Are Pinduoduo's High-Growth Days Already Over?

Shares of Pinduoduo (PDD 0.24%) recently plunged after the Chinese e-commerce company's third-quarter numbers missed expectations on the top and bottom lines. Its revenue rose 123% annually to 7.51 billion yuan ($1.05 billion), but missed expectations by $30 million and marked the company's slowest growth since its IPO last July.

Its net loss widened from 1.1 billion yuan to 2.34 billion yuan ($327 million). On a non-GAAP basis, which excludes stock-based compensation and other one-time expenses, its net loss still widened from 619 million yuan to 1.66 billion yuan ($232 million), or $0.20 per ADS -- which also missed expectations by $0.13.

Pinduoduo's big miss raises red flags since its bigger rivals Alibaba (BABA 0.09%) and JD.com (JD 1.23%) both posted robust e-commerce growth in their latest quarters. Does this indicate that Pinduoduo's high-growth days are already over?

Image source: Getty Images.

The star that burns twice as bright...

Pinduoduo was founded just four years ago, but it gained a lot of shoppers with its group purchase model, which offers shoppers bulk order discounts for convincing their friends and family -- usually via social media links -- to team up on the same orders. Pinduoduo initially sold cheaper generic goods to lower-income shoppers in lower-tier cities, but it recently started expanding into higher-tier cities like Beijing and Shanghai with brand name goods to challenge Alibaba and JD.

During the third quarter, Pinduoduo's average monthly active users (MAUs) rose 85% annually to 429.6 million, its active buyers grew 39% to 536.3 million, and its annual spending per active buyer jumped 75% to 1,566.70 yuan ($219.20). However, those three growth metrics -- along with its total revenue -- all cooled off over the past year:

Source: Pinduoduo quarterly earnings.

It's unreasonable to expect Pinduoduo to maintain its breakneck pre-IPO growth rates, but its rapid slowdown suggests that it's struggling as Alibaba and JD expand more aggressively into lower-tier cities.

Alibaba launched its discount and flash sale platform Juhuasuan in August, and JD launched a similar platform called Jingxi in September. JD stated that 70% of its new customers came from lower-tier cities last quarter and that Jingxi was off to a strong start. Moreover, JD's revenue growth accelerated over the past two quarters -- which suggests that it's pulling shoppers from Pinduoduo.

Pinduoduo didn't offer any forward guidance, but analysts expect its slowdown to continue with about 80% revenue growth (in USD terms) in the fourth quarter.

Pinduoduo admits that it's struggling with the competition

During the conference call, Pinduoduo's VP of strategy David Liu claimed that "dominant" e-commerce platforms were forcing "well-known brands" and merchants to "take sides" with exclusive partnerships.

Liu didn't call out Alibaba or JD by name, but he called those strategies "anti-competitive" and claimed that they hurt both merchants and consumers. Liu admitted that Pinduoduo couldn't "do much to stop such behavior," but that it would continue working with its merchants "to soldier through any obstacles."

Unfortunately, Pinduoduo's rising expenses indicate that it faces an uphill battle against those two titans. Its operating expenses surged 119% annually to 8.47 billion yuan ($1.19 billion) and completely overwhelmed its revenue. Within that total, its sales and marketing spend surged 114% to 6.91 billion yuan ($967 million).

Image source: Getty Images.

Subsidizing purchases to maintain low prices

That total includes subsidies for purchases of brand name products on its platform. Pinduoduo convinces big brands to sell their products at a loss on its platform, then subsidizes the difference out of its own pocket. It considers this strategy -- which it calls its "10 billion RMB ($1.4 billion) subsidy plan" -- a key way to flush out counterfeit and low-quality goods and attract bigger brands in its push into higher-tier cities.

This strategy might help it gain shoppers and stay relevant against Alibaba and JD, but it will keep losing money on each purchase. Liu claims that Pinduduo doesn't "mind making short-term concessions" to its take rate (the percentage of revenue it retains per order) if it "paves the way for better long-term growth."

But if it continues down this path as its revenue growth decelerates, its losses could widen significantly. There's also no guarantee that shoppers will stick around if Pinduoduo stops subsidizing their purchases.

Stick with Alibaba or JD instead

Pinduoduo remains the third-largest e-commerce player in China by revenue, according to eMarketer, so it won't fade away anytime soon. It also has more active shoppers than JD.

However, it faces fresh competition from Alibaba and JD as both companies expand into lower-tier cities to offset their slowing growth in top-tier cities, its revenue growth is slowing, and its aggressive subsidization strategy will lead to wider losses. Investors should stick with market leaders like Alibaba and JD until Pinduoduo's revenue growth stabilizes and its losses narrow.