Should You Chase Pinduoduo’s Post-Earnings Pop?

Shares of Pinduoduo (NASDAQ: PDD) rallied 8% on Aug. 31 after the Chinese e-commerce company posted its second-quarter earnings. The company generated 2.71 billion RMB ($409.4 million) in revenue, which represented nearly 26 times growth from a year ago and 96% growth from the first quarter.

However, Pinduoduo's net loss widened from 109.5 million RMB in the prior-year quarter to 6.49 billion RMB ($981.4 million). On a non-GAAP basis, its net loss widened from 106.7 million RMB to 673.4 million ($101.8 million), or $0.20 per ADS.

Pinduoduo's growth looks lopsided, and the stock's post-earnings rally merely bumped it back to its IPO price of $19. The stock remains down nearly 30% from its post-IPO high due to concerns about its business model, a regulatory probe regarding allegations of counterfeit goods, and escalating trade tensions between the US and China. Let's take a closer look at these headwinds.

Understanding Pinduoduo's business

Instead of offering brand-name products like Alibaba's (NYSE: BABA) Tmall or (NASDAQ: JD), Pinduoduo sells cheaper generic goods at steep discounts. Its target customer is lower-income folks. The company lets its shoppers form "shopping teams" by sharing listings through social media links. Its average monthly active users (MAUs) grew 495% annually to 195 million during the quarter.

Pinduoduo's trailing-12-month GMV (gross merchandise volume), or the value of all goods sold on its platform, rose 583% annually to 262.1 billion ($239.6 billion). During the same period, its active buyers grew 245% annually to 99.7 million, while its annual spending per active buyer nearly doubled to 762.8 RMB ($115.30).

Pinduoduo generates revenue from online marketing services for merchants and commissions from each purchase. It only launched its online marketing services this April, which significantly distorts year-over-year revenue comparisons.

During the quarter, Pinduoduo's online marketing revenue rose 114% sequentially to 2.37 billion RMB ($358.3 million) as its commission fee revenues grew 22% sequentially (and 366% annually) to 338.1 million ($51.1 million). Those growth figures look solid, but Pinduoduo's finance VP Tian Xu warned during the conference call that it was "still too early" for the company to provide any forward guidance.

Evaluating the headwinds

That lack of clarity regarding Pinduoduo's future casts a long shadow over the rest of its business, which is struggling with surging expenses and regulatory challenges.

Pinduoduo's cost of revenues jumped 260% annually to 387.8 million RMB ($58.6 million) during the quarter, as its total operating expenses surged nearly 75 times to 8.96 billion RMB ($1.35 billion).

The company attributes its higher sales and marketing expenses to bigger advertising and branding campaigns meant to strengthen its brand recognition and boost user engagement.

It attributed its rising general and administrative expenses to a higher headcount and new stock-based bonuses, and its rising R&D expenses to a higher headcount, the recruitment of "experienced" R&D personnel, and higher cloud service expenses.

That's troubling when we consider that Pinduoduo ranks a distant third behind Alibaba and JD, which together control about 75% of China's e-commerce market according to eMarketer. Pinduoduo holds a 5% share.

Alibaba also recently launched Taobao Tejia, an app for low-income shoppers that targets Pinduoduo's core market. Pinduoduo will need to keep spending more cash to counter Alibaba, so its expenses could continue outpacing its sales growth.

To make matters worse, Chinese regulators recently launched a probe into Pinduoduo over allegations of counterfeit goods being sold across its platform. During the conference call, CEO Colin Huang insisted that Pinduoduo has a "zero tolerance" policy for counterfeit goods with steep penalties for merchants who violate the rules, but admitted that there was "still quite a lot to do in eliminating infringement offenses" across the platform.

Too risky for my blood

Pinduoduo has an interesting business model and great sales growth. However, its losses are staggering, it faces tough questions about counterfeit products, and it could be rendered obsolete by similar offerings from Alibaba or JD.

I believe that Alibaba remains the best way to invest in the Chinese e-commerce market. I also like JD, but the company is still struggling with high expenses as it expands its logistics network. Pinduoduo, however, will likely remain a money-burning underdog for the foreseeable future.

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