It seems like we have a new king of e-commerce.
In case you have missed it, Pinduoduo, PDD Holdings Inc – ADR (NASDAQ: PDD) is now China‘s most valuable e-commerce company, dethroning Alibaba Group Holding Ltd (HKG: 9988).
No one could have imagined this, but the numbers do not lie.
So, is it as straightforward as selling Alibaba, and buying PDD?
The rise of Alibaba and e-commerce in China
China’s e-commerce scene has evolved over the years.
The first official online retailers were Amazon.com Inc (NASDAQ: AMZN) and eBay. While Alibaba was founded in 1999, it only entered the B2C segment in 2003. Before that, it was launched to connect small-medium enterprises in China to do business.
That was also the same period when eBay announced its expansion into China.
Long story short, the Crocodile in the Yangtze River managed to fend off the shark to become the de-facto e-commerce leader in China.
The rise of Pinduoduo
Alibaba’s Taobao and Tmall flourished under the growing Chinese economy. While JD.com, Inc. (NASDAQ: JD, HKG: 9618) slowly entered into the e-commerce race, both companies have their strengths and there was still room for the big two to grow.
Alibaba and JD.com enjoyed almost 10 years of growth as the duopoly in China’s e-commerce.
In 2015, just less than 10 years ago, another force awakened. No doubt, Alibaba and JD’s improvements and scrutiny of product authenticity attracted and retained affluent users, but it also created room for a copycat to enter the lower rungs of the e-commerce audience.
Pinduoduo disrupted the Chinese e-commerce landscape by targeting China’s lower-income and rural area markets. With a twist of its own, the self-pioneered concept of social commerce allowed Pinduoduo to grow its user base and sales meteorically.
Just like its name, which means ‘group buying for more discounts’, users share items they want to buy for additional discounts, driving up user base and sales together.
Even with the counter-attacks launched by Baba to fend off PDD, PDD proved to be a tough nut to crack.
As of today, the Padawan has become the master.
Is Alibaba broken?
Alibaba’s share price peaked at around USD300 in October 2020. However, for the past 3 years, Alibaba has not revisited its historical high.
So the question is, is Alibaba broken? Is the company at a point of no return?
You might be surprised that despite the stock price dismay, Alibaba’s financials are not in tatters. Revenue has continued to grow, but net income has shrunk.
The main reason for that is due to the one-off impairment of goodwill concerning the Digital media and entertainment segment.
That said, if we zoom into Baba’s margins, gross margins are slightly compressed, by 8.27 percentage points while operating margins are down from 18.74% to 12.22%.
Granted, Alibaba might be facing its toughest challenge yet. Its cloud venture and other smaller ventures do not seem to be the next growth phase story that investors are looking for.
Baba is not broken. It is still a very good company. Just lacking the next growth map.
Is PDD the real deal?
Like Alibaba, PDD stock prices saw a correction post 2021, witnessing a nearly 80% drop from peak to trough.
Pinduoduo had to deal with 3 major events – its founder and then-CEO Zheng Huang leaving, the antitrust clampdown by the Chinese government, and a sector rotation that saw most people dumping high-growth, loss-making companies.
But PDD swiftly turned profitable for its FY 2021 and was back as a favorite. Better revenue and a more well-managed operating expense saw improvements in its gross margins and also turned profitable operationally.
What’s more interesting is, that with Alibaba’s operating cash flow and free cash flow margins slowly coming down, PDD recorded a more promising cash flow and FCF margin growth.
What PDD has that Baba does not is inroads and growth into the US. While going head-on with JD and Baba, PDD has also launched a global growth assault via its Temu app – a masterstroke that many other e-commerce companies have been looking at but failed to execute.
Is PDD’s valuation justified?
To do so, let’s compare where PDD is right now versus a historical Alibaba at a similar size.
| Metrics | Alibaba Group Holding Ltd (FY 2017) | PDD Holdings Inc – ADR (FY 2022) |
| Revenue | RMB 158.273 million | RMB 130.558 |
| Revenue YoY % | +56.5% | +39% |
| Gross profit | RMB 99.647 million | RMB 99.095 million |
| Gross margin % | 63% | 75.9% |
| Operating profit | RMB 48.912 million | RMB 30.401 million |
| Operating margin % | 31% | 23.3% |
| Net profit | RMB 43.675 million | RMB 31.538 million |
| Net margin % | 27.6% | 23.3% |
| NTM P/E | 31x | 21.53x |
| NTM Enterprise Value/EBIT | 33.64x | 16.74x |
By going back to FY 2017, we managed to pick Baba at a similar size versus the current PDD.
Back then, Baba was growing its topline at a much higher rate compared to PDD. Even though PDD enjoys a far better gross margin, 2017 Baba was a better company than current-day PDD.
That said, this is just a simple comparison to gauge PDD’s valuation as of today against Baba when both were doing similar revenue.
Judging by the growth momentum that PDD can continue to achieve, today’s valuation does seem cheap.
Risks in joining China’s new E-commerce king’s coronation
With Temu making waves in the Western world, surprising even the local e-commerce players, the geopolitical aspect will inevitably come into play.
Just like TikTok, both Temu and SHEIN are bound to face the same scrutiny and concerns from the US government. If history does repeat itself, we could witness the founders of both companies appearing in congressional hearings.
Moreover, cheap products and group buying drive prices lower, making sense for profitability but often leads to alleged counterfeit products claims.
As consumers slowly become more savvy and affluent, will they continue sticking with PDD, or switch to genuine certified products offered on Taobao and Tmall?
The runway for growth needs to be ascertained for PDD to justify its market cap as China’s largest listed e-commerce company, with more room to grow bigger.
Sell Baba, Buy PDD?
I genuinely have no answer to this. I’m skeptical of Baba’s restructuring plans, and nothing has seemed to have gone well with their plans apart from Cainiao and a rejuvenated growth in the e-commerce sector.
On the other hand, even though PDD is not expensive, I am left to wonder whether selling cheap stuff that encourages group buying and still achieving good margins is something sustainable for the next 5, 10, or even 20 years.
Perhaps I am in camp “watch-Baba-and-PDD”, while I go off buying other stuff that I like.
