Aswath Damodaran, the “dean of valuation,” says company valuation is the interplay between stories and numbers. Every number that makes up a valuation has a story behind it. Every story about a company has a number attached to it.

Tech growth stocks epitomize the interplay between stories and numbers. We might not like to admit it, but we’re enamored with these firms’ rapid ascension, disruptive innovation, turf wars, and occasional meltdowns. They’re Michael Bay blockbusters, with slightly more intelligible plotlines.

Michael Norris is a TechNode contributor and Research and Strategy lead at AgencyChina. Opinions expressed here do not necessarily represent TechNode’s editorial stance. TechNode has not independently verified the claims made here.

The growth story of Pinduoduo has been described as “miraculous.” It’s the fastest-growing e-commerce scale-up in China, cracking the RMB one trillion (about $141 billion) in transactions milestone in less than half the time it took Alibaba and JD. That, alongside a few other numbers, tells the story of an irresistible force shaking up China’s e-commerce landscape. If you took that story to the bank and picked up PDD shares at IPO, you’d be up 150% right now.

PDD’s growth story is on the verge of a plot twist: revenue growth is weaker than it should be. Questions are also mounting over its subsidy scheme. Here’s why it needs to write a new chapter better suited to its current circumstances, before investors get wise and start asking tougher questions.

Houston, we have a monetization problem

Two issues threaten to derail PDD’s tale of incredible growth and disruptive innovation.

The first is revenue growth. PDD’s revenue growth has missed analyst estimates two quarters in a row.

A quick word on PDD’s revenue: 90% comes from “online marketing services”, not commissions from e-commerce transactions. “Online marketing services” include keyword bidding and advertising placements such as banners, links, and logos. 

That means the best gauges of revenue health are the number of merchants on PDD and their online marketing services spend.

If you buy into PDD’s current growth story, this is probably why: the scale of its e-commerce marketplace approaches Alibaba.

Here’s what those figures look like, per PDD’s annual report: Where do your eyes gravitate when you see this table?

Pinduoduo financial numbers
(Image credit: Michael Norris, TechNode)

I look at the last line. Merchants are spending next to nothing on online marketing services, despite massive increases in GMV. That RMB 5,257 per year works out to just $61 a month. The 64% increase looks impressive, until you realize it comes from such a low base.

But maybe it’s not the average merchant who matters, but the big ones. We’ll assume the Pareto Principle applies to PDD’s online marketing services revenue, whereby 20% of merchants are responsible for 80% of revenues.

Under these assumptions, top merchants might be spending an average of RMB 21,030 on PDD online marketing services. That’ll buy you one-tenth of a front-page banner on Taobao.

Scale vs advertising

PDD’s online marketing services are either cheap-as-chips, or merchants are parking their money elsewhere. On paper, Pinduoduo’s online marketing services, particularly keyword bidding, should follow a tight supply and demand model. Low per merchant revenue suggests that few merchants are keen to shell out .

In the short-term, PDD can divert attention away from low merchant spend by trotting out the hackneyed line that advertising revenue will pick up with increases in platform GMV and user expenditure.

However, there’s plenty of evidence that scale doesn’t automatically translate to big digital advertising bucks.

Given that Pinduoduo is already China’s second-largest e-commerce platform by users and third-largest by GMV, it’s only a matter of time before savvy investors ask why merchants aren’t spending more on digital advertising and preferred product listing slots.  

Subsidy accountability

The second issue that threatens to derail PDD’s growth story relates to subsidy accountability and investor relations.

PDD has never had a CFO. The previous VP of Finance departed in April 2019 (Chinese). The company is on the search for a CFO as it continues a subsidy program that is the longest ongoing subsidy program in China’s e-commerce history.

PDD’s growth story must change before investors realize GMV growth isn’t attracting more online marketing services revenue.

The subsidy program’s results are worth standalone treatment outside this article, but here’s the CliffsNotes version:

Supporters have argued the subsidies have given PDD more users and engagement. Detractors have argued the short-term spike in platform GMV masks issues with stubbornly low user spend and is too high a price to pay for continued losses.

Two charts show why Pinduoduo desperately needs an adult in the room to run a ruler over the subsidy program.

The first chart looks at GMV growth. It suggests subsidies may have been a stopgap to arrest declining sequential change in trailing 12-month GMV growth, but they didn’t work for long.

The second chart shows PDD’s cash and cash equivalents. This is, in part, a measure of how much free cash PDD has got on hand to commit towards its growth. Its subsidy program has cut that number by half.

Together, these two charts suggest that Pinduoduo may be overpaying to fight gravity. Any future CFO must determine whether it’s in the company’s best interest to continue a subsidy war with Alibaba, JD, and Suning. As I will discuss below, there are uses for cash other than incinerating it to juice metrics.

In addition to needing a CFO, Pinduoduo is walking on a few eggshells. It’s been called “the largest bubble in Chinese internet history” by Guosheng Securities (Chinese). The folks at Guosheng reckon PDD is subsidizing merchants and users, running up losses to keep products on the platform artificially cheap. This, they contend, is what’s driving PDD’s GMV growth. PDD has been suspected of not having the right payment clearance processes in place (in Chinese). All this signals a mounting level of market and regulatory scrutiny as Pinduoduo gets a seat at the big boy table.

A new story for Pinduoduo

If you buy into PDD’s current growth story, this is probably why: the scale of its e-commerce marketplace approaches Alibaba.

The story has worked wonders so far. Pinduoduo added $15 billion in market capitalization between Q1 and Q4 2019. That works out to roughly $100 in market capitalization for each user it added over the same period. Clearly, investors have high expectations for what PDD can do with its scale.

The warning signs covered earlier could sour these expectations. Even with PDD’s strong growth, merchants aren’t spending big on online marketing services, leaving a hole in revenues. And that’s not to mention macroeconomic or pandemic-induced headwinds that may dampen digital advertising spend or consumer confidence.

PDD’s growth story must change, before investors realize GMV growth isn’t attracting more online marketing services revenue.

PDD’s new narrative should center on its war chest.

The company raised $1 billion in March. That follows a similar-sized debt financing round in September 2019. That was after a follow-on equity raise in February 2019, also to the tune of $1 billion. Get the picture? PDD is a money-raising machine.

At present, Pinduoduo has a good chunk of these proceeds (and more)—about $5 billion—stashed away in highly-liquid short-term investments.

This war chest creates an opportunity for Pinduoduo to mold itself into a Tencent-like investor. The latter’s investment record is stellar—of the 800 companies Tencent has invested in, 160 hold unicorn status. Of these, five have generated returns of more than $1 billion, six have generated returns of more than $5 billion, and one company (unnamed) has generated returns of more than $10 billion.

Even if Pinduoduo doesn’t quite match Tencent’s lofty returns, their eye for disruptive commerce models could still be highly lucrative—think GGV Capital, who focus on spotting opportunities that transfer between developed and developing economies.

An appetite for change?

I predict that a combination of business challenges and increased scrutiny will make it challenging for Pinduoduo to keep parroting its previous growth story this year. But I’m not sure how much narrative shift the company is up for.

The company’s success to date and its current share price are powerful forces that could tempt it to stay course. Why rock the boat, especially when you have the mother of all scapegoats—COVID-19—up your sleeve?

We won’t have to wait long to find out. Pinduoduo’s Q1 2020 earnings will be with us very, very soon.

Correction (May 12): An earlier version of this article wrote that Pinduoduo added $15 billion in market capitalization between Q1 and Q4 2020. In fact, this happened between Q1 and Q4 2019.

Correction (May 14): A previous version of a chart in this article incorrectly labelled LTM GTV as Quarterly GMV. It also wrote that Pinduoduo’s CFO stepped down in April 2019. Pinduoduo has never had a CFO, and it was the VP of Finance who stepped down.

Michael Norris is a TechNode contributor and Research and Strategy lead at AgencyChina. He focuses on how culture, technology, and digital trends affect industry and business. Michael is a TechNode Insider.