Pinduoduo: "Fallen from Grace," How Long Can Its Pride Last?

On the evening of March 20th, Beijing time, before the US stock market opened, $PDD(PDD.US) released its fourth-quarter financial report. At first glance, both revenue and profit missed expectations, leading to a significant pre-market drop. What is the specific situation?

1. Revenue misses again: This quarter, Pinduoduo reported total revenue of approximately 110.6 billion RMB, a year-on-year increase of 24%, which was over 5 billion lower than Bloomberg's consensus estimate, marking the second consecutive quarter of revenue falling short of expectations. Fortunately, the core revenue— advertising revenue for this quarter was 57 billion, a year-on-year increase of 17%, which was basically in line with the consensus estimate from sell-side analysts, avoiding a "blow-up" in core business.

However, some leading sell-side analysts had higher expectations for this quarter's advertising revenue growth, between 20% and 24% (based on around 20% GMV growth on the main site), which may still be somewhat disappointing for optimistic investors looking forward to performance.

2. Temu transformation, commission reduction on the main site: The reason for the total revenue falling short of expectations this quarter is still in transactional revenue, with Bloomberg's consensus estimate at approximately 59.3 billion, while the actual figure was 53.6 billion (year-on-year growth of only 36%), fully explaining the more than 5 billion difference from the expected total revenue.

Dolphin Research believes that the significant shortfall in commission revenue should primarily be attributed to the structural changes in Temu's business (the proportion of semi-managed business has clearly increased), with the company's reduction of commissions for main site merchants being secondary. Although it is impossible to accurately break down the numbers, qualitatively we speculate the following possible changes:

The transition of Temu to semi-managed may be progressing quite rapidly, with the GMV of semi-managed business possibly reaching around 30% or higher of the total by the fourth quarter;
In fully managed business, Temu's markup rate may have also declined compared to the previous quarter;
This quarter, commission income from the main site likely also saw a year-on-year decline, and the company's reduction of commissions for merchants is not merely "talk."

3. Gross profit barely meets expectations: This quarter, Pinduoduo's gross margin was 56.8%, which has declined by over 3 percentage points both year-on-year and quarter-on-quarter. However, the sell-side consensus estimate was more pessimistic, at only 54%. The actual performance was slightly better than the pessimistic expectation, possibly due to Temu's shift towards a semi-managed structure, which is relatively beneficial for gross margin. However, due to the reduction in commissions on the main site (with revenue possibly experiencing negative growth), the overall gross margin still declined.

Moreover, because total revenue was below expectations, although the gross margin was slightly higher than expected, the gross profit amount was only in line with market expectations, at 62.8 billion.

4. "National subsidies" funded by the company: On the expense side, two points are worth noting. First, marketing expenses amounted to 31.4 billion, a year-on-year increase of 18%. Additionally, compared to the implied expectations, it was slightly over by more than 1 billion. According to reports, Temu's marketing expenses this season may have narrowed year-on-year, while conversely, the marketing expenses for the main site this season may have increased by several billion compared to the same period last year. This may reflect Pinduoduo's own spending on "national subsidies."

Additionally, the year-on-year growth rate of R&D expenses has significantly increased to 32% this season, with actual spending of 3.78 billion, showing an increase of 800 to 900 million both year-on-year and quarter-on-quarter. Although the company did not explain this in the announcement, it is speculated that Pinduoduo may also be developing AI-related features, but has not yet publicly promoted them.

5. Profit declines again quarter-on-quarter: Due to a significant miss on the revenue side, although the actual gross margin was slightly higher than pessimistic expectations, the gross profit just barely met the target. Additionally, due to national subsidy expenditures and potential investments in AI, expenses were also slightly higher than expected by several hundred million. Ultimately, the company's overall operating profit was 25.6 billion, which was slightly less than the expected 1.2 billion.

In terms of trends, the operating profit margin continued to decline by 1.4 percentage points to 23.1%, and the year-on-year growth rate of profit has only remained at 14%. Pinduoduo's profit growth rate has officially entered the 10% range.

Dolphin Research Perspective:

Clearly, Pinduoduo's performance this time should be classified as poor, with revenue significantly missing expectations by over 5 billion, missing for two consecutive quarters, and growth rate sliding to the 20%+ level. On the profit side, considering the impact of national subsidies, although market expectations for this season were already low, it was assumed that the profit margin would continue to decline compared to the previous season, the actual performance was still lower than expected by over a billion. The growth rate of operating profit has officially entered the 10%+ era. Both revenue and profit growth rates have entered "new lows," seemingly officially announcing the end of Pinduoduo's era of significantly outperforming its peers in growth.

The underlying business trend reflects that the domestic main site business, due to positioning reasons, enjoys fewer national subsidy benefits compared to JD and Alibaba, which are more quality-oriented. The gap in revenue and profit growth rates between these two peers has further narrowed. The reduction in commission rates for merchants is also, to some extent, a backlash against the previously high monetization rates for merchants. A significant portion of the previous excess profits has been returned. Meanwhile, overseas Temu, due to significant policy risks, has been forced to accelerate its transformation pains of "de-Americanization" and "direct small package sales." This has somewhat reduced Temu's main competitive advantage of low prices. These are the current operational challenges faced by Pinduoduo.

From an investor's perspective, as the second-largest e-commerce company with an annual GMV of around 5 trillion, Pinduoduo is now a cash cow in the strictest sense. By the end of the fourth quarter, the company's cash-like assets (cash + short-term investments) had soared to 330 billion, accounting for about 30% of the company's market value; with a net increase of 120 billion in a year, the increase is roughly equivalent to the company's overall Non-GAAP net profit for 2024. Additionally, due to the company's low debt, shareholder equity is also above 300 billion The main site has passed the investment period, and revenue growth has slowed down. Temu is also encountering obstacles in expansion due to policy factors, and the company's growth is gradually returning to the level of its peers. A large amount of cash is piling up on the balance sheet without returning to shareholders. With the numerator of the return on equity (ROE) growing at a slowing margin while the denominator continues to expand, ROE will quickly decline, undoubtedly placing a "tightening spell" on Pinduoduo's estimated stock price.

The market will inevitably question Pinduoduo's capital management. With the main site’s growth slowing down and lacking good investment tracks, and Temu nearing self-sufficiency without needing to consume cash flow significantly, why does Pinduoduo still refuse to distribute dividends or repurchase shares, preferring instead to use its earnings to buy short-term financial products?

Especially due to the impacts of option incentives and convertible bonds diluting the share capital, Pinduoduo's share capital growth in 2024 is close to 1%. Through repurchases or dividends, at least offsetting the impact of equity dilution is clearly not an excessive request.

Dolphin Research appreciates Pinduoduo's extreme efficiency and execution, but in the context of weakening growth, if it refuses to return value to shareholders, it will clearly struggle to enjoy valuation premiums and can only hover around a 10x PE, comparable to its peers. Of course, Dolphin Research hopes Pinduoduo can tell a new growth story, as it remains a top player among domestic companies in terms of successful execution probability.

Detailed interpretation of this quarter's financial report:

1. Revenue misses again, still the fault of commission income (Temu)

This quarter, Pinduoduo total revenue was approximately 110.6 billion RMB, a year-on-year growth of 24% , which was over 5 billion lower than Bloomberg's consensus expectation, marking the second consecutive quarter of revenue falling short of expectations.

"What is somewhat reassuring" is that the core revenue—which mainly reflects the main site's situation—advertising revenue this quarter was 57 billion, a year-on-year increase of 17%, which is basically in line with the consensus expectation from sellers, and there was no "explosion" in core business. However, Dolphin Research understands that some leading sellers had expected the advertising revenue growth this quarter to be between 20% and 24% (based on around 20% GMV growth for the main site). Therefore, although the actual growth rate met the consensus expectation, it may still be disappointing for funds that were optimistic about the performance period.

In other words, the reason for the total revenue falling short of expectations this quarter is still due to the significant fluctuations in business, with the market having a low grasp of transaction service income, Bloomberg's consensus expectation was about 59.3 billion, but the actual was 53.6 billion, with year-on-year growth slowing to only 36%, which fully explains the over 5 billion shortfall in total revenue.

Setting aside the expectation gap, the growth rate of advertising revenue this quarter continued to decline from 24% last quarter to 17%, indicating that Pinduoduo's GMV growth for the main site this quarter may be lower than the approximately 20% expected by sellers. Compared to Alibaba's 9% CMR growth this quarter and JD's over 10% growth in self-operated retail revenue, the growth rate gap between Pinduoduo and Alibaba, JD in domestic business is likely continuing to narrow. Although there is a sense of "new stars fading," it aligns with Dolphin Research's judgment that domestic e-commerce will continue to consolidate in the medium term.

II. Temu accelerates transformation to semi-managed model, and the reduction of commissions on the main site is not just talk

Although the reason for the revenue miss still lies in commission income, unlike the previous quarter, Dolphin Research believes that this time the commission income fell short of expectations should primarily be due to the change in Temu's business structure (the proportion of semi-managed business has significantly increased), with the company's reduction of commissions for main site merchants being a secondary factor. The reason is that, on one hand, due to the election of Trump and the expectation of the cancellation of the small package tax exemption policy, the company has already taken steps to shift Temu's business focus towards a semi-managed model. On the other hand, the significant revenue miss but consistent gross profit with expectations also aligns with the fact that the semi-managed model accounts for revenue on a net basis, thus having lower revenue than the fully managed model but higher gross margin.

Due to the significant structural changes between semi-managed and fully managed models, coupled with the lack of official data, it becomes increasingly difficult to isolate Temu's performance. Therefore, we do not provide specific calculated figures this time, but qualitatively speculate on some possible signs based on the commission income that fell short of expectations by over 5 billion:

The progress of Temu's shift to a semi-managed model may be quite rapid, with the GMV of semi-managed business possibly accounting for about 30% of the total by the fourth quarter;
Unless the actual proportion of semi-managed business is much higher than the above expectations, even the markup rate of Temu's fully managed business may have declined compared to the previous quarter;
Even considering the above impacts, the commission income from the main site this quarter may still show a year-on-year decline, reflecting that the company's reduction in commissions for merchants may not be small.

III. Gross margin continues to decline under commission reduction, but better than more pessimistic expectations

From a gross margin perspective, Pinduoduo's gross margin this season is 56.8%, which has declined by more than 3 percentage points both year-on-year and quarter-on-quarter. However, the consensus among sell-side analysts is more pessimistic, at only 54%. We believe the actual performance is slightly better than the pessimistic expectations, mainly due to the rapid progress in Temu's shift towards a semi-managed structure, which will have a relatively favorable impact on gross margin. However, due to the reduction of commissions on the main site, the net impact on gross margin remains negative.

But since total revenue is below expectations, although the gross margin is slightly higher than expected, the gross profit amount is only in line with market expectations, at 62.8 billion.

IV. Main Site Operating Expenses May Increase by Nearly 10 Billion? The Impact of Self-Funding "National Subsidies"

In terms of expense spending, this quarter's marketing expenses amounted to 31.4 billion, an increase of 18% year-on-year. From the perspective of year-on-year growth, compared to the over 40% growth in previous quarters, there is a significant slowdown. However, compared to the market's implied expectations, it is still slightly more by over 1 billion.

According to our understanding, Temu's marketing expenses this quarter may have narrowed year-on-year, while total marketing spending increased by nearly 6 billion compared to the same period last year. In contrast, the marketing expenses for the main site this quarter may have increased by several billion compared to the same period last year. This part may reflect Duoduo's self-funded subsidies in the "national subsidies."

Another point worth noting is that the year-on-year growth rate of R&D expenses has significantly risen to 32%, with actual spending of 3.78 billion, showing an increase of 800-900 million both year-on-year and quarter-on-quarter. Although the company did not explain this in the announcement, we speculate it may be related to Pinduoduo also developing AI-related features, which have not yet been publicly promoted.

Overall, the combined rate of the three operating expenses has narrowed by about 1.7 percentage points year-on-year, to 33.6%. From the perspective of expected differences, the total of the three expenses is only slightly higher than the consensus expectation of sell-side analysts, indicating that the performance on the expense side is slightly negative, with no significant erosion of profits beyond expectations, but also no pleasant surprises.

V. Profit Declines Again

Overall, due to a significant miss on the revenue side, although the actual gross margin is slightly higher than pessimistic expectations, the gross profit amount just meets the target. The national subsidy spending on the main site business and possible investments in AI have led to no surprises on the expense side, with a significant year-on-year increase, and spending slightly exceeding expectations by a few billion. Ultimately, the company's overall operating profit is 25.6 billion, slightly less than expected by 1.2 billion. In terms of trends, the operating profit margin continued to decline by 1.4 percentage points from the previous quarter to 23.1%, and the year-on-year growth rate of profit is only 14% remaining. Duoduo's profit growth rate has officially entered the level starting with 10%.

According to preliminary calculations by Dolphin Research (as the data cannot be verified, it is only for rough reference), based on Temu's losses this quarter being slightly over 1 billion, close to the break-even assumption, we estimate that Pinduoduo's main site operating profit this quarter may be around 26 billion, a significant decline compared to our estimate of over 30 billion for the same period last year. This clearly reflects that, while reducing commissions for merchants and self-funding "national subsidies," the originally "highly profitable" main site business has seen a significant reversal and retraction in profits