Summary

• PDD Holdings maintained strong Q3 2024 momentum with $13.9 billion in revenue, but growth slowed to 44% YOY from 94% last year.

• Regulatory pressures and compliance costs are rising, impacting profitability and merchant relationships, with a $1.4 billion fee reduction program as a response.

• Competitive landscape intensifies as traditional e-commerce giants enter PDD's value segment, challenging its unique positioning and high take rates.

• Despite strong financial health and international expansion, I maintain a neutral rating due to regulatory, competitive, and market maturity concerns in China's e-commerce space.

Choice

PDD Holdings' (NASDAQ:PDD) Q3 2024 represents another strong growth, with revenues of $13.9 billion, even though the YOY growth rate slowed to 44% from 94% last year. Online marketing revenues were up 24% at $6.9 billion, and transaction services increased by 72% to $7 billion. It is pretty evident that PDD still has the benefits of its core strengths: massive scale, deep merchant relationships in China, and strong operations. But the real question is, will PDD be able to keep this up as the competition heats up and regulators start to engage?

Counter-Cyclical Advantages Won't Last Forever

Lots of people are impressed by Temu's explosive success in the U.S. However, PDD remains a China-based company with most of its operations based in China and a minimal presence in the U.S. workforce (even for Temu business). So PDD’s financial results still highly depend on China’s economic environment, which remains uncertain. The government’s GDP growth of 5% is not accurate in my view. The more reliable National Bureau of Statistics report shows enterprise profits fell 4.7% YOY through November 2024, with a sharper 7.3% drop in November alone, indicating significant economic pressure on businesses and consumers. This challenging Chinese environment has paradoxically bolstered PDD’s market position as manufacturers need to destock their products and consumers look for more affordable products. However, this macro tailwind may be temporary as the economy normalizes. Merchants will eventually shrink their workforce and productivity, and consumers will demand higher-quality products.

Regulatory Pressures & New Compliance Costs

As with all Chinese businesses, PDD has to do and say what the government wants. This is evident from a view of their Q3 2024 earnings call where management kept repeating "high-quality development" and “Xinzhi”, a political concept that has been pushed by President Xi recently. This is very revealing because you don't find this careful messaging in calls from JD or BABA.

I think PDD's growing market share has surfaced the company to regulatory scrutiny. Its stock price has helped founder Colin Huang the richest man in China. This may be of interest to the CCP as I think they don’t want people to get rich fast when the country is struggling. Just like Alibaba was called into question at its peak, PDD has entered the same bracket of being too big to fail. This will likely bring lots of government scrutiny (no monopoly is allowed in China in any industry). Moreover, the recent incident of the PPD merchant protest has irritated the Chinese government, which won’t allow any social unrest to happen. In response, PDD has to ramp up their ‘trust and safety initiatives’ - a dramatic shift to merchant protection from the growth-focused messaging they had earlier.

The recent regulatory requirement for e-commerce platforms to report merchant tax information is another significant development. This rule eliminates the so-called 'grey area' which previously allowed small merchants to operate with minimal tax oversight. The change not only requires substantial investment in compliance systems for PDD but also causes merchant dissatisfaction. PDD already has relatively high take rates. The additional tax burden will add more cost for their merchants who live on low margins.

Management has warned of profitability declining gradually as they implement these regulatory responses. The company will have to pay for compliance teams, strengthen merchant support systems and impose new product quality controls. The $1.4 billion merchant fee reduction program, although presented as a proactive step, essentially seems like a move to mitigate the effects of these mounting pressures.

Competitive Landscape Changes

The traditional e-commerce giants are now entering into PDD's value-focused territory, and Alibaba and others are now copying its high-volume, low-price model. While PDD does get the benefit of economies of scale in high-volume sales, this is not unique to established players like Alibaba and JD who also have the capability and resources to compete effectively with PDD. I think PDD’s retail-only platform has limitations when compared to JD and BABA, who also operate logistic networks.

PDD's supposed competitive advantages of their gamification model could show vulnerability in the future. Similar features have already started appearing on other platforms, indicating they can be easily replicated by competitors. Previously strong merchant relationships have weakened as sellers can now operate on several platforms. The company’s high take rates could come under increasing pressure as new tax regulations add a further cost burden on merchants, which could force PDD to cut its fees to keep the merchants.

PDD has recently expanded to 40+ countries and has a potential growth vector on global expansion, but is in its early stages. They have to compete with well-established players like Amazon and Alibaba's AliExpress, as well as grapple with international regulations and rising compliance costs. This global push, although still promising, doesn’t fully offset the growth ceiling they face in China's domestic market, which is still key to PDD's success.

Bottom Line

PDD has good execution and financial health, with a strong cash balance of $43.1 billion. It is a growing business this year, and they may have the ability to grow even further. Despite very good current performance and relatively attractive valuation at 8x PE, I don’t recommend buying PDD Holdings now at here.

Three key concerns are there for my outlook in total. First, as a pure e-commerce play in China's mature digital retail space, PDD has the government's pressure of preventing them from reaching market dominance, a pattern previously seen with Alibaba. Third, competitive pressures will likely increase operational costs, with an unclear impact on future margins. Most importantly, China's tech investment thesis has shifted. Instead of investing in already established sectors like e-commerce where the government retains strict control over market share distribution, investors should look for opportunities in emerging technologies and business models with still evolving regulatory frameworks. I believe that PDD's best growth days are behind it. The stock may look cheap, but growing as a $130 billion market cap giant is so much harder than when they were a $2 billion startup.