Wiedhower Capital – JD.com Long-Term Thesis

Smart Money
  • JD.com is the third largest e-commerce website in China
  • What makes JD.com unique is that they own their entire end-to-end logistics network. They buy products from manufacturers, store it in their own warehouses, sell direct to consumers, and even manage the last-mile delivery to the customer’s door
  • Largest competitors, Tmall and Taobao, are both marketplaces that connect buyers and sellers – they are more similar in concept to ebay. JD.com is more akin to Amazon
  • Just in the 10 years from 2008 to 2017, China’s average yearly wage went from 29,229 yuan to 74,318 (for a CAGR of 9.8%); this increasing wealth is expected to continue
  • Consumption by the younger generation is growing 1.5x faster than the overall population
  • 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. As people get more comfortable with the internet and come to trust online shopping, their purchases go up over time

Competitor Analysis

  • Tmall and Taobao are both owned by Alibaba. Taobao is the market leader, Tmall is the second, JD is third, and then there is a large gap between JD and the smaller players
  • Best estimate is Taobao’s share of the online retail goods market is in the low-30s, Tmall is in the mid-20s, and JD is in the mid-teens
  • Taobao is a consumer-to-consumer (C2C) marketplace; Tmall is a business-to-consumer (B2C) marketplace
  • Tmall is more of a competitor to JD than 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
  • While Taobao has historically dominated Chinese e-commerce, there has been a shift in preference the past few years for the higher quality and reliability that comes from the B2C segment; Taobao has been losing meaningful 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 growth 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
  • As the Chinese population gets wealthier, they will care more about convenience, delivery speed, quality, and authenticity as opposed to just price (even though JD’s logistics scale will allow them to win on price as well)
  • JD has excelled most in the largest and wealthiest Chinese cities. JD has its 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. The wealthiest Chinese are clearly liking JD more
  • Surveys show the younger generation prefers JD over Tmall; JD consistently ranks higher in customer satisfaction than Tmall and Taobao
  • JD is the only Chinese e-commerce retailer that owns a massive logistics network and that’s probably not going to change. To replicate what JD has built as a direct retailer with their own logistics network would require billions of dollars and many years
  • 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. And on and on. And once that flywheel reaches critical mass, it’s almost impossible for a competitor to catch up (Costco, Walmart, and Amazon are other retailers that have successfully accomplished this scale flywheel)

Risks

  • My biggest concern was the risk of government regulations or interventions. Throughout my research, I noticed that other big Chinese tech companies – Alibaba, Baidu, and Tencent – had far more run-ins with the Chinese government than JD had
  • While President Xi Jinping has openly endorsed and encouraged more entrepreneurship, tech innovation, and e-commerce, he is extremely strict on censorship; blogs, social media, and news outlets are where people criticize the government, not e-commerce sites
  • 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
    • I struggle to see this ever happening. Hundreds of billions of dollars being stolen from American investors would not be taken lightly. 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
  • 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
  • Largest near-term risk to JD would be losing their WeChat partnership. WeChat is the dominant chat and social media app in China – they have one billion monthly active users and the average user spends almost 2 hours per day in the WeChat universe
    • In March 2014, JD and Tencent (owner of WeChat) signed a 5-year partnership for e-commerce retailing, meaning the partnership ends in March 2019. Tencent also had a noncompete in that deal until 2022
    • As of late, JD has been getting around 25% of new clients through WeChat, so that is a very significant risk if the partnership goes south
    • Good news is that JD and Tencent recently announced a plan to expand their partnership, which probably means that it’s safe over the near to medium-term
    • Tencent bought an 18.1% equity stake in JD (Alibaba is a major competitor to Tencent as well)

Valuation

  • Beyond JD’s market share growth, the Chinese e-commerce industry as a whole has massive tailwinds behind it: a wealthier population that is consuming more and spending more time and money online. It’s not unreasonable to think that China’s e-commerce industry can grow 10x over the next 15-20 years
  • JD’s e-commerce segment:
    • Online continues to take share from traditional retail. Online is currently around 15% of China’s retail consumer goods industry. Expect online retail’s share of overall retail to keep increasing, eventually reaching over 30%
    • JD continues to take market share within online retail. Baseline assumption is JD’s current mid-teens market share can get up to the mid-20s
    • JD is able to achieve net margin goals of 3-5%. Sanity checking this against other mass retailers gives me confidence that 3-5% is very reasonable and achievable
  • JD has two other significant segments:
    • JD Logistics manages the warehousing network and last mile delivery for JD’s retail business. It became a standalone subsidiary in April 2017
    • On February 24, 2018, JD sold 18.6% of JD Logistics at a valuation of $13.4bn (meaning JD’s portion is valued at $10.9bn)
    • JD Finance provides credit to JD’s suppliers, merchants and consumers, and they handle online payments. JD Finance was spun off from JD in June 2017. JD sold its equity stake in the business, but they will get 40% of JD Finance’s pre-tax profits going forward (which can be converted back to 40% equity upon regulatory approval)
    • Current private market valuations for JD Finance are over $20bn. One reason JD wanted to spin-off this segment is so that JD Finance can expand into broader areas of the financial services industry
  • It’s tempting to strip out JD Finance and JD Logistics using their recent private market valuations and value JD’s e-commerce business separately, but the problem with doing this is the logistics and financing segments support the e-commerce business
    • They are intertwined, so I think completely removing these two segments and then assuming the e-commerce business would still be as successful as it is on its own is quite aggressive
    • On the other hand, not giving any additional value to these two segments is overly conservative
  • In addition to these two segments, JD has recently focused on growing their small advertising business
  • JD’s core e-commerce business is undervalued on its own. The business has several other segments that have significant value on top of JD. Content owning JD for its e-commerce business, while also recognizing that additional value will probably become more known in the coming years

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