2018 Interim Shareholder Letter

My 2018 interim letter is linked below. Topics include:

  • My evolution to focusing exclusively on compounders
  • JD.com investment thesis
  • Four significant changes to Wiedower Capital to help align my investment strategy with my partners and my own pay structure

Wiedower Capital 2018 Interim Shareholder Letter

As of this writing, Wiedower Capital owns shares in JD. This is subject to change.

25 thoughts on “2018 Interim Shareholder Letter

  1. Hi Travis! Enjoyed your letter very much.
    Just wondering, have you read the recent short writeup on JD by APS Asset Management that went around? I’d love to hear if you had any responses to his points.

    Also, would love to hear, what do you think about BABA’s strategy of offline integration? Would that help to cement their place in Chinese retail mindshare?

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    • Thanks Michael. I’ve read several APS write-ups about JD from the past couple years. If they put out something very recently, I don’t think I’ve seen it. I’m happy to address specific questions if you have them, but in general I felt APS focused too much on things that ultimately don’t matter—price to earnings ratio, historical losses, comparing JD to Amazon, etc.

      Personally, I make the Amazon comparison so that Americans (who are most of my readers) understand at a high-level what JD does. Beyond that, I don’t agree with many investor’s inclination to compare the valuations of the two. They are vastly different sizes, at different points in their lifecycles, operate across the world from each other, and Amazon is becoming less comparable by the day thanks to all kinds of tangential businesses they’re getting into (mainly AWS of course). My valuation and thesis for JD is not contingent upon them becoming the “Amazon of China”—it’s based on looking at China e-commerce, JD’s competitive position, and JD’s own financials. I specifically said in my letter that I don’t think JD will come to dominate e-commerce in China like Amazon has in the US. And I don’t think that’s necessary for a JD investment to work out.

      With that being said, APS has brought up some legitimate points about JD’s core business segments being commodities and if those items can be sold profitably over the long-term. We’ll see. Similar to my Interactive Brokers thesis, I can’t reliably predict the future, but if there’s a very long runway for growth in an industry and I believe a company has a better mouse trap than the competition, I’m happy to invest at what I believe to be a reasonable valuation and see what happens.

      I like both Alibaba and JD’s push to integrate more with traditional retail. Alibaba started and seems to have the lead, but JD is doing a lot as well. Alibaba probably gains mindshare thanks to their leadership position right now though. As I talked about in my write-up and I believe it relates here as well, I think JD’s ownership of the entire logistics network gives them an advantage in many areas, and integrated retail is certainly one of them.

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  2. Hi Travis,

    I found my way here after coming across your 2018 interim letter on SeekingAlpha. Solid write-up on JD (which largely mirrors my thinking–I have been very long JD as well).

    That said, I wonder what your thoughts are on two subjects:

    1) Alibaba’s attempt to develop a formidable logistics network through its substantial commitment in Cainiao:

    https://www.forbes.com/sites/jwebb/2017/09/28/alibaba-to-invest-15-billion-in-global-logistics-and-takes-a-controlling-stake-in-cainiao/#6a0e7bf1a034

    2) The recent surge by e-commerce upstart Pinduoduo, founded several years ago by a former Google engineer. As you can see from the chart in the Bloomberg article, PDD has moved ahead of JD in active daily users by capturing lower tier cities in rural areas and cleverly leveraging social media and a relationship with Tencent:

    https://www.bloomberg.com/news/articles/2018-06-30/chinese-e-commerce-platform-pinduoduo-files-for-1-billion-ipo

    Here’s a good write-up on PDD as well:

    https://www.forbes.com/sites/ywang/2018/04/06/pinduoduo-the-1-5b-startup-challenging-e-commerce-giant-alibaba-in-chinas-towns-and-villages/#7c335e2644d7

    It’s safe to say that PDD has taken both Alibaba and JD.com by surprise. I recall seeing an interview with Richard Liu last year I believe, in which he said he was “100%” confident that JD.com would be the largest B2C retailer in 5 years. I wonder if that % figure has changed over the last year at all.

    Anyway, very interesting write up. I hope for our sake that JD lives up to Richard’s prediction!

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    • Saeed,

      Good questions. Cainiao and PDD are both worth paying attention to.

      Thinking very high-level about logistics: if I wanted to have an efficient logistics network ten years from now, I think a far better choice would be to build my own and have everything integrated as one vs merging a bunch of logistics competitors into one network. I have no data to back up that thesis, but in my mind, JD’s approach has a better chance of working well in the long-term. I thought JD’s 4Q17 call had a few insightful comments about the logistics space.

      From what I’ve seen (and I haven’t had time to read PDD’s S-1 yet), PDD is more of a direct competitor to Taobao (cheap stuff, social) as opposed to JD (authenticity, vertical integration, consistent customer service). Looking at some of the extreme group discounts on PDD, I highly doubt merchants are profiting off a lot of those deals. Groupon looked like a great business for a few years until all the restaurants figured out they were losing money and not making up for it with repeat customers. Giving huge discounts to the type of customer who only cares about price doesn’t seem like a great long-term strategy to me. The fact that PDD is most popular in poor areas also tells me some of the major China tailwinds that are benefiting JD are headwinds for PDD (increasing wealth, urbanization, tier 3+ cities advancing).

      Do you have any differing thoughts on the above?

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  3. Travis, I would just put this out for thought:

    1) In Japan, Amazon relies on 3rd party logistics, yet they still have a great reputation and brand. How much of a competitive advantage will first party logistics prove to be? How much does the marginal utility to the customer move when improving your delivery time from 24 hours down to 8 hours? For the customer, is it a nice to have or a must have?

    2) Amazon is the scale leader and can spread their logistic costs over a large user base. However in China, Alibaba is the volume leader. Even though Alibaba is later on their logistics investments, I wonder if their scale advantage will ultimately prove too powerful?

    Any thoughts about that?

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    • Michael,

      Good questions, although I don’t have any great insights into the answers.

      1) My answers are: I don’t know, marginally, nice to have. I responded to Saeed’s question above about logistics and why I like JD’s strategy more than Alibaba’s, but ultimately, I can’t predict the future and I don’t know how much of a competitive advantage (or disadvantage) 1P logistics will end up being. From the data sets I’ve seen, Chinese consumers currently do care about logistics efficiency. They also consistently rate JD higher than Tmall and Taobao with respect to customer satisfaction, which is probably at least somewhat due to the better logistics and timely delivery. Finally, I’d argue that almost all public companies are offering products and services that are nice to have and not must haves. Humans survived just fine before the Internet existed.

      2) Maybe. JD has been gaining market share on Tmall and Taobao for several years and I like their logistics strategy more, but I could be 100% wrong and that market share trend could reverse tomorrow.

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  4. Travis,

    I don’t, fundamentally–I think your analysis is largely on the mark but, like any careful investor, I am continually looking to examine others’ reasoning (both in support of and in opposition to my positions). I think the key is whether JD can truly continue to improve upon their competitive advantage in terms of shipping cost, speed and quality (i.e., fewer damaged, missing or counterfeit goods) relative to Alibaba. If they can, it truly is both a scale business and a market share growth business and should be able to confer substantial benefits to shareholders for decades to come.

    I agree that stitching together logistics via Cainiao is a structurally disadvantaged (though certainly cheaper) way to proceed in terms of building an end-to-end logistical network, but I suppose much depends upon the execution of it. In the Forbes article it is noted that Alibaba’s stated aim is to have the most efficient logistics capability of anyone in the world, including the ability to deliver anywhere in China within 24 hours. Cainiao is already infused with big data and analytics capabilities and is pushing aggressively into unmanned delivery via drones and autonomous delivery vehicles. JD is certainly ahead in these technologies, but it remains to be seen exactly how much of a competitive advantage JD can extend over time. Richard Liu recently said that the shift of Alibaba and other competitors to managing their logistics more tightly proves the foresightedness of JD’s business model, and he’s right.

    You are right also to compare PDD to Taobao. The comparison to Groupon is apt as well. I think the ex-Google engineer who founded PDD created an amazing economic situation for himself and his family out of thin air by building out a capability that generated a massive GMV and rapid revenue growth story which, in this market, was quickly rewarded with a multi-billion dollar private valuation. But I think it has probably reached its natural limits for the reasons you cite.

    Given that PDD really can’t replicate JD’s massive logistics and economy of scale advantages, he cleverly employed social network strategies to hook in the underserved part of the market. But yes, ultimately it’s about long term free cash flow generation and growth, and I don’t see a path to that at all, unless PDD can expand to more lucrative segments of the economy which looks pretty much impossible.

    A couple of years ago, when there was some bearishness on Apple because of perceived weakness in China (Carl Icahn sold a big stake around $95/share), I eagerly bought in, and obviously have been quite well rewarded since then. I think the fundamental insight I had then was that Apple, for all its much-noted market share slippage to Android over the past few years, would continue to be the leading aspirational brand, cultivating a fervent following, premium prices, high profit margins and strong global cachet–all of which would be a multi-decade boon with global economic and demographic tailwinds. And sure enough, the last I saw, Apple generates an astonishing ~90%+ of the profits of smartphone makers worldwide. And of course by uniquely controlling its own design and manufacturing of integrated chips, hardware and software, it could continue to press its advantage over time to continually deliver a range of premium smart phones to cover a wide range of customer price points.

    The comparison to Apple is highly imperfect to JD of course because their business models and resulting economics are completely different. That said, JD in China is the aspirational brand, rather than Tmall or PDD or anyone else. The central question is whether JD will ultimately prove adept at converting Tmall customers over time to JD customers. As long as JD continues to be tops in customer service and a combination of delivery cost, delivery speed and delivery quality, I think it’s only natural that this occurs over time, particularly with the economic tailwinds you describe. Regarding Michael’s question about improving from 24 hours down to 8 hours, I’d say that, all things being equal, I personally would rather have a delivery in 8 hours (or better yet, in 2-3 hours which is becoming likelier by the day with the advance of drone technology). That represents true value to me as a customer, and it’s no wonder that Amazon is relentlessly pushing in the US to get deliveries down to same day / 2 hours via Prime Now and other means.

    So all in all, I think JD is playing a very, very long game here that will be hugely rewarded over the next 2-3 decades. I own a substantial stake and will likely never sell any shares.

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    • I appreciate the insightful dialogue Saeed. I do believe that 1P logistics is more likely to win on the metrics you listed (cost, speed, quality). Getting a bunch of low-margin companies who are highly competitive against each other to work together and somehow create more efficiencies just doesn’t seem like a fantastic strategy to me. It would be one thing if they all merged and were aligned with the same goal (which sounds like an integration nightmare), but these businesses are still trying to outcompete each other while at least somewhat cooperating through Cainiao.

      Also, I think your comment about JD’s strategy being more expensive than Alibaba’s is a big part of JD’s competitive advantage. Not that either option is easy, but I think it would be far easier for someone to create a Taobao or Tmall competitor (basically build a third-party marketplace) as opposed to someone creating a JD competitor. Replicating JD requires far more time and effort, and the reward for succeeding is an asset-heavy, lower margin business.

      Finally, I like your comment about JD being the aspirational brand vs Tmall and Taobao. I hadn’t thought about it like that before, but you’re probably right.

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  5. Yes, the more asset heavy model, lower margin business is indeed a competitive advantage–it’s more expensive for JD but less expensive for the consumer, since JD doesn’t make a profit on the shipping expense passed on to the consumer whereas 3P shippers in the Cainiao network do. Ultimately this should drive more shoppers to JD over time as JD extends and cements that advantage. As long as JD can remain free cash flow positive and long-term oriented, it can continue to grow faster and ultimately take market share.

    Michael’s question about Alibaba’s scale advantage is an interesting one, however I don’t know how they press their (current) scale advantage over a stitched-together logistics network with a bunch of different fragmented 3P warehouse, distribution center and shipment operators. It doesn’t seem like they could throw enough scale to any given partner to drive any significant cost savings leverage relative to JD on a per unit basis, particularly when you consider the profit motive I mention above. But I confess that is all conceptual; I haven’t seen any numbers one way or another.

    One other question I haven’t had the time to start getting my arms around is why JD is expanding into the US market. Taking on Amazon in its home market seems like a quixotic thing to do. Amazon is my single biggest position by far and this seems kind of like a lose-lose for both JD and Amazon. I’ve read that this move positions JD to be a major conduit of the vast amount of goods made in China that are imported to the US, a role Amazon and Walmart play now. Do you have any thoughts on that? I appreciate your thoughtful insights on this discussion as well, Travis.

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    • I agree that going head-to-head against Amazon on their home turf sounds like suicide. One of my main takeaways from the book Six Billion Shoppers was that it is extremely difficult to replicate success in countries that are very different than your own (e.g. Amazon has done well in most first world countries, but failed miserably in China).

      I’m really hoping Liu isn’t planning on taking on Amazon’s core business. JD has talked about selling Chinese goods through Walmart and they also mentioned selling Chinese goods through Google Shopping as part of their recent partnership. Even if JD launches their own website / logistics in the US, I hope it is focused on Chinese-specific goods and not necessarily directly competing with Amazon.

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  6. Well, the only thing is that Amazon sells a ton of Chinese-made goods, because the US as a whole buys a ton of Chinese-made goods, so I don’t see how this doesn’t bring them into head-on competition in a lot of stuff, assuming JD actually gets a foothold in the US. I actually bookmarked the Q4 earnings transcript based on your comment about some interesting thoughts re: logistics. It will probably be well worth reading for more on their expansion plans in future earnings transcripts as well.

    Also, my impression is that Amazon failed in China not because they couldn’t compete but rather because of Chinese governmental policies that have largely blocked American companies from getting a foothold so that Chinese companies can nurture and grow off the country’s native massive market. Thus Baidu instead of Google, WeChat instead of Facebook, Alibaba/JD instead of Amazon, etc.

    Have a great weekend. I really like the blog and your thoughts on investing and so have bookmarked it among my investing links.

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  7. Hi, not sure if folks saw the WSJ article yesterday on the diverging fortunes of Apple and Samsung re: their high-end smartphones, but I think this gives credence to what I was saying about Apple being the aspirational brand. It’s not just marketing but (in my opinion) the brilliant decision made early on by Steve Jobs to be the sole maker of both the hardware and iOS (which later got applied to chips) rather than only doing hardware. That probably wasn’t a decision so much as just part of his DNA to make the best products, but it really (along with the supporting marketing) proved to be an amazing competitive advantage. I think from this perspective JD will have an even stronger long-term competitive advantage in terms of being the aspirational, high-end, affluent customer, profitable brand over time, despite today’s excitement about Alibaba and PDD.

    https://www.wsj.com/articles/diverging-fortunes-high-prices-propel-apple-sink-samsung-1533135010?mod=hp_lista_pos3

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  8. Hi Travis,

    Maybe you have seen already, but I just thought it was interesting that in Hillhouse’s latest 13f, they made Alibaba their top position and cut down their stake in JD by 40%. Hillhouse of course knows JD very intimately. Obviously its complete speculation, but what do you think might be their thinking?

    Of course, it may very well be the case that both BABA and JD will thrive and generate tremendous value for their shareholders. BABA seems to have a lot of momentum going with their Cloud services, Hema stores, their partnership with Starbucks, their offline-online integration efforts.

    JD has talked about expanding into Europe and America, and it seems a little distracted.

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    • It’s not even worth speculating on because I have no more insight into Hillhouse’s operations than any other outsider. There are only a handful of money managers who I both highly respect and know well enough to put value into their opinion, and Hillhouse isn’t one of them. That’s nothing against Hillhouse – they seem very smart – I’m just not going to put any weight into another investor’s decision who I don’t even know.

      I agree that Alibaba is doing very well. My opinion is that the pie is big enough for both Alibaba and JD to succeed, not that JD has to beat Alibaba necessarily. I suspect both companies will do well over the long-term, I just personally like JD’s business model more.

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      • I completely respect your view of not putting any weight into the opinion of another investor who you don’t even know. You’re absolutely right that we have no idea about Hillhouse’ position sizing rules, specific investing processes, or analytical thought.

        I only brought it up because it seems at least curious that the guy who was one of the early investors in JD, has a personal relationship with Richard Liu, and the guy who actually brought JD and Tencent together would be taking such a large position in the main rival/enemy of JD. I find it even more strange because arguably JD is now at its most competitively advantaged point in its history.

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  9. Michael, here’s some recent scuttlebutt on the topic… https://twitter.com/wondurrrrboy/status/1020336972848455681

    JD’s earnings announcement are tomorrow, as you both may know… I just upped my stake in JD by about a third yesterday on the 10% pullback from the last couple of days. It’s now my second largest position, distantly trailing Amazon and edging past Bank of America. Of course tomorrow’s earnings are only of marginal importance as I plan on holding JD for many years to come. Good luck to all!

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    • Well, rape accusation was definitely not a risk I considered when evaluating Liu. Worst case scenario: he is guilty and is forced out of JD (and hopefully goes to prison). Even then, I struggle to imagine current management couldn’t take over and justify something higher than today’s stock price. If the company can even achieve a 2-3% net margin at maturity, today’s price is going to look absurdly cheap.

      Best case scenario is Liu is innocent and someone was trying to extort a billionaire. Another scenario is that Liu had consensual sex, cheated on his wife, and the girl changed her mind / freaked out after the fact. That scenario would obviously lessen my trust in Liu.

      Honestly, I don’t know what to think and I’ve been going back and forth on this a lot the past few days. With that being said, I don’t want to make any rash emotional decisions (buying more, selling out) until I know what actually happened. Thus, I will hold for now.

      Liked by 1 person

      • Another major piece of news, apparently Jack Ma is announcing his full retirement from Alibaba to focus on charity work.

        Although he probably had general plans to retire from way back, I have a sneaking suspicion that he decided to accelerate his announcement to take advantage of the Richard Liu scandal. Richard and Jack are watched by Chinese internet users the way Justin Bieber is watched by American internet users. I think Jack wants to send a message to the Chinese internet, “we are the good guys”.

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  10. … in any case, his behaviour (and, it seems, past events) seems to depict a person not exactly right for the big responsibility:
    [ theepochtimes.com/richard-liu-chinese-billionaire-arrested-in-u-s-for-suspected-rape-linked-to-communist-advocacy_2642615.html ]
    “The alleged victim, who was sitting beside Liu and was the only woman among the ten people in the party, is reported to be a Chinese student and model attending the university. After the diners consumed 32 bottles of wine, the victim called the police to report that she had been raped and Liu was arrested early the next day.

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