In the last several years, Chinese tech giants have come under regulatory pressure amid a crackdown on the tech sector, pushing their stocks lower.
Among those affected was PDD Holdings Inc. (PDD, Financial). Founded in 2015 by Colin Huang, the multinational retail company owns and operates a diverse portfolio of businesses, including Pinduoduo and Temu. As China's third largest e-commerce company, it has demonstrated promising growth and strong financials.
At a time when the regulatory environment is potentially changing for the better, the stock looks attractively valued.
The business model
Pinduoduo is one of China's largest online marketplaces that aims to enhance consumers' shopping experience through social commerce. The platform offers users a unique shopping experience and leverages the power of social networks to engage users and encourage word-of-mouth marketing. Users can invite friends and family to join them in purchasing products, earning discounts and rewards in the process.
What sets Pinduoduo apart is its popularity among millions of users, especially those residing in lower-tier cities and rural areas of China. These users appreciate the platform's social aspect and its ability to offer products at affordable prices. Additionally, the company has been instrumental in helping small and medium-sized merchants as well as farmers reach a broader customer base, enhancing their efficiency and profitability. As of March 31, Pinduoduo served 882 million annual active buyers. This figure is only marginally lower than Taobao, the largest online retailer in China that is operated by Alibaba Group Holding Ltd. (BABA, Financial).
The platform covers a wide range of product categories, including agricultural produce, apparel, electronics, furniture, cosmetics, sports items and more. Pinduoduo's innovative "team purchase" model encourages buyers to share product information on social networks and form shopping teams, leading to more attractive prices for everyone involved. This social element fosters a highly engaged user base.
The innovative approach to digital inclusion
Pinduoduo actively supports the digital inclusion of smallholder farmers by leveraging its platform resources. The platform aggregates demand and creates economies of scale for farmer merchants, enabling them to sell directly to consumers and reduce dependence on wholesale distributors. This approach enhances supply chain efficiency, resulting in fresher and safer products at lower prices for consumers while empowering farmers to earn more and invest in improved farming practices and technology.
In 2020, Pinduoduo introduced Duo Duo Grocery, a next-day grocery pickup service. This service addresses the increasing demand for timely and value-for-money goods without home delivery requirements. The service connects local farmers and distributors directly with consumers on a daily basis, ensuring efficient delivery of goods to designated pickup points for consumer convenience.
Temu: Expanding affordable, quality products globally
In September 2022, PDD Holdings introduced Temu in the U.S. in an effort to expand its presence internationally. While still in the early stages of development, the business has potential to extend the company's reach. The platform is dedicated to meeting consumer demands for cost-effective goods, thereby contributing to the growth of the digital economy. The platform currently operates in the U.S., Canada, New Zealand, Australia, France, Germany, Italy, The Netherlands, Spain and the U.K.
Digital prosperity
PDD Holdings aims to bring more businesses and individuals into the digital economy, creating new opportunities and fostering increased productivity. The company has built a robust network of sourcing, logistics and fulfillment capabilities to support its various businesses. The majority of the company's revenue is derived from online marketing services. Over the years, PDD Holdings has experienced substantial revenue growth, which has increasing from 59.49 billion yuan ($8.50 billion) in 2020 to 130.55 billion yuan in 2022. Further, the company has swung from a net loss of 7.17 billion yuan in 2020 to a net income of 31.54 billion yuan in 2022, reflecting its ability to leverage its revenue growth to grow profitably.
In early May, the company also relocated its headquarters from China to Ireland, showcasing its dedication to expanding its global presence and penetrating new markets and communities worldwide. The move to Ireland is a strategic decision as the country is a favored destination for foreign technology companies, owing to its membership in the European Union and attractive headline corporate tax rate of 12.5%.
Pinduoduo’s position in China and the U.S.
In recent years, China has taken significant steps to crack down on monopolistic practices, including the enactment of antitrust laws in late 2022, with a focus on encouraging innovation and preventing businesses from abusing data and misuse of their monopolistic power.
The tightening regulations for tech companies in China serve multiple purposes.
One key objective is to safeguard consumers' data and privacy, as there have been several high-profile cases of data breaches and misuse of personal data by tech companies in the country. With regulators focusing on consumer safety, PDD Holdings needs to prioritize data protection, cybersecurity and consumer privacy to meet the evolving regulatory standards and maintain the trust of its users.
Recently, Google flagged several apps developed by PDD Holdings as containing malware. Consequently, Google suspended Pinduoduo - specifically non-Play Store versions - that were found to contain malware. This move comes after concerns that the malware in the app could track user information and activities across multiple apps, not just Pinduoduo. Google also activated Google Play Protect, its Android security mechanism, to prevent users from installing malicious apps and has notified users who have already installed these flagged apps, urging them to uninstall them. As the investigation into the malware case is ongoing, Google has suspended Pinduoduo's official app on the Play Store due to security concerns. Although Google Play is not accessible in China, anonymous security researchers have reported that the malicious apps were present in custom app stores of popular phone manufacturers like Samsung, Huawei, Oppo and Xiaomi. These developments underscore the importance of PDD taking immediate action to address these issues, ensuring the security of its apps and protecting user data.
Pinduoduo’s sister app, Temu, has also been under growing scrutiny from Washington since its launch in the U.S. in September. A report from the U.S.-China Economic and Security Review Commission highlighted that Temu's lack of association with well-established brands has raised concerns about product quality and has led to accusations of copyright infringement. However, despite these concerns, Temu continues to hold the top spot as the most popular free app for both iOS and Android users in the United States today. According to Apptopia, the app has garnered over 50 million installations since its debut, surpassing Shein's achievement of reaching this milestone in three years. Further, market research firm YipitData reports the gross merchandise value, representing the overall transaction volume on Temu's platform, experienced significant growth from $3 million in September of last year to $387 million this past March.
As a young e-commerce company that relies on its apps, the recent criticism highlights the potential vulnerability of its brands and reputation. Any harm inflicted on PDD Holdings' image can have negative consequences, significantly impacting its business operations and financial performance. The company's growth could be jeopardized if its apps are restricted or banned, especially in the current complex environment of worsening China-U.S. relations.
China’s evolving tech regulations also aim to promote fair competition and prevent monopolistic practices. The country is home to several dominant tech companies that hold substantial power in their respective industries. To level the playing field for smaller companies and prevent the abuse of market dominance, regulators started cracking down on anti-competitive behaviors two years ago. While these regulations have placed a burden on tech companies, there are positive developments for e-commerce, particularly for platforms like Pinduoduo.
For instance, the municipal government of Beijing has unveiled drafts of regulatory measures aimed at reviving e-commerce activities in the city. The focus is on optimizing services for online merchants, supporting flexible employment and promoting healthy and regulated development of the platform economy. Pinduoduo, as a growing e-commerce player, stands to benefit from the changing regulatory landscape in China. The new measures proposed by the Beijing government align with the company's business model, which focuses on cost reduction and delivering value to consumers and manufacturers. This makes it less susceptible to regulatory concerns related to monopolistic tendencies compared to other major Chinese companies like JD (JD, Financial), Alibaba, and Tencent (HKSE:00700, Financial). This alignment with government objectives may provide some level of stability and potentially mitigate certain risks associated with regulatory actions.
Further, the drafted regulations aim to optimize services for online merchants, making it easier for them to expand their businesses and increase sales. Allowing online merchants to establish physical stores with simplified registration processes and license changes opens up new avenues for growth. This flexibility enables Pinduoduo and similar platforms to bridge the gap between online and traditional retail, offering customers a more comprehensive shopping experience.
The plan to minimize interference with normal business activities by eliminating offline supervision and inspection is another positive development. This reduces the administrative burden on online retailers, allowing them to focus on their core operations and serving customers. This streamlined approach can significantly improve efficiency and reduce operating costs for individual entrepreneurs. This development might also be positive for merchants using Pinduoduo's platform.
Furthermore, the Beijing government's commitment to supporting healthy and regulated development of the platform economy creates a conducive environment for Pinduoduo's growth. By promoting fair competition and leveling the playing field, the regulatory measures prevent monopolistic practices that could hinder smaller players from thriving. This creates opportunities for innovative and agile companies to compete effectively with larger industry incumbents.
The new regulatory measures not only benefit Pinduoduo, but also the broader e-commerce industry in China. The focus on revitalizing online retail activities aligns with the sector's growth potential and consumer demand. Despite the challenges faced by the online retail sector in recent times, the total revenue for online retail in China has shown a positive trajectory, reflecting the resilience and opportunities within the market. According to Statista, in 2021, China’s digital economy's added value contributed to almost 40% of China's GDP, showcasing the sector's immense importance. The impact of e-commerce on China's retail landscape is also remarkable. Over 25% of the country's physical goods retail sales occurred online, surpassing the global average of 18.8%. This demonstrates the widespread adoption of online shopping among Chinese consumers and the substantial market share held by e-commerce platforms.
Further, China's National Bureau of Statistics released new data on May 16 revealing a significant surge in retail sales, which serves as a key indicator of the sector's performance. Retail sales saw a remarkable increase of 18.4%, marking a substantial acceleration compared to the 10.6% growth observed in March. This surge represents the fastest growth since March 2021, highlighting a strong rebound in consumer spending and economic activity. The recovering consumer spending will likely boost e-commerce revenue and aid PDD’s growth in China.
Takeaway
The Chinese economy is moving in the right direction after more than two years of grappling with zero-Covid policies. The regulatory environment for the tech sector is also improving, and PDD stands to benefit from the restrictive policies imposed by Chinese policymakers on tech giants. The company's Temu platform is gaining traction in the U.S. as well, which presents it with new opportunities to grow.
Investors looking for bargains outside of China may want to pay close attention to PDD amid these positive developments.
