Pinduoduo: Back to the Money Tree? Can't Compete with Management's 'Forced Submission'

$PDD(PDD.US) Once again, the familiar post-earnings volatility. On August 25th, before the U.S. stock market opened, Pinduoduo announced its second-quarter results, with profits significantly exceeding expectations, briefly pushing the stock price up by 10%. But how substantial is this earnings beat?

1. Revenue in line with expectations, no surprises: After two consecutive quarters of significantly underperforming revenue expectations, this quarter Pinduoduo's total revenue was approximately RMB 104 billion, up 7% year-on-year. Although the growth rate continued to slow, it was almost entirely in line with market expectations. This was mainly due to Temu's shift from full management (recording revenue based on total sales) to semi-management (recording only commissions) due to tariff impacts, which thinned the revenue recognition.

2. Core advertising revenue landed smoothly: The core advertising revenue reflecting the main site's performance grew by 13.4% year-on-year this quarter, also largely in line with market expectations, showing a slight slowdown compared to the previous quarter.

This suggests that Pinduoduo's domestic main site growth has entered a stable phase, with the GMV growth rate and advertising monetization rate of the main site being relatively stable, and the trend of narrowing advertising monetization rate year-on-year should have basically ended. From another perspective, it also means that Pinduoduo's significant growth advantage over its peers has (at least in the medium term) basically ended.

3. Temu's performance was not bad despite tariff impacts: This quarter's transaction commission income was about RMB 48.3 billion, with a year-on-year growth of less than 1%, further slowing the total revenue growth, but the market had fully anticipated this. The main reason was the significant increase in U.S. tariffs and the cancellation of small package exemptions, causing Temu's full management business in the U.S. to stagnate and quickly transition to semi-management.

Even with significant impacts, it is estimated that Temu's overall GMV growth rate still reached at least 40%. The company has done quite well by accelerating the expansion of semi-management and other models, and exploring new markets in Europe and the Middle East, without letting Temu's performance suffer significant impacts.

4. Marketing expenses unexpectedly narrowed: This quarter's revenue performance was almost entirely in line with expectations, with no surprises. The biggest highlight was the actual marketing expenses being far below expectations, driving profit recovery beyond expectations. Marketing expenses were actually RMB 27.2 billion, nearly RMB 8 billion less than expected, with a year-on-year increase of less than 5%. Dolphin believes that this is likely due to reduced investment in the main site.

According to Dolphin's calculations, although this quarter's main site marketing investment was still significantly higher than the same period last year, it has decreased by about 30% compared to the previous quarter's peak, indicating that Pinduoduo's channel disadvantage in state subsidies should be narrowing.

In terms of other expenses, R&D spending continued to grow by about 23% year-on-year, maintaining a stable growth rate. Meanwhile, management expenses decreased significantly by nearly 17% year-on-year, also significantly below market expectations, still reflecting Pinduoduo's extreme efficiency in human resources.

5. Profits are back: Due to the significantly lower-than-expected marketing expenses on the main site, this quarter's overall operating profit margin improved significantly from the previous quarter's low, reaching nearly 25% (compared to 17% in the previous quarter). The actual operating profit was about RMB 25.8 billion, RMB 4.3 billion higher than market expectations.

Although not as exaggerated as the net profit of RMB 30.8 billion, which was significantly above expectations due to investment income (over RMB 10 billion this quarter), it still shows that as long as Pinduoduo reasonably controls expenses, its profitability remains outstanding.

According to the company’s FY2024 annual report, by the end of 2024, out of the total RMB 273.8 billion in short-term investment assets, about RMB 44.5 billion consisted of equity investments (financial investments made for profit rather than strategic investments driven by business considerations). Given that both the U.S. and Chinese stock markets have seen a notable rebound following the sharp decline in April, it can be inferred that a significant portion of this quarter’s better-than-expected profit came from the company’s “stock trading” gains. However, such gains are not sustainable and therefore should not be factored into valuation.

Dolphin Research's View:

Through the above analysis, Dolphin believes that Pinduoduo's performance this quarter is undoubtedly good, with the biggest highlight being the rapid profit recovery after controlling marketing investment on the main site, dispelling market concerns that Pinduoduo's profit margin might permanently decline like last quarter, leading to a downward revision of long-term profit expectations.

However, Dolphin believes that while praising, it is also necessary to point out that the market beat of this quarter's performance is not very high. The obvious reason is that the company's revenue, especially core advertising revenue, did not have any bright spots, only continuing to grow slightly slower as expected.

Considering that the actual growth rate of overall online physical goods this quarter was slightly better than the previous quarter, and JD.com and Vipshop, which have already reported earnings in the second quarter, performed better than expected and showed an accelerating trend. In comparison, Pinduoduo's main site growth continued to slow this quarter + investment was reduced more than expected, which is more about the marginal reduction of the state subsidy disadvantage, but in absolute terms, it still underperformed its peers. The reduction in investment, therefore, still resulted in underperformance in growth.

Looking ahead to the company's future performance trends:

1. In terms of domestic business, referring to JD.com's strong revenue growth in the second quarter of the mall segment (about 20% yoy) and the good sales growth of home appliances and communication products as shown in social retail data, Dolphin believes that the company is likely to maintain a certain level of subsidies on the main site in the second half of the year to compensate for its relative disadvantage in state subsidy channels. However, from a marginal perspective, since last year's state subsidies mainly started from August to September, the negative impact of state subsidies on Pinduoduo in the second half of the year should continue to lessen.

On the other hand, the recent market focus on the "food delivery war" has greatly distracted Alibaba and JD.com's funds and attention in the short to medium term, preventing them from focusing too much on e-commerce business investment. This means a valuable time window for Pinduoduo, which is not involved in the food delivery war, to digest the impact of its "trillion merchant subsidy plan" and the disadvantage in state subsidies. Compared to peers whose profits have significantly deteriorated, Pinduoduo, with its marginal profit improvement, undoubtedly stands out.

Overall, due to the continued intense competition in the e-commerce industry, which is unlikely to see any real relief in the short to medium term, the growth rate of Pinduoduo's domestic business will also further return to the industry average level, but the profit margin of the main site compared to the low point in the first quarter should continue to show a recovery trend.

2. For the overseas business of Temu, in the second quarter, due to the impact of increased tariffs by the U.S. government and the cancellation of small package exemption policies, Temu's full management business in its largest single market (accounting for over 40% of GMV in 2024) -- the U.S. -- almost stagnated. However, the company successfully offset the decline in the U.S. market to a relative extent through geographic and model expansion. According to research,

Temu's growth in new markets such as Europe, South America, and the Middle East is very rapid; in terms of models, it has increased the proportion of semi-management models and increased the recruitment of non-Chinese suppliers to fundamentally reduce the impact of tariff policies from a business model perspective.

In addition to the above measures, it is reported that Temu was also "forced" to slightly increase the terminal prices of goods in the European and American markets and began to accelerate advertising monetization (reported monetization rate is about 6%~8%). The stage with the greatest impact from tariffs has now passed, and Temu has returned to normal operations.

Dolphin believes that the long-term impact may be that Temu has accelerated market diversification, which on one hand can reduce dependence on a single market, helping to raise Temu's long-term ceiling, but at the same time, operating multiple "smaller and different" markets undoubtedly increases operational difficulty and reduces overall economies of scale.

On the other hand, in terms of business models, Dolphin has always believed that a purely cross-border e-commerce model is not the "ultimate answer," and from historical experience, transitioning to localization is almost a necessary condition for successful internationalization of e-commerce. This tariff impact also helped accelerate the transformation of Temu's model, which Dolphin believes is a good direction. However, compared to the pure cross-border model of global inventory, localized operations tailored to local conditions also pose higher management requirements.

In a word, this tariff impact has helped Temu move towards a path with more long-term value, but whether Pinduoduo, which has historically been guided by subtraction and extreme efficiency, can handle complex businesses in multiple markets and operate various different business models, requires time to verify.

In terms of valuation, Dolphin still adopts the valuation method of domestic main site and overseas Temu division. Specifically:

1. For the main site, an important issue to consider is -- is the current state subsidy policy a phased one, or a continuous policy that will be repeated for a long time? If it is the former, then the main site profit margin, which is under pressure due to Pinduoduo having to pay out of pocket to make up for the state subsidy deficiency, will return to a higher normal level later. But if it is the latter, although the marginal impact will gradually lessen, it may mean that the profit margin of Pinduoduo's main site will never return to its peak in 2024.

Dolphin believes that state subsidies are unlikely to be a permanent policy (more likely to be cyclical), and from this quarter's situation, the negative impact of state subsidies on Pinduoduo is gradually lessening, so Pinduoduo's domestic main site returning to an annual net profit of RMB 100 billion or more is not a problem, and the company's performance corresponds to a valuation of no more than 13x PE.

Dolphin believes that for a player with a significant operational efficiency advantage in the industry, enjoying this level of valuation premium is undoubtedly reasonable and acceptable.

2. For the Temu business, its long-term business scale space and profit margin level are not yet clear, but the market currently generally does not give this business a valuation. From the perspective of upward options, considering a medium to long-term GMV space of $100 billion, and referring to Sea's 0.5x P/GMV valuation, Temu is expected to bring an incremental valuation (quite full) of around $50 billion. This is equivalent to slightly more than 1/4 of the company's current market value, or $35 per share, which is not a lot but not low either. However, it should be noted that this part of the incremental valuation also requires several years to be fully realized.

In addition, whether the company's cash and short-term investment assets of over $50 billion on the books can be reflected in the valuation is also a crucial factor. This depends on when the management is willing to conduct buybacks or dividends.

Detailed interpretation of this quarter's financial report:

I. Revenue finally didn't bomb, stable delivery

This quarter, Pinduoduo's total revenue was approximately RMB 104 billion, up 7% year-on-year, almost entirely in line with market expectations, finally ending the consecutive quarters of significantly underperforming revenue expectations. In terms of trends, the year-on-year growth rate slowed again compared to the previous quarter, mainly due to the impact of Temu's business being hit by U.S. tariffs, with overall commission income nearly zero growth this quarter, but this was already within market expectations.

Meanwhile, core advertising revenue grew by 13.4% year-on-year this quarter, also largely in line with market expectations, showing a slight slowdown compared to the previous quarter.

This indicates that Pinduoduo's domestic main site growth has entered a stable phase, although the company does not disclose GMV, it likely indicates that the GMV growth rate and advertising monetization rate of the domestic main site are relatively stable, and the trend of narrowing advertising monetization rate year-on-year should have basically ended, at least not significantly declining anymore.

However, compared to JD.com and Vipshop, which both benefited from state subsidies and performed significantly better than expected in the second quarter, Pinduoduo only showed a stable performance in line with expectations, still reflecting Pinduoduo's relative disadvantage in state subsidies.

II. Unafraid of U.S. "bullying," Temu quickly transformed without significant impact

This quarter's transaction commission income was about RMB 48.3 billion, with a year-on-year growth of less than 1%, also largely in line with market expectations. In terms of trends, the near-stagnation of commission income growth was mainly due to the significant increase in U.S. tariffs and the cancellation of small package exemption rules, causing Temu's full management business in the U.S. to almost stagnate, forcing a rapid transition to semi-management. (The full management model records revenue based on total sales, while semi-management records revenue based on commissions, thus leading to a decrease in reported revenue).

Setting aside the expectation gap, according to Dolphin's breakdown, even under the above impact on revenue recognition, the actual revenue of Temu's business this quarter should have declined very limitedly compared to the previous quarter, which is quite surprising to Dolphin.

According to Dolphin's preliminary breakdown (only for reference due to lack of official data, accuracy cannot be guaranteed). Assuming a nearly 20% decline in full management GMV quarter-on-quarter, Temu's overall GMV growth rate still reached over 40%.

It can be inferred that after the tariff impact, the company quickly adjusted its business, accelerating the expansion of semi-management and other models in business models, exploring new markets in Europe and the Middle East, and quickly recovering its U.S. business, without letting Temu's performance suffer significant impacts.

III. Gross margin unexpectedly declined, Temu reduced markup rate?

In terms of gross margin, Pinduoduo's gross profit this quarter was RMB 58.1 billion, a year-on-year decline of 8% (even in the extremely poor profit last quarter, gross profit was flat year-on-year), which is the only indicator significantly below expectations this quarter.

Originally considering the increase in the proportion of high-margin semi-management in Temu's revenue, and the decrease in the proportion of full management that drags down gross margin, the market expected gross margin to improve quarter-on-quarter this quarter, but the actual gross margin declined by 1.3% quarter-on-quarter.

Considering that the main site's advertising revenue performance was stable and in line with expectations, the unexpected decline in gross margin should still be affected by Temu. Although it is equally difficult to break down specific influencing factors, Dolphin speculates that the platform may have sacrificed some of its interests to reduce the increase in terminal product prices due to tariff impacts, reducing the impact of markup rates.

IV. Marketing expenses significantly lower than expected, state subsidy channel disadvantage reduced?

This quarter's revenue performance was almost entirely in line with expectations, with no surprises. Therefore, the highlight of Pinduoduo's performance this quarter was entirely in the significantly lower-than-expected expense spending, resulting in strong profit performance.

Specifically, the biggest source of exceeding expectations was the actual marketing expenses being far below expectations, with actual spending of RMB 27.2 billion, nearly RMB 8 billion less than expected. Year-on-year growth was also very limited, less than 5%.

Although Temu's U.S. business was significantly impacted by tariffs this quarter, and investment in the U.S. should have been significantly reduced, due to the need to explore non-U.S. markets, Dolphin believes that overall, Temu's marketing investment this quarter should not have decreased significantly compared to the previous quarter, at least not solely due to Temu causing a situation nearly RMB 8 billion lower than expected.

In other words, the significant reduction in marketing investment this quarter and the profit exceeding expectations should mainly be due to the impact of the main site business. According to Dolphin's assumption, this quarter's main site marketing investment was still significantly higher than the same period last year (high double-digit % growth), reflecting the continued intense competition in e-commerce performance. However, compared to the previous quarter's peak, it also decreased by nearly 30%, indicating that Pinduoduo's channel disadvantage in state subsidies should be narrowing.

V. Profits are back!

Finally, on the profit side, although there were no particular highlights in revenue, due to the significantly lower-than-expected marketing expenses on the main site, this quarter's operating profit margin improved significantly from the previous quarter's low, reaching nearly 25% (compared to 17% in the previous quarter). The actual operating profit was about RMB 25.8 billion, RMB 4.3 billion higher than market expectations.

According to the company’s FY2024 annual report, by the end of 2024, out of the total RMB 273.8 billion in short-term investment assets, approximately RMB 44.5 billion consisted of equity investments (financial investments made for profit rather than strategic investments driven by business considerations). Coupled with this quarter’s investment and interest income exceeding RMB 10 billion—well above the typical quarterly level—and the notable rebound in both the U.S. and Chinese stock markets following the sharp decline in April, it can be inferred that a considerable portion of the company’s better-than-expected profit this quarter came from “stock trading” gains. However, such gains are not sustainable and therefore should not be taken into account in valuation.