Alibaba Group (BABA -0.22%) and Pinduoduo (PDD -2.18%) are two of the largest e-commerce companies in China. Alibaba served 1.3 billion annual active customers globally at the end of fiscal 2022 (which ended in March 2022), including over 1 billion customers in China, while Pinduoduo reached 882 million annual active buyers in the first quarter of 2022.
But over the past 12 months, Alibaba's stock has declined about 25% as Pinduoduo's stock surged more than 40%. Let's see why that happened, and if Pinduoduo will remain the superior Chinese e-commerce play in 2023 and beyond.
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Alibaba faces long-term challenges
Alibaba's two largest Chinese marketplaces, Taobao and Tmall, provide consumer-to-consumer and business-to-consumer transactions, respectively. Both marketplaces generate most of their revenue from higher-margin listing and transaction fees. However, COVID-19 and macro headwinds have been curbing the growth of both platforms over the past year, while China's antitrust regulators are exacerbating that pressure by banning Alibaba's exclusive deals with merchants, forcing it to rein in its aggressive promotions, and closely scrutinizing its past and future acquisitions.
Alibaba's retail ecosystem also includes a growing mix of lower-margin businesses -- including its business-to-business platform Alibaba.com, its cross-border AliExpress and Kaola marketplaces, its brick-and-mortar Freshippo grocery stores, its overseas marketplaces in Southeast Asia and Turkey, and its Cainiao logistics unit. Alibaba has been increasingly relying on these lower-margin businesses to boost its total commerce revenue and offset the slower growth of Taobao and Tmall.
That shift is worrisome, since Alibaba generates all of its profits from its Chinese commerce business -- which in turn subsidizes the long-term expansion of its unprofitable cloud, digital media, and innovation initiatives divisions. In other words, Alibaba's core profit engine seems to be stalling out and curbing its ability to expand its digital ecosystem.
Pinduoduo is growing at Alibaba's expense
Pinduoduo operates a simpler business model that doesn't include any lower-margin cloud or digital media services. Its core business-to-consumer marketplace, which also generates most of its revenue from listing and transaction fees, disrupted Taobao and Tmall over the past several years by encouraging shoppers to team up on bulk purchases of lower-end products. That early success fueled Pinduoduo's expansion across China's lower-tier cities and enabled it to expand its agricultural business -- which cuts out middlemen retailers and delivers fresh produce directly from farmers to consumers.
In 2021, Pinduoduo phased out its lower-margin first-party merchandise business and reined in its marketing expenses. That strategic shift enabled it to finally turn profitable that year even as the COVID-19 and macro headwinds in China throttled its top-line growth. It also launched its first U.S. marketplace, Temu, in September 2022 to challenge Amazon's third-party marketplace, Alibaba's AliExpress, and lower-end marketplaces like ContextLogic's Wish in the discount market.
But most importantly of all, Pinduoduo wasn't as closely scrutinized by China's antitrust regulators as Alibaba. Therefore, the new restrictions against Alibaba could make it easier for Pinduoduo and other smaller Chinese e-commerce companies to pull merchants and shoppers away from Alibaba's Chinese marketplaces.
Which company is growing faster?
Alibaba and Pinduoduo face similar challenges in China, but the former is growing much slower than the latter. Alibaba's revenue rose 19% in fiscal 2022, but its adjusted earnings declined 19% as it ramped up its spending on its lower-margin businesses. Analysts expect its revenue and earnings to both increase about 3% in fiscal 2023 as its Chinese commerce business continues to struggle with macro, COVID, and competitive headwinds. Its cloud business should also generate slower growth as large organizations rein in their software spending to deal with those near-term challenges.
Pinduoduo's revenue rose 58% in 2021 as it posted its first full-year profit. That growth was driven by the expansion of its agricultural business, which is disrupting supermarkets with its farm-to-table approach, and its evolution from a discount marketplace into a business-to-consumer behemoth that is now luring higher-end brands away from Alibaba and JD.com. Driven by that momentum, analysts expect Pinduoduo's revenue to increase 39% in 2022 as its earnings per share more than quadruple.
The valuations and verdict
Investors should take analysts' expectations with a grain of salt, but Alibaba clearly faces more near-term headwinds than Pinduoduo. Alibaba only trades at 10 times forward earnings, compared to Pinduoduo's higher forward price-to-earnings ratio of 20, but this market leader also deserves to trade at a much lower multiple than the faster-growing underdog.
I wouldn't rush to buy any Chinese stocks until the COVID situation stabilizes and the delisting threats in the U.S. are formally resolved. But when those headwinds finally dissipate, I'd definitely buy Pinduoduo -- which is growing faster, operating a simpler business model, and largely avoiding the scrutiny of antitrust regulators -- instead of Alibaba.
