What does Tiger Global see in JD.com?
"If I have seen further than others, it is by standing upon the shoulders of giants." - Isaac Newton
Value investors thrive on having an edge over other investors due to deep fundamental research. So it's evident that for investors that want some of the best insights into ideas, it's a huge positive to know how hedge funds think about positioning or why certain ideas are longs while others are shorts.
I've attempted to do the same level of research done at a lot of these research-intensive hedge funds, and my findings have been remarkably similar to that of the great Tiger Global.
Who is Tiger Global?
Chase Coleman founded Tiger Global and has achieved an annualized return of 20% after fees since inception. The firm is known for selecting some of the best companies in the market as its team is very rigorous with its due diligence process.
Chase Coleman is known as a "Tiger Cub." Tiger cubs came from the teachings of the legendary Julian Robertson. He was one of the greatest investors and the crazy thing about Julian was that not only was he an amazing hedge fund manager, but he was an amazing mentor. He trained so many investment greats today like Lee Ainslie of Maverick Capital, Chase Coleman of Tiger Global, Mark Yukso of Morgan Creek, Steve Mandel of Lone Pine, and Andreas Halvorsen of Viking Global.
Julian Robertson had a famous saying, "We buy the best and short the crap."
Tiger Global is a long/short hedge fund focused on finding the best companies and shorting the worst. To make it in its portfolio, it goes through a rigorous process of DEEP fundamental research.
In this article, I attempt to explain to you what aspects of JD that's particularly appealing and why it's considered a "great" company.
JD has two distinctive and obvious competitive advantages.
- JD controls its own logistical infrastructure, which allows it to control delivery quality, speed, and accuracy. If done correctly, the delivery process adds a lot of consumer mindshare as a word of mouth effect impacts the e-commerce reach. JD has grown faster than the industry's CAGR of ~30% because of this distinctive advantage.
- JD's obsession with controlling the authenticity of its supplies. Although most won't consider this to be an edge in the U.S. This edge will be very apparent when the Chinese consumers spend more money for goods that require authenticity verifications. JD has taken advantage of its platform and its reputation for never selling a counterfeit to team up with global brands to offer consumers authentic products. If JD continues its pursuit of never selling a counterfeit, then it can take mindshare from consumers.
To explain in length why other competitors can't do this would take a great deal of page space, so I will attempt to highlight it below:
- Chinese logistical infrastructure is very dated. Couriers ride bikes with capacity of 5-10 packages per delivery. The quality level of these mom and pop couriers are rock bottom, but so are the prices. Due to the competitive landscape, and low barriers to entry into the shipping business in China, there are currently ~35,000 couriers competing against each other for business. Alibaba's Taobao has always had a problem getting the packages delivered in a timely manner, and so has its Tmall platform. Customer's number one complaint is the unreliability of the shipping and the quality it's delivered in. Some packages would be delivered damaged, which then would frustrate customers to have to pay for return packaging. JD, on the other hand, would send delivery personnel to pick up return packages saving consumers from the hassle of having to pack and ship the packages themselves. Due to the competitive landscape, industry competitors are deterred from investing heavily in the quality of its delivery system, and the speed in which it delivers products. Because shipping rates are so low ($1.50 to ship a product), companies do not find it enticing to invest in logistical infrastructure. This combination of massive competition, low barriers to entry, and low economic return will make JD the leading logistical company in China with the capacity to ship to 144 cities on the same day.
- A bulk of the current e-commerce sales belong in the C2C segment of the market. Market research has indicated that C2C comprise 60% of e-commerce sales with C2C contributing far less by 2020 (35%). As JD belongs in the B2C segment, Alibaba's Taobao is currently dominating the C2C market with 80% market share, while its Tmall (B2C) platform is 50% of the market. One aspect that makes JD so attractive is that there's no way to control counterfeits in the C2C market as Taobao relies on third-party suppliers to sell and ship products directly to consumers. This aspect of the business is overlooked many times as Alibaba is currently producing amazing quarterly profits. But similar to eBay and Amazon, eBay's scale became its own worst enemy as counterfeits began ruining eBay's reputation. Alibaba's Taobao has already started facing allegations that more than 60% of its products are counterfeits, but it's not physically possible to control counterfeits with no warehouses to verify the third-party goods, or the delivery channel that can quality check each product. Tmall faces the same issue as third-party delivery services deliver products, which could be damaged or swapped out for counterfeit goods during the delivery process.
Economies of scale - there are massive economies of scale. As Richard said in an interview, "We strive to sell something that's worth a dollar for $0.90, but make the same amount of profits as if we sold it for a dollar. That's how we can offer a value proposition for consumers and suppliers. The only way to get there is through scale." As JD builds out its logistical infrastructure, which is planned for 2018, its scale would reach 80% of China's population. This combined with JD's ability to offer suppliers end-to-end quality control will allow it to dominate its competitors.
Network effect - The network effect is massive. JD does not spend its marketing dollars on ads. It spends its marketing dollars on providing the best possible user experience it technically can. Because of this strive for customer excellence, the word-of-mouth marketing effect has allowed JD to grow its active customer base from 29.3 million in 2012 to 118 million in 2015 or a CAGR of 41.6%.
Intellectual property rights - Surprisingly, most of JD's intellectual property rights are in its logistical infrastructure and software. JD has more remarkable inventory turnover ratios than the likes of Wal-Mart, Amazon, and Costco. Its operating cost is half of Amazon clocking at 8% versus 16% respectively. Part of it has to do with labor costs, but JD is more efficiently operated, thanks to JD's superior cost tracking system.
Switching costs - The switching cost for buyers is low. As competitors could offer products at either the same price or lower prices. But buyers would also have to content with no free same day delivery, so the tradeoff is quite significant. Would a buyer be willing to not get his/her product the day he/she orders it to save 10-20 RMB? I don't think so. The implied hidden cost of switching is the customer's propensity and desire to want to receive the product the same day.
Corporate Culture - Richard is intense in the way he manages his team. I've spent hours figuring out what drives JD and its employees. Richard repeatedly tells his employees, "If we don't work hard today, we die tomorrow." He also does not tolerate lying whatsoever. There's been a lot of media coverage over why Richard fired some of his executives. One story Richard told the media was a senior executive that instructed his secretary to clock in for him (Yes, all executives have to clock in.) This was discovered by Richard, and the executive was gone immediately. Although the corporate culture is intense, honest, and high-spirited, Richard and his team have been able to attract the best of the best. The recruiting system at JD is one of the finest tuned recruiting system in the world. Each year, JD would hire 100 college graduates straight out of College. The requirements are that each individual come from a harsh family background, is intensely honest, and motivated to the hilt. During the interview process, each candidate goes through three levels of formal examination to test the individual's ability to think on the spot. In the final level, each individual is given an essay topic that wouldn't be revealed until the day of the exam. It is rumored that JD would send out employees with knowledge of what's on the essay topic to inform candidates the answers in exchange for money. Some have even said that there's actually no essay, but merely a test of the individual's integrity. Given that more than 60,000 apply each year, I'm going to go out on a limb and guess that the process is more than intense.
Using Porters 5 forces of Competitive Rivalry
Bargaining Power of Customers (can prices be raised regularly without impacting sales?) - Customers have all the power in the e-commerce business. As consumers are extremely price sensitive, it is the retailer's job to lower its costs and offer consumers the lowest price.
Bargaining Power of Suppliers - As JD scales up, its bargaining power with suppliers increases. Economies of scale kicks in, and given that JD is an outlet to massively release products, suppliers would be willing to give JD deals.
Threat of New Entrants - It is always easy to open an online store. The problem is getting the scale needed to make it profitable. The possibility of a competitor entering the Chinese market now and compete again JD or Alibaba is slim to none as the barriers to entry is too enormous.
Threat of Substitute Products - Physical retail shops are in structural decline. Competitors like Alibaba offer "substitute products." But no one can offer same day delivery with the same guarantee as JD.
What does Tiger Global think JD is worth?
In essence, Tiger Global believes that the total addressable market (TAM) for e-commerce in China will reach $1.3 trillion in 2022, and JD will achieve a 20% market share. That math leads to $260 billion in sales, and if JD just trades at 1x P/S, the stock would be worth over $150+.
In my premium service, subscribers got to read the letter that described the JD thesis.
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Disclosure: I am/we are long JD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.