(This article was updated on 28 August, 2024, with a section on PDD's August profit warning and an update to the introduction.)
PDD Holdings, the owner of one of China’s most popular online shopping platforms, seemingly ticked the right boxes with investors when we first examined this company in October 2023. The company had rallied more than 400% since its Nasdaq listing in 2018, making its founder one of China's richest men. This performance reflected PDD's extraordinary growth and profitability.
While investors loved PDD's exceptional numbers, we demurred because other factors besides growth and profitability determine the quality of a company.
Our AI-powered Manipulation Risk Analyzer (MRA) detected red flags in the company's financials for 2022 and prior years. The MRA gave PDD a manipulation risk score of 59% for its 2022 financial accounts, which equated to a risk grade of "C-." This rating means that the system detected significant issues with the accounting quality of PDD. Reports for previous years were even worse.
We noted that 59% was a very poor score for a large and seemingly high growth company. In particular, we noted that there were signs that PDD was taking almost 2 years to service its accounts payables, highly unusual for an apparently cash generative business with strong sales growth. The system also pointed to risk associated with business manipulation, poor cash quality, smoothing activity, aggressive use of accruals, and poor income quality.
We were concerned by these results given the company's troubling history of poor governance.
Incredibly, PDD's quarterly numbers strengthened until 26 August 2024, when the company issued a a profit warning alongside its results for Q2 2024, causing a 28% collapse in its stock in a single day.
Based on AI system's results from the 2022 financial statements, we were not surprised to see this warning.
In October 2023, 46 analysts covered PDD Holdings Inc. (PDD): 37 rated the company as a Buy, 6 rated it “Overweight” and 3 offered a “Hold” rating. Thus, apart from the three analysts lacking a strong view on the company, analyst recommendations suggest that PDD was much-loved by the broking community at the time.
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Figure I. The price history of PDD Holdings Inc. Source: Tradingview.com, transparently.AI |
There are good reasons why PDD appealed to analysts and investors. From humble beginnings in 2015, its budget shopping platform, Pinduoduo, has grown in popularity.
Pinduoduo enlists friends to buy items in bulk and enjoy great savings. It has a market share of about 10 percent, smaller than Alibaba, but claims more registered users, at around 900 million. This discrepancy suggests it should have plenty of scope to grow.
Growth has been stellar. In the 3 years to June 2023, top-line growth averaged 64.5% CAGR. Earnings grew from a loss of CNY9.1 billion in the year to June 2020 to a profit of CNY41.3 billion in the year ended June 2023.
In the space of three years from June 2020 until June 2023, the profit margin went from -28.7% to +25.0%. The consensus among analysts was that revenue was expected to grow a further 82% to CNY302.72 billion in the year ended December 2025.
Earnings are tipped to grow by 61% over the same period. Much of this future growth is expected to come from “Temu,” a sister shopping platform that PDD launched outside of China in October 2022.
Those estimates are now clearly in question, considering PDD's August 2024 profit warning.
A deeper dive into PDD reveals some troubling history. In 2018, Pinduoduo came under scrutiny following a spate of negative press articles in China calling the company out for inferior and imitation products.
Although the company claimed to have rectified the problem, in April 2019 Pinduoduo was named in the Office of the United States Trade Representative's list of Notorious Markets for Counterfeit Products and Piracy. As of today, Pinduoduo remains listed.
A second concern is the absence of stability in senior management. Colin Huang, a former Google employee, founded Pinduoduo in Shanghai in 2015. He stepped down as CEO in July 2020, less than two years after listing and just as sales were seeming to accelerate and the share price beginning to take off.
Huang initially stayed on as chairman but resigned from that position in March 2021, shocking the market. Just two days before that move, President Xi Jinping had called on China’s regulators to increase their scrutiny of internet and tech firms — particularly those that accumulated a lot of user data. (Beijing began its crackdown on Chinese tech in January 2021.)
The speed of Huang’s exit was unusual and unnerved investors. Many expected a government crackdown on PDD but it never eventuated.
Equally unsettling is the fact that PDD has never had a chief financial Officer (CFO) since going public in 2018. Instead, the VP of Finance was notionally responsible for the company’s accounting.
Three people have filled the position since 2018. Since the post was vacant for more than a year, this means that the average tenure of the key finance official at the company has been less than 18 months.
Without even looking at the company’s financials, the movement at the top of such an apparently successful company is highly unusual.
It is more comparable with a poorly run American OTC company. We invite readers to find any company worth more than US$100 billion that has operated without a CFO for a run of years.
Unsurprisingly, given the crackdown on tech and rotational leadership, PDD’s share price fell through 2021. It finally bottomed in February 2022 after a string of quarterly earnings beats which made the company compellingly cheap.
The share price staged a partial recovery through late February 2023, when the Chinese cybersecurity firm Dark Navy posted an online report detailing its suspicions about malware in a widely downloaded e-commerce app. Malware refers to software designed to steal data or interfere with a mobile phone’s operating system.
Dark Navy did not directly mention PDD directly but the report went viral and other cybersecurity researchers did name the company. Some issued quite detailed reports confirming the original findings and highlighting new concerns.
On 20 March 2023, Google suspended the Pinduoduo shopping app from its Play Store saying that “malware issues were found on versions of the Chinese e-commerce app outside Google's app store.”
In the statement, Google did not mention Temu, the US version of Pinduoduo, which is still available on the Play Store. At the time, Temu was the most downloaded app in the US for both iOS and Android.
CNN and Bloomberg covered the story in detail in subsequent weeks. Barron’s concluded that the news would just be a hiccup in PDD’s US expansion.
A Bloomberg report of 27 March drew on a press release from Kaspersky Lab in Russia, which identified and outlined potential malware in versions of the Pinduoduo app. This research, however, appeared to mainly draw upon the earlier work of Chinese researchers such as Dark Navy.
On April 3, 2023, CNN published an article which claimed to follow a tip-off from a Pinduoduo employee. It drew on employee interviews and responses from six global cybersecurity firms.
The report said that three of the six cybersecurity firms analysed version 6.49.0 of the app, which was released on Chinese app stores in late February. The three firms were Check Point Research, Oversecured and WithSecure. These companies are based in Tel Aviv, the US and Finland, respectively.
According to CNN, all three researchers “found code designed to achieve ‘privilege escalation’: a type of cyberattack that exploits a vulnerable operating system to gain a higher level of access to data than it’s supposed to have.”
CNN quoted Mikko Hyppönen, chief research officer at WithSecure: “The app was able to continue running in the background and prevent itself from being uninstalled, which allowed it to boost its monthly active user rates.” Hyppönen also said the app had the ability to spy on competitors by tracking activity on other shopping apps.
CNN said it had contacted PDD multiple times over email and phone for comment, but hadn’t received a response.
Back to topOn September 6, 2023, the short seller Grizzly Research issued a report claiming that “PDD is a Dying Fraudulent Company and its Shopping App TEMU is Cleverly Hidden Spyware that Poses an Urgent Security Threat to U.S. National Interests.”
PDD Holdings has thus far not responded to these claims on its website or in its press releases.
We, like most, are in no position to assess the legitimacy of the malware claims against Temu. While we are inclined to accept the apparent consensus among cybersecurity researchers on the previous malware on the Pinduoduo app, we have not seen support for Grizzly’s claims about Temu from other cybersecurity experts.
The only comment we have seen is from Kevin Reed, chief information security officer at cybersecurity firm Acronis. In an interview with CNBC, Reed asserted that Pinduoduo requests as many as 83 permissions whereas Temu requests only 23. Reed suggested that “Temu is far less aggressive than Pinduoduo.” If this assessment is correct, then the malware issue is primarily a concern for Chinese consumers and not US consumers.
The Grizzly report claims that Temu will likely be banned in the US. This is possible since a US Congressional committee has already drafted a bill (HR 1153) that could seriously affect TEMU’s business model and possibly empower the US President to ban it from the US.
We can’t assess how likely such an outcome might be, but we can say that Temu operates in 37 countries so a ban on Temu in the US may not be the death blow that Grizzly seems to suggest.
PDD Holdings has always registered poor accounting quality on the Transparently.AI Manipulation Risk Analyzer. This is the tool that establishes the probability that a company is manipulating its accounts and is at risk of collapse.
While we cannot disclose a full assessment of PDD Holdings, we can say that after listing in 2019, the system gave PDD a manipulation risk score of 76%. This was a very high score for a company that was already quite large.
Put in perspective, this score placed PDD in the 95th percentile for all technology stocks globally and also in the 95th percentile for all stocks globally. Companies in the 95th percentile have a high risk of being fraudulent.
In subsequent years, PDD's risk score has improved, mostly because its markedly improved profitability, and continued absence of debt, has lowered the risk of failure in the eyes of the system. While the risk of failure has eased, most of the red flags for manipulation have persisted.
Figure 2 shows a snapshot from PDD Holdings’ full risk report for 2022. The risk score for 2022 was 59%, which is a high score for a company with a market valuation of more than US$120 billion. It is an exceptionally high score for a company with so little debt and such strong apparent growth and profitability. PDD remains above the 80th percentile of manipulation risk for all companies globally.
Figure 2. Excerpt from PDD Holdings’ full risk report for 2022
Source: Transparently.AI
Our AI system is designed to pick up on signals that it has been trained to look out for. From our system’s standpoint, PDD raises many red flags. The overview from the 2022 risk report of the assessment for the main risk clusters is shown in Figure 3.
Figure 3. Red flags in PDD Holdings’ risk report for 2022
Source: Transparently.AI
PDD warranted "extreme care" on growth signals, smoothing activity, working capital signals, investing activity and business manipulation.
Gearing warranted "high caution" even though the company has virtually no debt. The system sometimes issues this perverse warning because too little debt can be a sign that banks do not want to lend to a company. Moreover, the system detects irregularities in cash flow, income quality and accrual management.
All of these are cues for further investigation. We shall simply highlight two: Capex growth and accounts payable.
Figure 4 compares the average 3-year capex growth of PDD versus regional peers. PDD's capex growth is more than 10 times the regional and sector median. Rarely have we ever seen a company with such strong capex growth.
Figure 4. PDD Holdings’ average capex growth (from the risk report for 2022)
Notwithstanding such strong capex growth, PDD demonstrates virtually no growth in fixed assets or investments in other businesses.
Figure 5 shows the growth of PDD's fixed assets versus total assets. A number less than 1 means that fixed assets are shrinking relative to total assets. Such an outcome is practically unheard of in a business with exceptional capex growth. Other types of traditional long-term investment at PDD are similarly weak.
Figure 5. PDD Holdings’ growth in fixed assets (from the risk report for 2022)
This all raises the question, where is all of PDD's capex going? We know assets are growing rapidly but what assets?
Any user of social media, at least here in Asia, will confirm that Temu, PDD's foreign operating company, spends heavily on advertising. It probably has the heaviest advertising spend of any company in Asia, certainly many times higher than Alibaba, which is a distant second.
This suggests a strong possibility that PDD is capitalizing much of its advertising spend. While this may be legitimate, it suggests that PDD's asset quality could be poor.
This matters because the AI system identifies many signs that PDD's profitability is much weaker than advertised.
Let's turn to accounts payable. Figure 5 shows the accounts payable turnover days for PDD. This metric shows the average number of days that a company's payables remains unpaid. In the 2022 financial year, PDD took an average of 590 days to pay its vendors.
Let this sink in: PDD takes almost two years to pay its bills. For a normal healthy company, the median payables time is about 60 days. No bank will lend to a company that takes two years to pay its bills. This could explain why PDD has so little debt. That is why the system sees PDD's lack of leverage as a negative signal. T
Figure 6. PDD Holdings’ stretched accounts payable (from the risk report for 2022)
It is inconceivable that a company with PDD's stated growth and margins should be taking this long to pay its vendors. Something is seriously awry.
We could go on but we think the message is pretty clear. PDD's numbers ring alarm bells that investors should question.
On 26 August, 2024, PDD's stock price fell 30% in a single day, erasing $55 billion from its market value. The stock collapsed after PDD missed market estimates for quarterly revenue and issued a downbeat assessment of the firm's Chinese and international sales outlook.
Speaking on the earnings call with analysts, Co-Chief Executive Chen Lei said,
"We will enter a new phase of high-quality development that calls for increased investments and our profitability will be affected as a result."
This, from a company that already demonstrates absurdly strong capex and asset growth. It's possible that the company can no longer afford the promotion-led sales growth of former years and must pivot its capex spend, perhaps to infrastructure.
We suspect that Chen Lei's projection of weak profitability for the company is well founded. This risk was well flagged in the Transparently.AI risk report for 2022, which we discussed in the original version of this report in 2023.
Disclaimer: Views presented in this blog are the author’s own opinion and do not constitute financial research or advice. Both the author and Transparently Pte Ltd do not have trading positions in the companies it expresses a view of. In no event should the author or Transparently Pte Ltd be liable for any direct or indirect trading losses caused by any information contained in these views. All expressions of opinion are subject to change without notice, and we do not undertake to update or supplement this report or any of the information contained herein.