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Wiedhower Capital 1H18 Letter: JD.com

  • Two of our previous holdings, Elbit Vision Systems and Fogo de Chao, were acquired in February
  • Elbit Vision Systems and Fogo de Chao acquisitions added 1.8% to our returns for the first six months of 2018
  • 1H18 returns of 2.72% vs. S&P 500 of 2.52%

JD.com

  • Third largest e-commerce website in China; what makes JD unique is that they own their entire end-to-end logistics network; they buy product from manufacturers, store it in their own warehouses, sell direct to consumers, and even manage the last-mile delivery to the customer’s door
  • JD’s largest competitors, Tmall and Taobao, are both marketplaces that connect buyers and sellers; they are more similar in concept to ebay; JD is more akin to Amazon
  • Just in the ten years from 2008 to 2017, China’s average yearly wage went from 29,229 yuan to 74,318 (compounded annual growth rate of 9.8%); this increasing wealth is expected to continue
  • As the Chinese get wealthier, their consumption rates increase and within that trend, people under 30 are not as frugal as the older generations who grew up in a very different economy
    • Consumption by the younger generation is growing 1.5x faster than the overall population
  • Internet penetration rates still have room for growth; in 2017, internet penetration in China was 56% vs. the US at around 80%; within this, 38% of the Chinese population shopped online in 2017 compared to 67% of the American population; even the 38% of the population who already shops online will almost certainly increase their rate of purchasing going forward; as people get more comfortable with the internet and come to trust online shopping, their purchases go up over time
  • Tmall and Taobao are both owned by Alibaba; Taobao is the market leader, Tmall is second, JD is third, and then there is a large gap between JD and the smaller players (best estimate, Taobao’s share is in the low-30s, Tmall is in the mid-20s, and JD is in the mid-teens)
  • Both Tmall and Taobao are marketplaces that connect buyers and sellers – neither owns inventory or their own logistics network; Taobao is a consumer-to-consumer (C2C) marketplace – it connects individuals selling to other individuals; Tmall is a business-to-consumer (B2C) marketplace – it connects businesses selling to individuals
  • Tmall is more of a direct competitor to JD that Taobao is; Tmall focuses on higher quality goods from established brands, while Taobao is filled with cheap products that are low quality and/or counterfeit; Taobao has been losing market share the past 3 years while JD and Tmall have both been gaining share
  • Taobao, Tmall, and JD are all too established at this point to not survive for the long-term. However, JD can continue to grow their market share as they have the past 3 years
  • Controlling the entire logistics network allows JD to do a lot of things that Tmall and Taobao can’t do – like providing more consistency across everything they do, better customer service, guaranteeing authentic products, and delivery speed and efficiency
    • And as the Chinese population gets wealthier, I predict they will care more about convenience, delivery speed, quality, and authenticity as opposed to just price
  • JD has excelled most in the largest and wealthiest Chinese cities. JD has the largest market share in Tier 1 cities, less so in Tier 2 and Tier 3 cities, and then it drops off quite a bit in Tier 4-6 cities
  • Surveys show the younger generation prefers JD over Tmall
    • JD consistently ranks higher in customer satisfaction that Tmall and Taobao
  • The best thing about scale as a competitive advantage is that it increases over time; JD is the only Chinese e-commerce retailer with their own logistics network and that’s probably not going to change; even if someone started today with the money in their pocket, it would still probably take 5-10 years to replicate the infrastructure that JD has
  • As JD grows, the logistics network becomes more efficient as more revenue gets spread out across the entire network; the larger and more efficient network allows them to lower prices, which attracts more revenue; more money coming in allows them to offer broader product selection, negotiate better pricing from manufacturers, and to expand their logistics network even more
  • Biggest concern was the risk of government regulations or intervention; the number of unknown-unknown go up exponentially when investing in a country that is so different than the US
  • Throughout my research, I noticed that the other big Chinese tech companies – Alibaba, Baidu, and Tencent – had far more run-ins with the Chinese government than JD has had, and it took me a little while to appreciate why
  • While Xi Jinping has openly endorsed and encouraged more entrepreneurship, tech innovation, and e-commerce, he is extremely strict on censorship
    • Think about the US: Facebook and Google get brought up in political discussions far more often than Amazon does
    • The same thing is true in China; JD focuses almost entirely in e-commerce, which is a far more politically neutral domain
  • Another common concern with JD is the weird corporate structure that allows them to list publicly in the US; many investors think it’s possible the Chinese government pulls the plug on this foreign ownership loophole, essentially saying “We don’t want our largest companies to be owned by Americans, screw the US investors, all their shares are now worth zero”
    • Hundreds of billions of dollars being stolen from American investors would not be taken lightly. If China completely screwed over the millions of Americans who own shares in those companies, it would permanently harm many successful Chinese companies going forward as they would almost certainly be barred from the largest source of capital in the world
  • The Chinese government recently endorsed the corporate structures that allow foreign ownership in their companies; Chinese citizens currently aren’t able to invest directly into the most successful Chinese companies listed in the US, but the government is changing that; as part of this change, the government explicitly said the current structures are being kept in place

Wiedhower Capital 2018 Interim Shareholder Letter, July 1, 2018

Image Source: the Beijinger

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