Pinduoduo: Sadly, New Regulations Have Broken The Growth Engine- Downgrade To Neutral

Summary

After initiating coverage on the company with plenty of excitement, the latest results have seen our worst fears come true as new regs has forced a fundamental shift in business model.

Revenue (excl. merchandise) came in 10% below our forecast and consensus, mostly driven by lower-than-expected growth in ARPU, up 18% YoY vs our expectation of 32%.

PDD has now shifted its strategy from promoting growth through Sales and Marketing related subsidies (now banned by new regulations) to agriculture-related R&D.

We revisit some of the regs impinging the growth of Chinese e-commerce companies and see it as one of the most impacted platforms given its focus on price-sensitive users.

Valuing PDD is an impossible task given the story is now broken and charting the new growth trajectory remains unintelligible. We downgrade PDD to “Neutral.”

Kevin Frayer/Getty Images News What’s changed in our investment thesis?

After initiating coverage on the company with plenty of excitement, the latest quarterly results have seen our worst fears come true as new regulations have not only hit Pinduoduo’s (NASDAQ: PDD ) growth hard but also forced a fundamental shift in the company’s business model.

Revenue (excl. merchandise) came in 10% below our forecasts and consensus, mostly driven by lower-than-expected growth in ARPU, up 18% YoY vs our expectation of 32% YoY.

PDD has now shifted its strategy from promoting growth through Sales and Marketing related subsidies (now banned by new regulations) to agriculture related R&D which management stated clearly is not focused on profitability but rather on promoting long-term growth.

Both Alibaba and JD have called out a slowdown in general e-commerce spending in Q4 2021 which we see further decelerating growth for PDD over the next quarters.

We revisit some of the regulations impinging the growth of e-commerce companies and see PDD as one of the most impacted given its focus on price sensitive customers in lower tier cities.

Emerging competition in social commerce, the traditional stronghold of PDD will impact growth trajectory as rivals, both new (Kuaishou and Douyin) and old (Alibaba and JD) have launched their own social commerce offerings with some of them even on its core app WeChat.

Even though bulls would like to hang their hat on the company turning profitable, management has clearly noted that is not the aim of the company in the short-term. Besides valuing PDD on profitability see its share price even further overvalued.

Valuing PDD is a Sisyphean task, given the old story is now broken and the fundamental shift in its business model makes it challenging to chart the new growth trajectory. We downgrade the stock to “Neutral” and recommend investors to sit out the ongoing transition phase of PDD, preferring to see a recovery in the financials before going long on the stock again.

Impact from regulations have hit PDD’s core business model

Even though Chinese regulators are aiming to improve the quality of life in lower tier cities which PDD operates in, the impact of multiple regulations in the past year or so has proved detrimental for the young e-commerce company as they have impacted its core business model which we highlight below..

> Fake goods: PDD has always been known for being the go-to-platform for discounted goods which attracted users in lower tier cities. Higher quality merchants/brands (Low tier cities and price sensitive consumers which means demand for low priced products was higher – This seems to have hit PDD harder than most other platforms). Given the perception of PDD being a price sensitive shopping destination we see it difficult for PDD to attract higher quality merchants to the platform. Having said that – on the upside it will be difficult for any merchant to ignore PDD’s biggest userbase of ~867m in the Chinese e-ecommerce space. Management spoke about how attracting higher quality merchants is a gradual task and will take some time highlighting the difficulty it faces in shrugging off its image of a price sensitive platform for largely unbranded goods.

Predator pricing: Ban on subsidies will further impact PDD’s sales given that its model was based primarily on attracting price sensitive customers. Management has seen a fundamental shift in strategy from focusing on growth through its previous RMB 10bn incentive program aimed at sales and marketing to RMB 10bn incentive program focused on agriculture R&D Privacy related rules reducing ROI : New Privacy and data protection laws have also hit the e-commerce company hard. Management in its Q2 2021 call highlighted that ROI for merchants […]

source Pinduoduo: Sadly, New Regulations Have Broken The Growth Engine- Downgrade To Neutral