PDD engages in accounting fraud and is less profitable than it claims. It's engineered to reward insiders at the expense of the public equity investor.
#1 – they are generating revenue for items refunded to pad their profitability numbers
Like some other companies (looking at PayPal here), they take a percentage of the sale even if the item is refunded. In the case of PDD, they use this as an opportunity to misrepresent their revenue and earnings in China significantly. They claim to be subsidizing the Chinese consumer in their marketing. They advertise merchandise at impossibly low prices to generate sales, then they refund the customers. All of this shows up as revenue, and each of these refunded orders has a high profit margin to PDD.
Given their use of other entities to misrepresent their financials, and given that no merchant would go into business on the platform just to lose massive amounts of money to PDD by fulfilling none of the orders, this is another case of moving money from the left hand to the right hand to make their financial look more solid than they are.
A buyer in China talked about this, with regard to Apple iPhones: https://www.reddit.com/r/wallstreetbets/comments/vxaihh/pinduoduo_potential_1billion_usd_financial_fraud/ – “PDD started its dramatic promotion activities 'Billions Subsidies', which means that PPD promises that they will spend more than a Billion RMB as Subsidies to help lower price of goods sold on their platform as a strategy to attract customer and supplier, in 2019. … They do not ship the product. I waited for more than a month. They just refuse to ship the product. PDD customer service guy even ask me to apply for refund. I searched on 'Baidu', a popular search engine in China, millions of PDD cases like this happened, most of them are related to 'Billions Subsidies' Activity. They just make 'Fake Sales'. … Even if the order is canceled, refunded or in other situations, the transaction fee is not refundable to suppliers. This means that PDD can infinitely recogize its transaction revenue as they want, through 'Fake Sales'.”
And a seller in China reported on seeing phantom orders collecting their 0.6% cut for PDD, quoted in the Grizzly report: https://grizzlyreports.com/we-believe-pdd-is-a-dying-fraudulent-company-and-its-shopping-app-temu-is-cleverly-hidden-spyware-that-poses-an-urgent-security-threat-to-u-s-national-interests/ – “There were also comments on the investment forum that one purported seller on the Pinduoduo platform observed that in the early morning and in the evening, a large number of orders would emerge from the back end of PDD, which would then be canceled. Even though those orders were canceled, Pinduoduo would still collect 0.6% of those payment transactions. It is unclear about the scale of these kinds of activities, but it gives the indication that large and repeating numbers of 'abnormal transactions' are part of the PDD culture.”
#2 – PDD's main reported revenues come from online marketing services, which is inflated both by insiders and outsiders
Given the way they handle transaction revenue and market non-existent products, PDD is also directly misrepresenting their marketing revenue with ads from their own entities. There is also marketing and transaction volume from fake orders by third parties.
Because PDD is focused on cheap white label mercandise, from many merchants with similar products, sellers seek to generate fake transaction volume, generating fees for PDD, that can help catapult their products to the top of the results: “Based on our conversation with the order brushing 'expert', when people opened new shops on Pinduoduo’s platform, the owner of the shop could grant access to the order brushing expert. Depending on the terms set between two parties, for example, the new shop owner could ask for how many transactions happened during a certain time period, how many positive reviews that shop would receive, etc. The owner will need to pay fees to the order brushing expert, depending on the terms.” (from the Grizzly report)
As to the economics of how it would make sense to generate all these fake orders, there is evidence of a link between “brushing” and money laundering: “According to the article, two criminals controlled thousands of 'empty package' websites and there were about 600 million of these logistics orders [for empty package]. It was later found that these empty packages were actually used as the transaction payments of cross-border gambling. In early June [2020], police from Wuxi city arrested 40 people involved in 15 cities. The police from Wuxi compared those empty package order numbers and many of these orders appeared in two cross-border gambling money laundering cases with the total amount of funds of 7 Billion RMB.”
#3 – they have an undisclosed captive entity (Leqee), established by the founder of PDD, that allows them to underreport headcount, which was more than 4x what they put on financial statements
Blue Orca Capital revealed this a while back: https://static1.squarespace.com/static/5a81b554be42d6b09e19fc09/t/5bec448e562fa7b00abd26f5/1542210719984/Blue+Orca+Short+Pinduoduo+Inc+%28NASDAQ+PDD%29.pdf
Leqee put out job advertisements on behalf of PDD. Their own website contradicted their filings regarding headcount. Then they edited the website to reduce the number and match their filings.
#4 – accounting discrepancies overreport revenue and underreport losses significantly
Also in the Blue Orca Capital report. Misrepresentation by 30% to 100% for important figures are estimated. This includes explicit misrepresentation on different financial reports, one from PDD, the two others from entities (VIE) that it controls. The difference is a discrepancy in revenue of 36% between those reports from PDD.
#5 – their prospectus states that they're counting unsold items as 'merchandise sold'
So they intentionally inflate their figures. There's plenty of orders with unsold items, because anything that doesn't create a team purchase or anything just placed into the equivalent of a shopping cart gets counted as merchandise sold. This is to mislead an unskeptical investor about the volume of business at PDD.
#6 – they spun off the lucrative payments processing business with ownership by the executives, instead of rewarding the owners of PDD
From the Grizzly report: “Shanghai Fufeitong was formed to 'supplement' (e.g. 'displace') the payment services that Tencent has been providing to PDD. We believe the eventual goal for PDD is to use Shanghai Fufeitong to control and cash in on as much as possible of the payment transactions that Tencent is currently providing. … This game of 'hide-the-ball' allows a large amount of the cash flow generated by TEMU to be siphoned off to TEMU executives with little to no oversight or financial accountability. This is a rerun of the AliPay playbook! … Eventually shareholders found out that Alipay was worth hundreds of billions of USD, but they were not able to enjoy the fruits of that part of business as Alibaba’s shareholders. If you follow investing in Chinese companies, this sounds familiar!”
#7 – more accounting fraud and misrepresentation of revenue
The Grizzly report also notes that the figures provided regarding payments revenue and transaction services show another likely instance of accounting fraud: “How can PDD increase its transaction services revenue at a 95% annual rate, yet its transaction processing services received from its two main payment processing companies declined 10.6%? This just doesn’t make sense to us.”
The Blue Orca report shows that PDD claims third party transaction revenue as part of its own revenue figures: “PDD explicitly tells merchants that it collects no commissions, and that the 0.6% transaction fees are collected on behalf of third -party payment services such as WeChat Pay and Alipay. … We think in this case that accounting rules clearly prohibit PDD from recognizing transaction fees collected on behalf of third parties on a gross basis. But that, it appears, is exactly what they do. … This is material because it demonstrates PDD’s aggressive approach to accounting rules. It is also material because firms like PDD trade on a multiple of sales. Even if it is zero margin revenue, PDD can inflate its stock price by recording a higher top line.”
#8 – shenanigans regarding where billions in stock went
From the same report: “It was reported (Link) that the main reason for the shareholding decrease was that Chairman Huang donated many shares to different charities. However, the article below was questioning these donations because they were unable to find any information about those charity funds, either in Chinese or in English. … The takeaway from all these sources is that the correct amount of Chairman Huang’s shareholding in PDD is undisclosed. That holding is worth appx $12 Billion USD in value, at the current price of PDD. Investors don’t know if Mr. Huang really owns those PDD shares, or perhaps he is just a proxy for another party or entity, be that PDD or an undisclosed person or entity. There’s no way to know whether whoever is controlling them is waiting for the right moment to dump these shares on the market.”
#9 – it's an open secret that nobody outside the company knows the real accounting numbers at PDD
From the Grizzly report: “Even the usually promotional sell side analysts have pointed out that PDD’s accounting is akin to a 'Black Box' as disclosure becomes ever more opaque. Despite being a company with a market cap of appx $135 billion, PDD has not had a CFO since 2018. The key financial positions are a revolving door. There seems to be no accountability. The local audit partners from Ernst&Young Hua Ming LLP are in our judgment untrustworthy and have audited numerous Chinese companies whose shares have proven next to worthless in the past. … There have been at least 3 people employed as VP of Finance since 2018, plus the company didn’t even have a VP of Finance (not to mention CFO) for over a year! How can any prudent investor trust the financials of a company which had this lack of financial oversight since the day it went public in 2018? This is governance worthy of a small-cap OTC company.”
The report also notes: “Ernst & Young Hua Ming LLP has been PDD’s auditor since it went public in 2018. According to PCAOB, E&Y Hua Ming’s Engagement Partner Wei Liu was in charge of PDD’s audit for the fiscal year 2021 and 2022, but before that, another engagement partner Congyue Song was in charge of the audit from 2018 to 2020. Through searching Wei Liu’s audit history, it can be found that Wei Liu only audited another China-based company LightinTheBox (NYSE: LITB) from 2019 and 2020. Congyue Song was in charge of 21Vianet Group, Inc. (NASDAQ: VNET) from 2016 to 2018, Molecular Data Inc. (OTC: MKDTY) from 2018 to 2019, and BEST Inc. (NYSE: BEST) from 2019 to 2022.” All of the companies audited by these firms have lost more than 90% in shareholder value.
#10 – growth in China has stalled
PDD in China initially gained users from marketing and 'subsidies', which operated at a loss, and from an initial wave of people recruiting peers for deals (also at a loss with promotional freebies). It benefited from the regulatory action against Alibaba, which constrained their marketing spend. PDD is now in a weak position in China, unable to keep operating at a loss and under increased competition from Alibaba and JD. It's now reporting a profit, but it's hiding key numbers on market share and growth.
PDD stopped reporting many different relevant figures during 2021 and 2022: “GMV, active monthly active users, active buyers in the twelve-month period, annual spending per active buyer in the twelve-month period.” Not reporting the figures is both another indictment of the culture at PDD and of the veracity of their recent growth in China.
The Grizzly report mentions: “PDD’s quarterly averaged DAU has taken a big drop in Q2 2023. Because in the article, PDD’s estimated DAU in the month of March should be about 354 million (=380m – 26m), but for Q2 2023, the quarterly averaged DAU is only 238 million. There seems to be over 100 million DAU drop from Q1 2023 to Q2 2023. As we just mentioned, different analytic companies might have slightly different numbers when calculating DAU, but we do not believe a difference of over 100 million can be attributed to this. The trend is clear: PDD is sliding while Taobao is gaining ground. … The decline in PDD's DAU has also been corroborated by some other sources. For example, an account on Snowball (a popular and widely used investor forum) posted a screenshot of a part of Goldman Sachs research report from July 19th 2023, which shows that PDD’s DAU in month of June 2023 'continues to decline at -21% YoY post its app version update'. … In addition, this article ( Link ) also shows that both Taobao and JD have positive year-over-year growth in their DAUs since February 2023. Yet PDD’s DAU growth rate kept decreasing since February 2023 and its year-over-year growth rate reached over 20% decrease in month of June.”
#11 – TEMU props up the share price as it sinks the company
Just when it needs to defend its position in China, PDD is operating at an enormous loss to expand internationally. This is costing the company across several fronts: online advertising to acquire users and bring them back to the app, promotional freebies given to users, taking orders at tiny receipt sizes despite all the costs of processing an order, and of course paying for shipping by air. This might even be a decent strategy, in spite of generating massive losses, if it could be turned into a profitable segment of the business.
As reported in this article – https://www.wired.com/story/temu-is-losing-millions-of-dollars-to-send-you-cheap-socks/ – “In the US, most of Temu’s subsidies come in the form of free international shipping. WIRED looked at multiple analyses of shipping costs, including data from financial research company Haitong International Securities Group, which suggests that the cost of shipping even a small package from Guangzhou, where Temu has its warehouses, to the US is around $14. Haitong’s analysis—confirmed by the Temu insider—shows that J&T Express, the company’s logistics partner, bears some of the costs, but that Temu is on the hook for $9 or $10 per shipment. … J&T Express is due to go public soon. Analysts say the company has also been subsidizing its own clients to build its market share, but, once public, may need to reduce its incentives to improve its own profitability, with a knock-on impact on Temu’s costs. … Taking into account other costs beyond shipping—including discounts and cash coupons that Temu gives to customers, and service and administrative costs—the average amount that Temu loses on each order to the US is around $30. These figures were confirmed by the company insider, who, speaking on condition of anonymity, says that the company’s long-term target is for Americans to purchase 30 times per year from Temu, with an average order size of $50, meaning each user spends on average $1,500 a year.”
There's already a company that Americans use to purchase 30+ times a year, one of the world's most valuable brands, with higher quality products, a higher average order size, and exceptional logistics providing extremely fast shipping that is “free” — obviously, that's Amazon.
It's impossible for a company on the other side of the world, without the logistics network, built on the back of freebies and cheap stuff to get there. As soon as the 'subsidies', freebies, and marketing spend punch bowl goes away, the TEMU app becomes less and less relevant to American consumers. If customers in China are fickle about their platform of choice for cheap stuff with goofy marketing, Americans will be even less interested in this second rate company and its third rate products, with a quickness.
#12 – unsustainable business models, rewarding insiders, and fraudulent accounting are all from the same playbook
The cases of accounting fraud are too many to list them all. Luckin Coffee is a famous one. The goal is to defraud the investor.
The cases of rewarding insiders at the expense of the company are also common. PDD's payment company carve-out is a repeat of AliPay in destroying shareholder value.
The cases of unsustainable business models are found everywhere, but you'd think maybe people would see it when it's “the same picture.” The TEMU app and wish.com will have the same fate. This has propelled PDD to its highest market cap yet, all on the tale of an e-commerce company with unprecedented growth. Short-term growth that comes by borrowing from tomorrow, impairing whatever long term value could have been built instead.
An evident motive for the management at PDD is to enrich a few at the expense of those investing in the stock. Are you buying it?
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