Hayden Capital 1Q18: Long Thesis for JD.com

Smart Money
  • Portfolio returned 6.6% (net of fees) during the quarter vs. S&P 500 and MSCI World Indices of -0.8% and -0.5%, respectively

JD.com (JD)

  • Renewed concern recently, about JD’s near-term margin profile for 2018-20; in the latest earnings call, company guided to a 1-2% operating margin for 2018, which is below what the street had modeled
  • Primary reason for the slower margin expansion, is increased investment in logistics and technology capabilities
  • Market’s bear case is: JD has to invest all this money back into the business, just to stay in place / defend market share; competition from BABA has woken up to the JD threat, and is posing more of a challenge
  • We’re confident the incremental ~$2.8Bn plowed back into the business over the next 3 years, isn’t just to stay still; this capital will be used to enhance its lead in categories such as FMCG, and logistics delivery capabilities
  • Similar investments have drastically raised JD’s mind-share with China’s most affluent consumers in the last year; in fact, Tier 1 city data is strong, with 68% of shoppers preferring JD over Tmall
    • The negative is, that they have lost share with Tier 3-6 city consumers, where they’ve lost ~5% share in the last year
    • There is an increasing bifurcation in Chinese shopping habits – richer, urban, and more demanding customers prefer JD.com, while those less-affluent and value-conscious consumers prefer Alibaba
  • As China’s economy continues to expand and GDP per capita grows 5-6% y/y, it will only be a matter of time before lower-tier residents have the same shopping habits as those in Beijing, Shanghai or Shenzhen
    • Product selection, quality, and delivery speeds remain the top criteria – JD beats out Tmall and Taobao on the last two and is rapidly catching up on the first
  • In terms of valuation, it’s important to note that we recently got indications of private market values for the two subsidiaries, JD Logistics and JD Finance; company separated these businesses out of the core business over the last few years, and has been raising capital for these divisions externally
  • Latest round for JD Logistics was done at a $10.9B valuation or ~$6.20/share; for JD Finance, we don’t have exact details, but the rumors are that the latest valuation is at a $20bn valuation or ~$5.60/share; company has also made ~$3/share of investments in other strategic firms (VIPS, Bitauto, Yonghui, etc), and another ~$3/share of net cash
    • Altogether, this equates to ~$18/share of total value, which lies outside of JD’s core retail business; this equates to 50% of the stock’s value
    • This implies the core retail business is valued at only $26Bn, for a company that will do $75Bn in sales this year and growing at a 25-30% CAGR
  • Even if we look at the entire market cap, it’s trading at trough multiples of 0.6x P/S and 0.25x price-to-GMV
    • It’s unfathomable that shares are now trading at valuations similar to what traditional brick & mortar stores trade at… despite growth rates 4x as high, and a massive secular tailwind from shifting demographics
    • The last time shares were at these valuations in 2016, there were rumors that the company was facing a liquidity crisis and may have trouble keeping the lights on; shares subsequently rose +150% over the next year
  • There is a possibility of a dual-CDR listing in China as early as this summer, with the first batch being the large tech companies; if it happens, this will likely provide a major catalyst for these low multiples
    • My thesis is that many of these Chinese US-listed tech companies are trading at lower multiples than they should be, since the majority of their Chinese customer-base can’t invest in these foreign-listed shares due to capital controls, and US investors have never used these platforms
    • It’s as if Amazon were listed in China, US-based investors weren’t allowed to invest in it, and Chinese shareholders had never used the site
    • What type of valuation do you think Amazon would get in that situation?
  • Chinese government is unhappy that its own citizens haven’t been able to participate in the growth of its most innovative companies, and is rapidly changing domestic listing requirements to fix that

Hayden Capital 1Q18 Letter, May 2, 2018