JD Finance Spin-Off Is A Near-Term Catalyst

| About: JD.com (JD)

Summary

JD’s 3Q16 earnings beat earnings whilst revenue comes out at top-end of management’s guidance range.

Management upgrades revenue guidance for 4Q16 coming out tops of analyst’s forecast.

Favorable impact from this year’s Single’s day as Gross Merchandise Value (GMV) grew 59% y-y.

Three benefits from JD Finance spin-off.

I am currently long JD and am looking to accumulate further in the next few days.

Introduction:

JD.com (NASDAQ:JD) reported third quarter 2016 results that beat street's earnings estimates and revenue coming out at the top-end of management's guidance range. Management also upgraded next quarter's revenue that beat the street's estimates. All of this bode well for the long-term prospects of the JD, but the near-term catalyst in my view, is JD's announcement of the spin-off of JD Finance, which will unlock shareholder value for investors. I am currently long JD.

Third quarter results come out at above

For 3Q16 revenue, JD grew revenue by 37.7% on a year-on-year (y-y) basis to RMB60.7 billion with 1P sales growing 35.8% and 3P sales growing at 60.1%, coming out at the top-end of management's guidance of 34 - 38% growth. Their GAAP net loss of RMB921.6 million also beat the Bloomberg consensus estimate of a net loss of RMB950 million, driven primarily by better than expected gross profit margin of 15.9%, which is 40bps better than street estimates.

I think the gross margin expansion continues to show JD reaping economies of scale driven by improvements from prior investments in 1P and 3P. The 15.9% GPM they manage this quarter is also higher than last year's 13.8%, a 210 bps increase. Moving forward, as sales continue to increase for both 1P and 3P, we can expect to see JD expand on GPM.

For the fourth quarter, I think we can expect even better earnings driven by seasonality and this year's strong Single's day performance, which saw GMV grow by 59% on a y-y basis. Management has also guided for 4Q16 revenue of RMB75 - 77.5bn, which translates to a 37 -42% growth on a y-y basis, this is higher than the current street's estimates of RMB72.5bn. Over the next few days, I expect the street to upgrade their numbers to reflect management's revised earnings estimates that will see a continued re-rating of JD.

Possibility of spin-off of JD Finance to unlock shareholder value

During the results briefing, management also announced that they are considering a spin-off of JD Finance (JD Finance lends money to shoppers at JD.com). The move will see JD dispose its entire 68.6% stake in JD Finance and receive a cash infusion for their stake.

I see three obvious benefits from this spin-off; 1) unlocking of shareholder value, 2) spin-off in China to see higher valuations vs. US and 3) better credit ratings improve debt market standing.

The first benefit is obvious, the spin-off of their stake in JD Finance will see them receiving a cash infusion equivalent to the fair value of their 68.6% stake in JD Finance. The cash that they receive from the sale of their stake will give them more cash to spend on their other investments such as the online supermarket initiatives they are currently embarking on.

The second benefit is the higher valuations that the Chinese market offers relative to the US. This of course stems from greater familiarity amongst Chinese investors of the JD brand. The higher valuations will translate to a higher fair value gain and result in the realization of higher shareholder value for current investors. Based on JD's filing, JD Finance's A-round financing saw them receive valuations of about RMB46bn, which is 20% of their current market capitalization. The cash infusion from this sale will therefore be huge if JD manages to spin this off.

Lastly, better credit ratings from debt agencies. The problem that debt rating agencies have of JD is the lack of information available about JD Finance. The lack of information such as loan book and quality of the loans means a lower credit rating for JD. The spin-off does two things; 1) remove such uncertainty from the books and 2) boost the cash on JD's books. The higher credit rating that JD could receive from this proposed spin-off will improve their credit standing and result in a lower cost of funding in the future, which will improve their valuations.

Considerations

I think the main consideration at this point is how the impact from anti-brushing on 3P GMV will affect overall GMV. In my view, whilst the impact from this means a lower GMV in the near-term, JD's business model means they have an extremely high chance of controlling sale of fake goods, which translates to higher quality GMV in the long-term. This can only be good for them.

Final Thoughts

The combination of a strong results beat, results upgrade for the fourth quarter and the proposed spin-off of JD Finance sets JD up for a strong finish for 2016 in my view. I am currently long JD and will accumulate further in the coming days.

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.