CTI26 Notes – Pinduoduo 1Q19 – Disclosure changes, coupons, and take rates

Disclaimer: These notes are shared for informational and educational purposes only. THIS IS NOT INVESTMENT ADVICE.

These notes are for China Tech Investor podcast episode 26, listen on overcast or anchor.fm.

Pinduoduo announced earnings on May 20th 2019. But, before we jump in, let’s look at some excerpts from their SEC filings.

Disclosure changes

“Furthermore, we offer coupons from time to time to stimulate buyer engagement on our platform.” (page 58, Form 20-F filed 24 April 2019)

“Sales and marketing expenses. Sales and marketing expenses consist primarily of online and offline advertising, promotion and coupon expenses, as well as payroll, employee benefits and other related expenses associated with sales and marketing. We expect our sales and marketing expenses to increase in absolute amounts in the foreseeable future as we seek to increase our brand awareness.” (page 78, Form 20-F filed 24 April 2019)

New Disclosure

Form 20-F filed 24 April 2019:

• Page 81: “Sales and marketing expenses. Our sales and marketing expenses increased substantially from RMB1,344.6 million in 2017 to RMB13,441.8 million (US$1,955.0 million) in 2018, primarily attributable to increases of RMB11,608.2 million in advertising expenses and promotion and coupon expenses. The increase in advertising expenses and promotion and coupon expenses were focused on building our brand awareness and driving user growth and engagement on our platform.”
• Page F-26: “Advertising expenditures are expensed when incurred. Total amount of advertising expenditures and incentive programs recognized in sales and marketing expenses were RMB113,691, RMB1,259,610 and RMB12,867,833 (US$1,871,549) for the years ended December 31, 2016, 2017 and 2018, respectively.”

Old Disclosure

Form 20-F filed 26 July 2018:

• “In order to promote its online marketplace and attract more registered consumers, the Group at its own discretion issues coupons to consumers. These coupons can be used in future purchases of eligible merchandise offered on the Group’s marketplace to reduce purchase price that are not specific to any merchant. As the consumers are required to make future purchases of the merchants’ merchandise to redeem the coupons, the Group recognizes the amounts of redeemed coupons as marketing expenses when future purchases are made. During the years ended December 31, 2016 and 2017, the Group recorded marketing expenses related to the coupons of RMB76,679 and RMB321,531 (US$51,260), respectively.”
• “Advertising expenditures are expensed when incurred and are included in sales and marketing expenses, which amounted to RMB32,867 and RMB907,250 (US$144,636) for the years ended December 31, 2016 and 2017, respectively.”

Did you see that? They changed (or removed) their disclosure of “promotion and coupon expenses” by combining it with “advertising expenses”. Here’s a table that tracks the numbers across three separate filings.

Coupons

I previously mentioned how you could find the amount of coupons & promotions (a.k.a. ‘incentive programs’) in their sales & marketing expenses. You had to dig, but it was there. Pinduoduo has obfuscated that away. It is now grouped with “advertising expenses” and is called “advertising expenditures and incentive programs”, which is 96% of sales and marketing total expense. So, why even disclose this?

To me, this is a Red Flag, these changes are carefully considered, they are not accidental. Increasing obfuscation shows, at the very least, a lack of respect for shareholders. Previous disclosure indicated (see table above) the amount related to “coupons and credits” was 32% of revenues for first 9 months of 2018, up from 18% of revenues for full year 2017. In my opinion, 32% is significant and deserves to be disclosed separately.

I can only speculate, but I believe coupons [and credits] as a percent of revenue will continue its increasing trend to above 40% for full-year 2019.

In Q1’2019 Pinduoduo had a revenues of RMB 4.5 B, which was up 228% YoY but down 20% sequentially. Their first sequential drop in revenues. But, this is the same seq decline (20%) for Alibaba and quite normal in the March quarter for e-commerce in China because that is when Chinese New Year occurs.

On the Earnings Call, Colin Huang said their marketing expenses should be viewed as investments rather than expenses. The idea being that they get a return on investment in their marketing spend. I presume he means over-time they’ll get a return on marketing spend. Like all things in the future, there is uncertainty.

I note that no analyst asked about incentive programs, promotions or coupons on the earnings call.

Take Rates

Trailing 12 month take rate was 2.92%, up from 1.56% a year ago and up from 2.78% in Q4 2018.

I’ve been trying to estimate their quarterly numbers to see if there are any indicators there, but it’s not easy (and probably overkill). PDD makes this a bit difficult because they only announce certain metrics on a trailing 12 month basis. These metrics are “GMV”, Active buyers, and Spend per buyer.

So I’ve played around with my assumptions and got something I’m somewhat satisfied with. It’s not perfect, I’d prefer actual numbers of course. I have two sets of assumptions, and I’m not sure if either is correct:

1. Where the Quarterly “GMV” sequential percent change roughly matches up with the revenue sequential percent change, and
2. Where the quarterly Active Buyers sequential percent change roughly matches up with sequential percent change in Average MAU for that quarter.

I played around with a lot of other assumptions, and the majority of them show that the quarterly take rate peaked in Q2’18. (Take rate is revenues divided by “GMV”.) That is (or could be) significant because, if it is true, unless Q2’19’s take rate matches or is better, we should see a sequential decline in trailing 12 month take rate. That would be a first for Pinduoduo.

While doing this analysis I was curious what Alibaba’s take rates were like when they were growing. So I went back to Alibaba’s filings and they averaged around 2.44% per quarter in the 16 quarters from Jun-2011 to Mar-2015 with a high of 3.05% in Dec-13 quarter. For 12M ended Mar-2019 Alibaba’s take rate was 4.5%. [Note: I said 5.65% on the podcast, but that was wrong!]

For comparison, Alibaba’s annual active customers is 654 million for Mar-2019 versus 443.3 million for Pinduoduo in the same period. Also, Alibaba’s mobile MAUs were 721 million in Mar-2019 quarter versus 289.7 million for Pinduoduo.

Interestingly, Alibaba’s annual active customers is BELOW MAUs, which Pinduoduo’s is ABOVE (and always has been). But that wasn’t always the case:

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