JD.com IPO: Approach With Caution (Update 1)

An earlier version of this story said Alibaba vendors receive their money in 14 days and $27 million came from U.S. government incentives. TheStreet regrets these errors.

NEW YORK (TheStreet) -- Investors have done well with Chinese Internet companies such as Baidu (BIDU), Qihoo 360
(QIHU), Sohu.com (SOHU) and a select group of others. However, JD.com may be a different story, once you dig beneath the surface.

JD.com, formerly known as 360buy.com, filed last week to raise $1.5 billion in an initial public offering, the first Chinese company to go public since certain accounting firms were suspended. These include Shanghai-based Pricewaterhouse Coopers Zhong Tian, which was the auditor of JD.com's 2011 and 2012 financial statements included in the company's F-1 filing, similar to an S-1 filing for an American company going public.

The $1.5 billion figure is a placeholder used by underwriters Bank of America and UBS, and may change, subject to demand.

JD.com has big name investors, including Saudi billionaire Prince Alwaleed bin Talal, with a 5% stake, and Tiger Global Management, with a 22% stake, and is trying to position itself as the Amazon.com (AMZN) of China (Amazon already operates a Chinese unit, Amazon.cn). Nonetheless, aspects of the company's financial statement give cause for concern, especially as other Chinese companies, including Alibaba Group Holding, 24% owned by Yahoo! (YHOO), get ready to go public later this year.

JD.com could not be reached for comment for this story, and an Alibaba spokesman declined to say when or if the company would go public, only that it was still evaluating its options.

Revenue growth at Beijing-based JD.com has been exceptionally strong, with the company surpassing $8 billion in revenue for the first 9 months of 2013, on the back of 35.8 million active customer accounts, similar to Amazon's model. Like Amazon, JD.com also has a third-party business, which generated $3 billion in sales.

However, the similarities to Amazon don't stop there. For the first 9 months of 2013, the company claimed a profit of 60 million Reminibi ($10 million USD), but $36 million came from Internet income, and $27 million in Chinese government incentives. JD.com, which has a strained relationship with vendors, does not pay its third-party sellers for up to 60 days, making money off the float between the time of the sale and actually paying the vendor. Conversely, Alibaba pays its partners within 3-5 days, holding the money only to make sure the buyer is happy, according to sources.

Alibaba, via its Taobao and Tmall units, had $160 billion in gross merchandise value in 2012. On Singles Day in Nov. 2013, Alibaba did more than $5.7 billion in payments volume, setting a new record.

JD.com has been struggling to grow its third-party unit business, which accounts for the bulk of the company's profits, similar to Amazon. Unlike Amazon, however, which essentially has no competition in the United States, JD.com competes with Alibaba's Tmall.

Consumer electronics is an intensely competitive business, with companies such as Amazon, Best Buy (BBY), hhgregg (HGG) and others selling their wares to consumers, all with exceptionally low margins. Approximately 85% of JD.com's sales come from consumer electronics. Consumers have been largely loyal to brands such as Apple (AAPL) or Samsung, so it's difficult to see margins getting better over time. Remember, Circuit City filed bankruptcy just a few short years ago, as the company faced the same issues.

JD.com has noted that it's becoming a consumer goods company, similar to Amazon or Alibaba. However, JD.com appears to be more like Best Buy starting up its BestBuy.com initiative, not a typical Internet e-commerce company. With consumer electronics, there are fewer items, and thus inventory management is much simpler, than say, managing women's sweaters or men's boots. This will severely impact the company's cash haul. JD.com had $1.44 billion in cash and cash equivalents at the end of Sept. 2013 but it also had $1.745 billion in accounts payable at the same time, so the company really has a negative cash situation.

Not only does JD.com face a potential cash crunch as it seeks to diversify its business away from consumer electronics, its management team faces scrutiny as well.

A look at the company's F-1 shows that many of its management team have only recently joined the company, with some joining late in 2013. Haoyu Shen has served as chief operating officer since August 2011, Ye Lan has served as chief marketing officer since February 2012, Guoqing Zhao has served as chief strategy officer since June 2012, Yu Long (also known as Rain Long) has served as chief human resources officer and general counsel since August 2012, Sidney Xuande Huang has served as chief financial officer since September 2013, and Shengqiang Chen has served as the chief executive officer of the company's Internet finance group since September 2013.

Perhaps even more troubling than the revolving door is the fact that Xufu Li, who has served as a JD.com's director since January 2009, will resign before the completion of the initial public offering.

If that weren't enough, the company's founder, Richard Qiangdong Liu, has enormous control and influence over the firm. Liu, who founded the company in 2004, owns 18.4% of the aggregate voting power through Max Smart Limited, a company wholly owned by Mr. Liu, and owns an additional 22.5% of the aggregate voting power of the company, "as certain holders of our ordinary shares have granted the voting rights associated with their ordinary shares to Mr. Liu as their exclusive proxy and attorney-in-fact," according to the risk section of the F-1. Liu also owns 5.3% of the company's stock through another company where he is the sole shareholder and the sole director, Fortune Rising Holdings Limited.

There is a dual class structure, with Class B shares having 20 times the voting power of Class A shares, effectively meaning that Liu has 80% of the voting power. "Based on our proposed dual-class voting structure, holders of Class A ordinary shares will be entitled to one vote per share in respect of matters requiring the votes of shareholders, while holders of Class B ordinary shares will be entitled to twenty votes per share, subject to certain exceptions," the company stated in its filing.

In addition to the vast voting power that Mr. Liu has, he also has the ability to cancel a board meeting, if he decides not to show up. That is cause for concern right there, never mind the enormous voting power Liu has.

In the filing, JD.com said it intends to use the proceeds from the filing to buy more land rights, build new warehouses, expand distribution and acquire other companies. However, the company also wants its own delivery people, effectively owning the last mile of shipping. Amazon, which partners with UPS (UPS), FedEx (FDX) and the United States Postal Service, has been looking into building its own drones for the last mile of delivery, but that's years away and would not be able to handle the scale of Amazon's roughly $100 billion in yearly sales any time soon. To suggest JD.com could do otherwise is a pretty lofty goal, especially when Alibaba, which is much larger than JD.com, is working with third-party companies.

While the offering is still months away, it will be interesting to see who is actually selling their stake. With firms such as Tiger Global, DST, and Sequoia Capital all involved, it will be important to see if these firms have faith in the company, or if the risks in JD.com's F-1 filing and liquidity concerns have them running for the hills.

--Written by Chris Ciaccia in New York

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