Recently Richard Liu, the CEO of JD.com (JD, Financial), appeared on major U.S. media websites recently, and not for good reasons unfortunately. The stock sold off as a reaction to the negative news. In the past, I’ve written about why I invested in JD. Today, I’ll discuss why I’m no longer an investor in JD and the lessons I learned from it.
When I first looked at JD.com, Liu was determined and more humble and knew his circle of competence. JD was very strong in consumer electronics and had a good reputation for never selling fake products. JD was targeting premium tier 1 and tier 2 cities and was in the process of building a massive moat in its logistic system and distribution centers.
The key thesis in JD’s long-term success was the national competitive advantage of China in terms of technological and infrastructure leapfrog and in terms of the persistence, diligence and resilience of the Chinese working class. JD’s typical employees work more than 60 hours a week while only getting paid a little over USD $15,000 to $16,000 per year. Liu designed the system in a way that most of the employees are like the Vietnamese Americans that Peter Kaufman hired at Glenair. I thought this extraordinary culture, coupled with China’s national competitive advantage and rising e-commerce needs, was crucial for the long-term success of JD.com.
Liu was also unconventional because with the support of Hillhouse Capital and a few other long-term investors, he had been spending billions and billions to widen JD’s moat day by day, burdening short-term financials. Naysayers criticized JD’s level of capital expenditures because they think the return on investment is at best uncertain. But as a long-term investor of JD, I was applauding the level of capex. JD’s last-mile delivery network would make Jeff Bezos jealous – if only Amazon could hire low-cost, hardworking countrymen to ride around on motorbikes for last-mile delivery, which is critical but very expensive in the U.S. even with Amazon.
It looked like JD’s business was doing well, especially in 2016 and 2017, with accelerating growth in gross merchandise value and monthly active users and growing customer satisfaction. Liu married a beautiful and intelligent woman, and the happy pictures of the family went around in China. All looked good on the surface.
At the same time, some concerning signs developed along the way.
First of all and most concerning was Liu started to show signs of having too big of an ego and Persian messenger syndrome. He started to exaggerate JD’s success and made the claim that JD would surpass Alibaba in five years. He was running a one-man show at JD and made it very hard for his senior executives to disagree with him.
Another red flag was JD’s stepping out of its circle of competence in offline efforts. JD’s offline retail effort was probably doomed for underperformance. China’s internet and e-commerce penetration rates rose rapidly. However, it is also obvious that peak penetration is not far away, and the combination of online channel and offline channel is the future.
The tech giants took different approaches in the online-offline integration. Amazon (AMZN, Financial) started on its own but then bought Whole Foods Market. Alibaba (BABA, Financial) and Tencent (TCEHY, Financial) partnered with businesses that have extensive offline retail experience such as Suning, InTime and Yonghui Supermarkets.
But JD chose to do it on its own with a super aggressive and unrealistic expansion plan. Suning, JD’s biggest competitor in the 3C (computers, communication, consumer) market, with extensive experience, is going much slower and partnered with Alibaba. My channel checks earlier this year suggested a very large amount of JD’s new retail stores are unprofitable.
China’s e-commerce is still growing at a decent rate. But in JD’s traditionally strong 3C market, both Suning and T-Mall are catching up. And in JD’s weak markets, Pinduoduo came out from nowhere and has grown its user base to more than 300 million in three years.
I also have to admit that back in early 2016, I didn’t think Alibaba had much of a chance to catch up on logistics. It looked like JD had built a wide moat and was years ahead of T-Mall and Taobao. But what happened subsequently was really impressive. Hats-off to Alibaba’s management team. Amazingly, Alibaba’s Cainiao Network has very intelligently caught up with JD. JD’s logistic moat has narrowed considerably. At the same time, JD’s cost was much higher because Liu has promised his largely rural-born employees good welfare and a salary.
Looking back, there are a few old lessons.
1. As investors, we constantly evaluate both confirming evidence and disconfirming evidence. With JD.com, both confirming evidence and disconfirming evidence were present during the time I held the shares. Obviously it was too late to overweigh the disconfirming evidence.
2. I’ve watched Liu's ego getting bigger and bigger over time. When management started to make bold and unrealistic claims, it was time to reevaluate the thesis even though the fundamentals of the business were progressing as expected.
3. Valuation matters, but when the management team and the competitive environment changes, it’s time to remember the adage, “Not everything that counts can be counted, and not everything that counted truly counts.” In terms of multiples, JD’s appearing very cheap now. But as the moat has narrowed considerably, JD’s probably more expensive now than it was two years ago when the multiple was higher.
Disclosure: Long Alibaba and Tencent.
