Spying Accusations Put PDD In Global Hot Seat

It's been a roller-coaster ride for PDD Holdings Inc. (NASDAQ:PDD) this year, as the company that revolutionized Chinese e-commerce with its cut-to-the-bone prices tried to take its show on the road with its globally-focused app called Temu.

Shares of the company, formerly known as Pinduoduo, briefly topped the $100 mark earlier this year, tripling over the last 12 months on a surge of optimism about its prospects, including its potential to become China's next global internet success story. But they have fallen significantly since then, dropping nearly 30% from their high in late January, in a downward drive that accelerated after revelations first surfaced of suspected malware in its app late last month.

The highly anticipated Temu made a big splash in its debut last September by offering a wide range of affordable products, many priced at less than $1, allowing it to deliver impressive results in just seven months. According to data from market research firm Sensor Tower, Temu was the most downloaded app in the U.S. in the first three weeks of March, followed by video editing software CapCut, short video platform TikTok and fast fashion clothing seller Shein, all of which are Chinese-owned.

Since TikTok CEO Chew Shou Zi addressed a U.S. congressional hearing on March 23, the U.S. and its allies have significantly intensified their scrutiny of the app due to its ownership by China's ByteDance (BDNCE). Japanese lawmakers proposed banning TikTok at the end of March. The British government fined TikTok 12.6 million pounds ($15.6 million) in early April for "misuse of children's personal data." And Australian media also recently reported the government will ban the installation of TikTok on all government-use equipment.

As suspicion of China grows in the West, Chinese tech brands have become increasing targets for attacks by foreign governments and the media. Just seven months after its launch, Temu is quickly shaping up as the next potential prey in the geopolitical attack game following the latest malware revelations.

PDD's management mentioned in the company's latest earnings report that Temu wasn't a big contributor in last year's fourth quarter as it was still in its early stage of development. As part of its development strategy, PDD said it would focus on understanding customer needs first rather than financial metrics, with a goal of building a unique value proposition over the longer run as it expands into a growing number of global markets.

Team reportedly disbanded

As the malware accusations were still lingering, CNN on April 2 reported that PDD had set up a team of 100 engineers and product managers in 2020 with the task of finding loopholes in Android phones that would allow its app to collect more user data for more precise products feed. The report also cited cybersecurity researchers who believe the e-commerce platform was involved in privacy and data security violations by bypassing users' cellphone security settings, spying on the activities of other apps, and even reading private information and changing settings.

PDD's shares sank about 5% in the four trading days last week after the CNN report, closing at $72.03 last Thursday before the Good Friday holiday.

The 100-member team has been recently disbanded after initial reports of the malware broke, but it's still too early to estimate the impact of the revelations on Temu, one former PDD employee told CNN. PDD's sudden promotion of Zhao Jiazhen to executive director and co-CEO on April 4, together with Chairman and co-CEO Chen Lei, could possibly be a result of the malware revelations.

China's e-commerce platforms have been jockeying in their home market for new opportunities following Beijing's retirement of its "zero Covid" policy in December and a resumption of more normal economic activity. That activity was apparent in PDD's fourth-quarter results, which showed its expenses surged 57.7% to 21.8 billion yuan ($3.16 billion) during the period due to big spending on promotions and advertising campaigns. The company's adjusted profit also rose 43% to 12.1 billion yuan year-on-year after its revenue jumped 46% to 39.8 billion yuan.

Growing R&D spend

On a full-year basis, PDD's sales and marketing expenses accounted for 41.6% of its total revenue, far bigger than the 3.6% and 12.2% for leading e-commerce companies JD. com (JD; 9618.HK) and Alibaba (BABA; 9988.HK), respectively. That shows that PDD, which has always focused on China's smaller cities, relies heavily on finding innovative ways to reach such highly price-sensitive markets to drive revenue growth.

But Temu can't rely solely on such a model. As management has said, the company needs to understand the preferences of consumers in the markets it enters, requiring more R&D investment for areas like platform optimization, improved interfaces, and systems that can match products with likely buyers the most efficiently.

Last year, PDD spent about 8% of its revenue on R&D, which was also higher than JD.com and Alibaba's spending of 2% or less. Such spending notably rose 19% year-over-year in the fourth quarter, helping to drive a smaller but still sizable 15% increase for the year. The company explained that this was due to an increase in headcount, the recruitment of more experienced R&D staff, and higher server costs.

But given Temu's launch in the fourth quarter, the increase in R&D spending also looks related to the new platform's rollout. Now, PDD's R&D spending could continue to grow as it nurtures the platform, which could affect its future profits.

PDD's latest price-to-earnings (P/E) ratio of about 32 times is lower than Alibaba's 48 times and global online shopping giant Amazon's (AMZN) 61 times, reflecting the market's conservative outlook on the company, especially after the recent malware scandal. To avoid following in the footsteps of TikTok, PDD needs to skillfully address the malware allegations as soon as possible, and revive users' confidence in Temu.

Disclosure: None

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.