Pinduoduo's Secondary Offering, Insights From New Economy Index

About: Invesco China Technology ETF (CQQQ), FXI, IQ, KWEB, MEIT, PDD, Includes: BABA, BIDU, CTRP, NFLX, TCEHY, TCTZF
by: Chinese Internet Weekly

The share price of Pinduoduo plunged following an upsized secondary offering. I argue that investor interest was below company expectations but nonetheless, it is an excellent time to raise money.

The January China New Economy Index is released and it throws out a couple of interesting insights.

Watch out for the possible quarterly results announcement of iQIYI and the management response to the recent admonition by the state media.

The post-IPO price movement of Maoyan Entertainment could shed some light on the sentiment towards Chinese internet stocks.

By ALT Perspective

In this week's issue of Chinese Internet Weekly, following the discussion on the underperformance of Pinduoduo's (PDD) share price, I provide my takeaways from the January China New Economy Index as well as my market outlook.

As explained in a past issue of the Chinese Internet Weekly, I found the top constituents of the KraneShares CSI China Internet ETF (KWEB) (CQQQ) (FXI) to be more relevant to the sector. Hence, allow me to provide an overview of the week's share price movements of the top few holdings of KWEB as compared with the ETF itself for an overview and convenient reference during the discussions in the subsequent sections. Note that there are substantial changes in the top holdings of KWEB which I detailed in the previous issue of Chinese Internet Weekly.


Data by YCharts

Pinduoduo's Secondary Offering

From the earlier stock price movement chart, readers should have noticed the obvious underperformance of Pinduoduo relative to KWEB and the other top holdings of the ETF. The Shanghai-based company, with a strong base of rural customers and calls itself "an innovative and fast-growing "new e-commerce" platform", announced a secondary offering on Tuesday after the market closed. Besides new shares, it also involves the sale of 14.815 million ADSs by selling shareholders including Banyan Partners, Sun Vantage Investment, and Lightspeed China. The profit-taking move follows its IPO lockup expiration last month.

The share price of Pinduoduo fell further after a filing revealed an upsizing of the follow-on public offering. Based on Friday's close, the stock is lower by 10.4 percent for the week, leaving it only $0.95 higher than the $25.00 at which the ADSs are priced to sell in the offering - a paltry discount for the subscribers.

The market reaction is appropriate given that more shares are offered ostensibly due to a tepid reception by prospective investors resulting in the bankers having to lower the offer price, rather than a consequence of overwhelming interest. My deduction stemmed from the fact that Pinduoduo had earlier indicated it aimed to raise up to $1.25 billion from the exercise but based on the final pricing, it could only achieve $1.00 billion or up to $1.21 billion if underwriters exercise an option to purchase additional shares within 30 days.

There were unsubstantiated speculations that Pinduoduo needed to raise money following a programming bug that allowed the unlimited redemption of coupons. A company spokesperson had claimed that the actual loss was less than $1.5 million, much lower than the nearly $3 billion as reported by some media. However, the boilerplate justification by the company for the fundraising did little to dispel the rumors.

The Company expects to use the net proceeds from the proposed offering to enhance and expand its business operations, for research and development, and for general corporate purposes and working capital, including potential strategic investments and acquisitions."

Regardless, it has been obvious that it is only a matter of time Pinduoduo needs to enter the capital markets again. The e-commerce player is facing multiple challenges, including hefty operating expenses and constrained cash flows. Its total operating expenses on a trailing-twelve-months ("TTM") basis is around $2.3 billion. As a percentage of its revenue on a quarterly basis, its operating expenses remained unsustainably high at 115 percent as of the last reported quarter. Despite making billions in revenue, its cash from operations on a TTM basis was only $80.2 million.


Data by YCharts

In any case, it is an opportune time for Pinduoduo to go cap in hand to investors, whether it needs the money or not. Its stock price has risen 76 percent from the trough in November, before the slump last week. Even after the plunge following the offering announcement, the share price is still 51 percent higher, far outpacing the gains by its internet peers such as Tencent Holdings (OTCPK:TCTZF) (OTCPK:TCEHY) and (CTRP). The KWEB ETF only gained 5 percent in the same period. With the market still enamored with its growth story, company executives are doing the right thing by 'striking the iron while it's hot'.


Data by YCharts

China New Economy Index For January 2019 Revealed Interesting Trends

The Mastercard Caixin BBD New Economy Index ("NEI") reading for January 2019 dipped slightly to 28.8, retreating 0.3 ppts from December 2018. The gauge indicates that the New Economy accounted for 28.8 percent of overall economic input activities last month. This is the lowest reading since May 2017 when the index was at 28.2. The decline is attributed to a larger extent a reduction in capital inputs, along with a gradual decrease in labor inputs.

Mastercard Caixin BBD New Economy Index ("NEI") reading for January 2019 dipped slightly to 28.8

The average monthly entry-level salaries for the New Economy have stagnated at a lower level since March 2018, after a strong run-up in the heady days of 2016-2017. Hiring in the New Economy sectors accounted for a smaller share of the total economy in January as compared to the prior month. The compensation share of the New Economy also shrunk by 0.5 ppt.

Mastercard Caixin BBD New Economy Index ("NEI") reading for January 2019, monthly average entry-level salaries

The so-called premium of the entry-level salary offered by the New Economy relative to the broader economy sunk further to 2.6 percent, establishing a new low since the index was published. The premium was as high as 17.2 percent back in March 2016. Apparently, the wider pool of talent available as the New Economy matures coupled with the necessity for the other sectors to provide more competitive compensation helped narrow the delta.

Looking into the employment by type, it was found that food couriers achieved the fastest growth in average salary with an increase of 132 percent, thanks to the 126-fold jump in the number employed. This is not surprising given the surge in food delivery orders in recent years led by heavy marketing from the likes of Tencent-backed Meituan Dianping (MEIT) and Alibaba's (BABA) Call center operators are a distant runner-up with a one-third increase in salary supported by a 53-time expansion in ranks. Again, the sharp rise is expected as phone support is instrumental in providing guidance to users of a multitude of apps and resolving customer complaints.

growth in employment numbers and average salary of china new economy - Mastercard Caixin BBD China New Economy Index January 2019

Market Outlook

News flow from China has been thin last week as the country celebrated Chinese New Year with a week-long holiday. Many Chinese citizens are on a longer break due to personal leave or company-instituted closure before and/or after the official holidays. Markets in Shanghai and Shenzhen will reopen on Monday while the stock market in Hong Kong has already resumed last Friday. Hong Kong stocks ended weaker on the first trading day after the holiday break following downbeat news of President Trump dismissing the possibility of a meetup with Chinese President Xi prior to the end of the truce. The firm stance by the U.S. president diminished hopes for a quick resolution in the U.S.-China trade tensions.

The leading Chinese video-streaming provider iQIYI (IQ), dubbed the Netflix (NFLX) of China, is expected to report its Q4 2018 and full-year results sometime this week. The market will be all eyes on its already high historical cash burn for signs of further escalation. Besides an astonishing level of cost of goods sold, it also has a staggering mountain of purchase obligations from its non-cancellable agreements for licensed copyrights.

Shareholders of iQIYI would also be keen on what the management has to say in response to a recent admonition by the Chinese state media. Its hugely popular costume drama series Story of Yanxi Palace, a Qing dynasty tale of scheming concubines and palace intrigue, has apparently incurred the wrath of the Chinese government. The Beijing Daily magazine published an article condemning the opulence and negative social behavior featured in imperial dramas. Following that, several similar shows were pulled off the screens of publicly-aired television channels and replaced with other programs.

The majority shareholder of iQIYI, Baidu (BIDU), is also scheduled to release its quarterly results.

On the IPO-front, Maoyan Entertainment, China's biggest movie ticketing app, debuted on the Hong Kong Stock Exchange as a listed company last Monday. Trading under the ticker code 1896, its stock was retreated by as much as 3 percent on the first day before recovering to close 1.4 percent lower than the IPO price. In the subsequent trading session last Friday, Maoyan managed to rebound and close just 2 cents shy of the IPO price at HK$14.80. The company is of attention to market players as it counts social media and gaming titan Tencent as well as food delivery giant Meituan Dianping as key shareholders with an ownership of 16.3 percent and 8.6 percent prior to the IPO. Investors are expected to closely monitor the performance of the stock which will serve as a barometer for the sentiment towards internet companies.

As for the macro-economy, China will have a busy week ahead. It is scheduled to announce its January foreign exchange reserves on Monday, followed by the January data for Foreign Direct Investments ("FDI") and vehicle sales. On Thursday, we would have the January trade figures, new yuan loans, outstanding loan growth, and M2 money supply. Inflation data and PPT would round up the week. The M2 data is useful for understanding the outlook for the general economy, as per the definition of Investopedia:

M2 as a measurement of the money supply is a critical factor in the forecasting of issues like inflation. Inflation and interest rates have major ramifications for the general economy, as these heavily influence employment, consumer spending, business investment, currency strength and trade balances."

Market players will have a field day second-guessing what the authorities will do depending on however the January data pans out. Finance Minister Liu Kun has earlier declared that a cut to the value-added tax is under consideration while the People's Bank of China, the country's central bank, has expressed its willingness to assist small and midsize businesses to obtain funding.

Disclosure: I am/we are long BABA, JD, NTES, TCEHY. 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.