu could gain operating leverage and reduce its subsidy, similar to the playbook of Pinduoduo.
What Grizzly Is Right About PDD: Competition and a Potential Ban by the U.S.
We agree that competition in the low-price goods segment will be fierce given it is widely adopted by Chinese e-commerce companies. However, we disagree with Grizzly Research that PDD is losing its battle with Alibaba and JD as regulatory crackdown on Alibaba comes to an end and JD ramps up its efforts to regain market share.
While the end of exclusive agreements with merchants at Alibaba helps its peers, we don’t think merchants will join other e-commerce platforms if they aren’t attractive. We think revenue and operating profit growth are the better indicators of a firm’s operation compared with daily average users, or DAU, year-on-year growth as cited by Grizzly Research. In our view, while DAU could fall, it can be offset by higher total time spent or spending per user. JD started its CNY 10 billion subsidy program in early March, yet in the June quarter, PDD still substantially outperformed Alibaba’s Taobao Tmall Group and JD Retail in terms of revenue and profit growth.
Year-on-year revenue growth was 66% in the quarter at PDD, versus 5% at JD Retail, and Alibaba’s China commerce retail sales (excluding Sun Art and Freshippo) growth of 12%. PDD’s non-GAAP operating profit rose 39% in the quarter, compared with zero year-on-year growth in operating profit for JD Retail and Alibaba’s Taobao and Tmall Group’s 9% year-on-year growth in adjusted EBITA in the June quarter.
We agree with Grizzly Research on the likelihood of facing a ban on Temu in the U.S. The U.S. is one of the largest consumer markets in the world with almost 29% of global consumer spending as per The World Counts.
However, Temu operated in over 37 countries as reported by 163.com on Aug. 29. Temu operates in many other developed markets, such as Japan, Germany, the U.K., France, and Italy that are significant consumer markets. As Temu is still at the early stage of operation, we have not assumed any monetization in our model, but we do assume a pickup in Temu’s costs in the coming years. Hence, a ban on Temu by the U.S. will not impact our fair value estimate.
Chelsey Tam, senior equity analyst at Morningstar
