JD.com To Face Negative Impact From Regulatory Developments

In recent years, China’s government and regulators have mounted pressure across various industries and markets such as internet retail, ridesharing, and fintech. In this analysis, we first examined the regulatory developments in the country’s internet retail industry and determined the industry-wide net impact based on our Porter’s 5 Forces analysis on key areas such as exclusive dealing, misinformation, data privacy, misuse of consumer data, and counterfeit goods. Furthermore, we narrowed our analysis on JD.com, Inc.’s (JD) e-commerce business to determine the potential net impact on its growth outlook. Moreover, we also examined the growth drivers of its e-commerce business including a shift of its product sales breakdown from consumer electronics to the broad general merchandises segment as well as its logistics business where we expect its growth to be supported by its established network and technological focus.

China E-commerce To Slow Down as Regulators Crackdown

In 2021, the State Administration for Market Regulation in China promulgated the Antitrust Guidelines for the Platform Economy. According to law firm Fieldfisher, the guidelines “takes into account the characteristics of the platform economy and provides guidance on monopolistic behaviours in the platform sector, and compliance with the provisions already stated under the AML”.

Furthermore, according to IFLR, “the rules provide guidance on the anti-competitive behaviour that SAMR will be targeting including monopolistic agreements, abuse of a dominant market position, concentration of operators and abuse of administrative power to exclude or restrict competition.”

We believe this will result in a potential shift in the Chinese e-commerce industry landscape. Based on Porter’s 5 Forces, we underlined our expectation of the potential impact of the areas of regulations on the industry.

Exclusive dealing

As referred to Article 17 of the Anti-monopoly Law: “exclusivity shall not be imposed on the merchants by means of written agreements or oral warnings.”

• Bargaining power of suppliers: We believe the regulation could lead to a higher power to sellers/merchants as e-commerce companies cannot forbid their sellers to participate in the platform’s promotional activities, downgrading their product ranking in search results, and the cancellation of other benefits normally granted to the merchants on the platform.
• Bargaining power of buyers: Buyers would indirectly benefit as there would be greater competition and possibility be advantageous in terms of costs and convenience as well as provide more options.
• Competitive rivalry: Competition could significantly increase as e-commerce companies would have to compete with other platforms as sellers could be in more than one
• Threat of substitution: More likely to affect competition risk than threat of substitution
• Threat of new entrants: Allowing sellers to opt to sell on more than one platform could spur the growth of entrants.

Misinformation

Companies are banned from using algorithms or fake reviews to promote goods or services and from spreading misleading information about competitors.

• Bargaining power of suppliers: The power of suppliers could be reduced as they are prohibited to make false claims of product quality and compete more fairly
• Bargaining power of buyers: Buyers could benefit by having more accurate product information which may influence their purchasing behaviour on products based on more accurate reviews
• Competitive rivalry: Competition may increase as a more level playing field is created as product information is more accurate and internet companies required to crack down on false product reviews
• Threat of substitution: More likely to affect competition risk than threat of substitution
• Threat of new entrants: Ensuring more accurate product information may ease the barriers to entry compared to before when companies artificially inflate their product competitiveness

Data privacy

Companies must respect and protect their customers’ data privacy and are required to obtain consent from customers using their platforms and provide notice.

• Bargaining power of suppliers: The power of suppliers may increase as the influence of e-commerce companies leveraging customer data may be reduced.
• Bargaining power of buyers: The power of buyers could increase as e-commerce companies have less influence over the choices of consumers
• Competitive rivalry: Competition may increase as larger companies that may have had leveraged off of their massive user base to gain an unfair advantage may be prevented from doing so
• Threat of substitution: More likely to affect competition risk than the threat of substitution
• Threat of new entrants: May increase as larger companies that leverage their massive user base’s data could have less power

Misuse of Consumer Data

Under this rule, operators cannot use “data, algorithms or other technical means to influence a user’s choices or access to products or services.”

• Bargaining power of suppliers: We expect greater power to suppliers as companies are prevented from misusing its advantage from harnessing consumer data to gain greater leverage of sellers
• Bargaining power of buyers: Buyers could benefit from greater protection of their data and prevent it to be misused by companies to unfairly manipulate consumer behaviour or price to push them to spend more
• Competitive rivalry: Competition could increase as companies especially larger ones who leverage their massive user base cannot misuse their data to gain a competitive advantage
• Threat of substitution: More likely to affect competition risk than threat of substitution
• Threat of new entrants: Threat may increase as smaller companies may be at a lesser disadvantage by larger companies with a massive user base

Counterfeit Goods

According to SAMR, e-commerce platforms could be restricted or have their license revoked if found violating IP rights by vendors. The authenticity of products is one of the most critical factors according to a survey of Chinese consumers.

• Bargaining power of suppliers: We expect lower power to suppliers as the e-commerce platforms could take more stringent action to monitor their sellers
• Bargaining power of buyers: Buyers could benefit from being cheated with counterfeit products
• Competitive rivalry: We expect competition to increase as a more level playing field may be created by preventing unfair competition through counterfeit goods
• Threat of substitution: More likely to affect competition risk than threat of substitution
• Threat of new entrants: More entrants likely due to a more level playing field without counterfeit goods

To sum it up, we see the overall impact on the Chinese e-commerce industry would likely increase the power of suppliers, buyers, and promote greater competition amongst all existing and new players and promote a more level playing field by preventing companies from abusing their power especially larger players with a massive customer base and traffic. In terms of power of suppliers, we believe the benefits could shift from sellers to buyers and may add to margin pressures. Whereas for power of buyers, we expect that with greater choices for consumers, this could put pricing pressure down and negatively affect the companies’ revenues. With higher competitive rivalry, we believe this could result in a change in the market positioning of companies and compete more aggressively on pricing and may squeeze margins. Lastly, we see the higher threat of entrants putting more pressure on companies and margins.

Policy	Bargaining power of suppliers	Bargaining power of buyers	Competitive rivalry	Threat of substitution	Threat of new entrants
Exclusive dealing	Increase	Increase	Increase	No Change	Increase
Misinformation	Decrease	Increase	Increase	No Change	Increase
Data privacy	Increase	Increase	Increase	No Change	Increase
Misuse of Consumer Data	Increase	Increase	Increase	No Change	Increase
Counterfeit Goods	Decrease	Increase	Increase	No Change	Increase
Net Negative Impact	Increase	Increase	Increase	No Change	Increase

Source: Khaveen Investments

Based on our Porter’s 5 Forces analysis, we assigned an adjustment factor of -0.5% to each of the negative net negative impact to the internet retail industry. From the table above, this amounts to 2%. Based on 5-year average China retail growth (6.8%) and the average 5-year increase in the e-commerce penetration rate (14.2%), we forecasted the future retail e-commerce sales. We then adjusted the e-commerce sales by our adjustment factor of -2% for each year.

China E-commerce Sales Forecast ($ bln)	2021	2022E	2023E	2024E	2025E	2026E
Total Retail Sales (‘a’)	6,834	7,298	7,793	8,321	8,886	9,489
Growth %	20.3%	6.8%	6.8%	6.8%	6.8%	6.8%
Penetration Rate (‘b’)	29.7%	33.3%	36.7%	39.8%	42.3%	44.0%
Retail E-commerce Sales (‘c’)	2,029	2,432	2,863	3,309	3,755	4,180
Growth %	19.1%	19.9%	17.7%	15.6%	13.5%	11.3%
Adjusted Growth %	19.1%	17.9%	15.7%	13.6%	11.5%	9.3%

* c = a x b

Source: China Internet Watch, Khaveen Investments

Company Expected to Face Negative Impact

In terms of the impact on individual companies, we see JD.com having an overall negative impact with the evolving regulatory environment. Whereas we view Alibaba (NYSE:BABA) as potentially the most affected company while smaller competitors are likely to be the key beneficiaries.

Firstly, we believe JD.com and others could benefit from the action against exclusive dealing practices as Alibaba has previously been fined by the SAMR for $2.75 bln forcing sellers to sell exclusively on its platform. Previously in 2018, JD.com claimed that 100 brands defected to Alibaba because of pressures by the company. Thus, we see the crackdown in this area to potentially benefit JD.com with a more level playing field.

However, in terms of other regulatory aspects, we believe the company could face a negative impact regarding misinformation as citing a previous fine by the SAMR for irregular pricing strategies during the Singles Day sales. For product quality, while the company has been previously reported to have issues with counterfeit goods for certain products, we highlight several changes the company has undertaken to improve its system capability to deal with the counterfeit goods. Therefore, we provide a neutral outlook for the company in this area.

Besides that, we also rated a potentially negative impact for JD.com in terms of data privacy and misuse of consumer data. The company has a huge user base of 552.2 mln active users in Q3 2021 but Alibaba has a higher user base of 863 mln active customers. We believe that this could be a risk as it makes it might be more susceptible to cybercriminals which would raise the importance of better data privacy. According to research by Cyble, 1.3 bln sensitive records of Chinese citizens were discovered on a forum including JD.com data. In the past, JD.com was involved in a data leak in 2013 which exposed personal information of users. Alibaba has also suffered a data leak ruled by a Chinese court. Taking these factors into account, we maintain a negative impact outlook based on these regulatory areas. On the other hand, we see Alibaba and Pinduoduo (NASDAQ:PDD) also having a negative impact while expecting smaller companies to gain an advantage with a more level playing field.

Company	Exclusive Dealing & Anti-monopolistic practices	Misinformation	Product Quality	Data Privacy	Misuse of consumer data	Net Impact	Adjustment Factor
Alibaba (BABA)	Negative	Negative	Negative	Negative	Negative	Very Negative	0.33
JD.com	Positive	Negative	Neutral	Negative	Negative	Negative	0.51
Pinduoduo (PDD)	Positive	Neutral	Negative	Negative	Negative	Negative	0.51
Sunning	Positive	Neutral	Neutral	Neutral	Neutral	Positive	1
Gome (OTC:GMELF)	Positive	Neutral	Neutral	Neutral	Neutral	Positive	1
Vipshop.com (VIPS)	Positive	Neutral	Neutral	Neutral	Neutral	Positive	1
YihaoDian	Positive	Neutral	Neutral	Neutral	Neutral	Positive	1
Dangdang	Positive	Neutral	Neutral	Neutral	Neutral	Positive	1
Jumei	Positive	Neutral	Neutral	Neutral	Neutral	Positive	1
Mogujie	Positive	Neutral	Neutral	Neutral	Neutral	Positive	1

Source: Khaveen Investments

Based on our analysis of the potential regulatory impact on each company, we assigned an adjustment factor based on the net number of negative impacts with the formula 0.8^n, where n is the number of net negatives. We projected the 5-year revenue growth of each company based on their average revenue growth with the adjustment factor derived for each company.

E-commerce Forecast	Past 5-year Average	Forecast 5-years Average
JD.com	32%	12.3%
Alibaba	42%	9.7%
Pinduoduo	279%	21.1%
Total Market	22.8%	13.6%

Source: Company Data, China Internet Watch, Khaveen Investments

Based on the market share chart below, we see the company slightly losing its market share similar to Alibaba while we expect Pinduoduo market share growth to slow and other smaller competitors to gain market share.

Source: Company Data, eMarketer, China Internet Watch, Khaveen Investments

As the e-commerce industry faces evolving regulatory pressures, we believe that based on our risk assessment of the top e-commerce companies, we believe JD.com could face a negative impact from the regulatory developments with its track record and its huge user base which we believe could be a threat in terms of protection of data privacy and prevent misuse of consumer data. Thus, we expect the company’s market share to decline based on our analysis from the impact of the China e-commerce regulations.

Expansion of Both E-commerce and Logistics Businesses

The company’s product revenues are split between electronics and other general merchandise. The company’s revenue breakdown by product sales shows its main product category being outpaced by other product categories. Based on its annual report, this category is broad as “net revenues from general merchandise products mainly include revenues from sales of food, beverage and fresh produce, baby and maternity products, furniture and household goods, cosmetics and other personal care items, pharmaceutical and healthcare products, books, automobile accessories, apparel and footwear, bags and jewellery.”

We expect its e-commerce revenue growth to be driven by the growth of other categories. The penetration rate of consumer electronics e-commerce in China was estimated at 55% in 2020 by Statista. In comparison, the total e-commerce penetration rate in China is only about 30% as a % of retail sales. We believe this signals the relatively matured market for consumer electronics which has an average growth rate forecasted by Statista of 2.77% until 2025.

As explained in the quote below, the company expects the electronics and home appliances to be outpaced by other product categories.

Typically wise, we expect to see that the capital mix shift will continue, general merchandise categories to grow faster than electronics and home appliances, in particular, the supermarket and healthcare factories. – Lei Xu, JD.com CEO

Furthermore, for its logistics business, based on its annual report, the company’s logistics and other service revenue represent around 43.1% of its net services revenue and 5% of its total revenue. Its logistics business has a market share of 2.7% according to its prospectus. The China logistics market is projected to grow at a CAGR of 7.5% through 2025. The outsourced logistics spending in China shows a rising trend with the penetration rate increasing from 39.1% in 2015 to 43.9% in 2020 and is forecasted to increase to 47.8% in 2025. According to JD Logistics, external clients accounted for 46% of its revenue.

We believe that the company’s logistics business stands to benefit as the market grows. According to the company’s prospectus, it has a massive supply chain network operating “more than 900 warehouses, which makes up about 21 million square feet of space.” Furthermore, we believed the company has displayed its focus on technology to improve its efficiency. For example, it used nearly 400 autonomous delivery vehicles across 25 cities in China during Singles Day and delivered 200% more orders compared to the previous year. Thus, we expect the company’s logistics business to benefit from the growth of the China logistics market.

We projected its net product and marketplace and marketing revenues through 2026 based on our projections of its market share in the China e-commerce market. Whereas its Logistics and other service revenues are based on 2021F tapering down by 13.21% per year.

JD Revenue Breakdown	2020	2021F	2022F	2023F	2024F	2025F	2026F
Net product revenues (‘a’)	99,905	129,930	151,047	172,575	193,719	213,580	231,206
Growth %	36.2%	30.1%	16.25%	14.25%	12.25%	10.25%	8.25%
Marketplace and marketing revenues	8,195	11,718	13,623	15,564	17,472	19,263	20,852
Growth %	33.7%	43.0%	16.25%	14.25%	12.25%	10.25%	8.25%
Logistics and other service revenues	6,199	11,215	18,807	29,055	41,048	52,569	60,378
Growth %	83.8%	80.9%	67.70%	54.49%	41.28%	28.07%	14.86%
Net service revenues (‘b’)	14,394	22,933	32,430	44,619	58,520	71,832	81,231
Growth %	51.5%	59.3%	41.4%	37.6%	31.2%	22.7%	13.1%
Total Revenue (‘c’)	114,299	152,863	183,477	217,194	252,239	285,412	312,437
Total Growth %	37.9%	33.7%	20.0%	18.4%	16.1%	13.2%	9.5%

*c = a + b

Source: JD.com, Khaveen Investments

As the electronics e-commerce market in China looks to grow modestly, we expect its broad product categories to support its product revenue growth. Additionally, we believe the company’s logistics business could continue to grow owing to its massive supply chain network and focus on technology to improve delivery productivity and efficiency.

Risks: Government Pressure on Companies

While we expect the company to face regulatory pressures on its e-commerce business, we also expect greater pressure in areas outside its core e-commerce business. Previously, the company along with Alibaba and Baidu (NASDAQ:BIDU) were fined around $78,000 each for unreported deals. While the fines are small, we believe this indicates a tougher stance on these large companies. Additionally, China’s government aims to narrow down the country’s wealth gap by imposing a “wealth tax”. According to Bloomberg, 73 companies including Meituan (OTCPK:MPNGF) (OTCPK:MPNGY), Ping An Insurance (OTCPK:PNGAY) (OTCPK:PIAIF) and Bank of China (OTCPK:BACHF) (OTCPK:BACHY) mentioned the term “common prosperity” in their earnings report. Alibaba has announced to contribute $15.5 bln through 2025, while Tencent (OTCPK:TCEHY) and Pinduoduo have also announced to contribute $15 bln and $1.5 bln respectively. We believe that JD.com could face the risk of pressures to the “wealth tax”, based on an average of 2.7% of revenues, we estimate this amount could be $4.9 bln based on our 2022 revenue forecast of $184.5 bln.

Company Contribution for Common Prosperity	Contribution ($ bln)	Revenue ($ bln) (‘TTM’)	% of Revenue
Alibaba	3.1	126	2.5%
Pinduoduo	0.3	14.46	2.1%
Tencent	3	85.23	3.5%
Average			2.7%

Source: Bloomberg, Reuters, FT, Seeking Alpha

Valuation

To value the company, we used a DCF valuation as we expect it to continue generating positive FCFs. For the terminal value, we used the e-commerce industry average EV/EBITDA of 27.96x.

Based on a discount rate of 6.4% (company’s WACC), our model shows an upside of -1.14% for the company.

Verdict

To sum it up, we analysed the evolving regulatory developments in China’s internet retail industry and determined it to face a negative impact of 2% on the industry’s growth outlook and projected its growth rate at a 5-year average of 13.6%. Moreover, we then analysed the potential net impact on the country’s e-commerce companies and believe JD.com could be negatively impacted by the regulatory developments with a projected e-commerce growth rate at a 5-year average of 12.3%. In terms of its growth drivers, we expect its e-commerce business to grow as its sales mix by-products shift mix from lower growth consumer electronics to the broader general merchandise segment while its logistics business expands with an established network and technological focus. Further, our DCF valuation based on the e-commerce industry average EV/EBITDA of 27.96x indicates a limited upside of -1.14% with slowing revenue growth. Overall, we rate the company a Hold with a target price of $68.55.