Meituan: A staggering loss of nearly 20 billion! Did Alibaba really succeed in this takeover?

$MEITUAN(03690.HK) released its Q3 earnings after the Hong Kong stock market closed on November 28, being the last among the 'Three Fools' in the food delivery battle to do so. During the summer quarter, which saw the most intense subsidies, Meituan reported a massive operating loss of 19.8 billion, compared to JD's 'slight loss' of about 1 billion and Alibaba's retained profit of approximately 5 billion. As the defending party under attack, Meituan's situation is much more severe compared to Alibaba and JD. Key points are as follows:

1. Is Meituan's actual loss 80% of Alibaba's? First, let's look at the most concerning issue of losses. This quarter, the operating loss of the local commerce segment reached 14.1 billion. Assuming the in-store business profit remains flat, it implies a loss of about 20 billion for the in-store business this quarter, which is generally in line with recent sell-side expectations. Considering that Taobao Flash Sale's order volume in Q3 was approximately 85% of Meituan's, it implies that the per-order loss for Taobao Flash Sale in Q3 was about 2.1 times that of Meituan. From this 'static perspective,' the gap between Alibaba and Meituan is significant.

However, from another perspective, considering that 'earning less is also a loss,' Meituan's local commerce segment profit decreased by about 29 billion compared to last year. If there were no competition, profits would have grown somewhat this year, meaning the actual cost Meituan paid due to the food delivery battle could reach 30 billion, which is over 80% of Alibaba's cost (36 billion), with a very limited gap.

2. Negative growth in delivery revenue: The delivery revenue, which is strongly tied to the home delivery business (i.e., food delivery + flash sale), significantly declined by 17% year-on-year this quarter. According to market research, the instant delivery order volume should have grown by about 15% year-on-year this quarter (for reference only), implying that the per-unit delivery revenue decreased by about 45% year-on-year. Assuming the per-unit delivery revenue remains unchanged, the subsidy for delivery fee alone (excluding incentives for riders) was over 9 billion this quarter. It's a real 'paying to do business.'

3. In-store business also affected by the battle: The commission and advertising revenue growth of the local commerce segment continued to slow significantly this quarter, growing only by 1.1% and 5.7%, respectively. This is mainly due to the food delivery battle, which also led to reductions in merchant commissions and advertising fees.

But it also suggests that the situation of Meituan's in-store business may not be optimistic.

As seen in the previous quarter, the cost-effectiveness of food delivery has significantly improved, causing some consumers to shift from in-store consumption to food delivery. Meanwhile, merchants may have reduced their in-store advertising budgets due to the need to bear more food delivery subsidies.

Therefore, the 'food delivery battle' actually impacts Meituan both in home delivery and in-store, based on this, the profit of the in-store business this quarter may not have grown.

4. Slowdown in growth of innovative business, but narrowing losses? Something unusual might be happening: This quarter, Meituan's innovative business revenue growth unexpectedly declined to 16%, which is slightly surprising. Among them, commission revenue maintained a high growth rate of 101%, reflecting Keete's rapid expansion.

Mainly due to the slowdown in other revenue (mainly Xiaoxiang Supermarket, which records revenue based on gross sales, thus having a large scale) growth to only 13%, dragging down the overall growth of the segment. It seems that besides the widespread closure of Meituan Preferred stores, the investment in Xiaoxiang Supermarket (or other self-operated businesses) has also been reduced, to focus resources on home delivery and overseas business.

Meanwhile, the loss of new business also decreased due to the significant slowdown in revenue growth, this quarter being 1.28 billion (vs. last quarter's 1.88 billion). Like the slowdown in revenue growth, it also points to the strong contraction of businesses including Preferred, Xiaoxiang Supermarket, or other businesses like Kuaidong.

5. Unallocated losses expanded abnormally: However, it is worth noting that the unallocated loss this quarter expanded abnormally by about 2.8 billion compared to last quarter. About 1.1 billion can be explained by changes in investment income/impairment and other non-operating factors. For the remaining part, the company claims it is due to the impact of AI and other project investments. But it raises suspicions that the narrowing of new business losses might have been shifted here.

Therefore, compared to the unexpected narrowing of new business losses, the significant expansion of new business + unallocated project losses is a more appropriate interpretation.

6. Flat revenue, soaring costs and expenses: This quarter's gross margin was only 26.4%, down another 6.7 percentage points from last quarter, leading to a year-on-year decrease in gross profit of about 11.6 billion. The main reason is delivery revenue decreased due to exemptions, while the growth in delivery costs (+24%) is likely to exceed the growth in order volume (due to additional subsidies for riders).

In terms of expenses, marketing expenses this quarter reached 34.3 billion, an increase of 16.3 billion compared to last year (equivalent to 91%), reflecting direct subsidies to consumers in the food delivery battle, customer acquisition promotions, and overseas business investments. Additionally, R&D expenses also increased significantly by 31%, likely due to the AI project investments mentioned in the announcement.

Under the resonance of flat revenue, plummeting gross profit, and soaring expenses, Meituan's operating profit this quarter resulted in a massive loss of nearly 20 billion.

Dolphin Research's View:

In short, Meituan's performance this time should undoubtedly be classified as very poor, even compared to the recently adjusted sell-side expectations, it is considered in line with expectations.

In Dolphin Research's view, a very important data point in this performance is that during the most competitive Q3, the cost Meituan paid (including losses and the part of earning less) is about 80% of the cost paid by challenger Alibaba. From the perspective of per-order profitability, Meituan's per-order UE dropped from last year's 1.2~1.3 yuan (including food delivery + flash sale) to this quarter's -2.5 yuan (all for reference only), with UE deteriorating by nearly 4 yuan year-on-year. Meanwhile, Alibaba's per-order loss went from last year's slight loss of a few cents to this quarter's loss of over 5 yuan, with UE deteriorating by around 5 yuan.

In other words, as the absolute leader in the industry, Meituan, which has always been recognized by the market for having significant competitive barriers, did not show a fundamental difference in marginal investment and UE deterioration compared to its competitors when facing challenges. More seriously, even after bearing such huge costs and losses, Meituan failed to maintain its market share (Q3 order volume share, Alibaba is about 85% of Meituan's, with a larger GTV gap).

Moreover, when the home delivery business is significantly impacted, the in-store business, which serves as a backup, is also considerably affected by the food delivery battle, with signs of deteriorating profits. Furthermore, Meituan's in-store business has sufficient 'blood-making ability' to support the investment needed for the food delivery battle.

Combining the above two points, on one hand, its blood-making ability is far inferior to Alibaba's and even JD's core e-commerce business, on the other hand, the actual cost paid is not much less than Alibaba's, resulting in Meituan's massive loss of 20 billion while Alibaba and JD can still retain some profit or slight loss.

After two quarters of digestion, the mainstream voice in the market has shifted from 'the impact of the food delivery battle will soon pass, Meituan's competitive barriers will not be shaken' to 'the long-term market share and per-order profitability space of Meituan's home delivery business may permanently decline.'

However, Meituan's stock price has been hovering around HK$100 since the Q2 report, but it has not continued to decline significantly. In other words, there is still considerable capital in the market that firmly believes Meituan can eventually escape the current quagmire.

So, from the current perspective, how does Dolphin Research foresee the evolution of the subsequent instant retail battle:

1) Instant retail competition: First, two currently basically certain states in the uncertainty are: one is that this year's Q3 is likely the peak of per-order investment and losses for all parties involved in the food delivery battle; the second is that from Q4 to date, the gap in order volume between Taobao Flash Sale and Meituan has slightly widened, but it is still very close, about 5:4.

This time, Alibaba clearly stated that the UE of Flash Sale in Q4 will improve significantly compared to Q3, implying that total investment and losses will decrease quarter-on-quarter. However, there are different interpretations of the impact this move will have on Meituan:

a. First, Alibaba's reduced investment means Meituan's loss situation in Q4 should improve, regardless of the long-term impact of Taobao Flash Sale's UE reduction, from a certain short-term perspective, the reduction in Q4 losses is a good signal compared to maintaining high losses.

b. But from a longer perspective, how should the narrowing of Taobao Flash Sale's UE be understood? One angle is that Alibaba actively reduced the intensity of subsidies. Whether due to financial pressure or the lack of obvious cross-selling, it is no longer willing to burn money extensively. As Alibaba reduces subsidies, its attractiveness to users declines, the market share gap with Meituan widens again, and Meituan's market position and profitability marginally return to pre-battle levels. This angle is undoubtedly favorable for Meituan, and we believe it is the logic behind the significant rise in Meituan's stock price after Alibaba's earnings release.

Another angle is that the improvement in Taobao Flash Sale's UE may also be due to reduced costs, including delivery, and an increase in the proportion of high-priced orders, releasing profits naturally through dual optimization. According to this logic, Taobao Flash Sale maintains the intensity of subsidies, holds onto Meituan's market share; UE losses gradually narrow, also approaching Meituan.

Ultimately, Taobao Flash Sale will become a strong competitor with market share and UE closer to Meituan, from this perspective, it would be a huge bearish factor shaking Meituan's foundation. Currently, we cannot assert which of the above two scenarios is closer to the final evolution, and we need to continuously track the evolution of market share.

But at least from the competition over the past six months, a rough judgment is that the so-called barriers of local life e-commerce, even if not as fragile as long-distance e-commerce, are by no means unbreakable. Even if Meituan's profits recover later, the market is likely to find it difficult to re-enact the expectation of 1.5~2 yuan per-order profit. The upward elasticity of the stock price will be suppressed.

2) In terms of innovative business, according to media reports, Keeta is making rapid progress overseas, having expanded into five markets in the Middle East: Saudi Arabia, UAE, Kuwait, Qatar, and Bahrain. Recently, it has also started entering Latin America, with Brazil as the starting point.

Moreover, from this quarter's financial report, besides overseas business, Meituan seems to be significantly shrinking other new businesses (revenue growth is slowing down). We believe that being able to relatively concentrate resources on the development of domestic core business and overseas business is a wise choice, better than spreading resources too thin.

However, the abnormally expanded unallocated loss makes the narrowing of new business losses have very limited value. Regardless of how the company explains it, regardless of which aspect the investment is used for, a loss is a loss. It did not control other losses to provide relief when the main business profit was already very poor, but instead further exacerbated the situation.

And from Didi's early entry into the Brazilian food delivery market, the overseas loss this quarter has already expanded significantly, indicating that Meituan is likely to fall into the 'food delivery battle' quagmire overseas as well. Although from the perspective of actual financial impact, the impact of the overseas version of the 'food delivery battle' should be limited, it is indeed somewhat 'ironic.'

3) As previously mentioned, compared to JD and Alibaba, Meituan's blood-making ability and cash on hand are relatively limited (even without deducting interest-bearing debt, only 140 billion). In other words, Meituan's ability to continuously bear high investment and losses is at a significant disadvantage compared to its competitors.

Therefore, Meituan issued five priority notes totaling nearly $3 billion in early November to supplement the 'financial ammunition' needed for continued investment in subsidies and other business development. As shown in the table below, the weighted coupon rate of the notes issued this time is about 4.2%, and a simple calculation results in an annual interest cost of nearly 900 million RMB.

It is somewhat reassuring that the notes issued this time are not convertible bonds, which will not directly dilute the equity of Meituan's shareholders. But it clearly verifies the above problem, if its competitors insist on maintaining high-intensity competition domestically, and Meituan persists in investing in overseas business, Meituan's already not abundant 'financial reserves' will face considerable pressure.

4) From a valuation perspective, although Meituan's market share has significantly declined under fierce competition, its order volume still maintains high growth under subsidies. Due to the massive loss under high subsidies, it is basically impossible to conduct a valuation.

We directly assume that under a stable state, Meituan's home delivery business order volume growth will not significantly decline, more likely the profit margin will narrow, with instant retail daily order volume at 90 million, per-order net profit at 0.5 yuan, operating profit at about 16.5 billion. Considering the in-store business is also affected to some extent, we lower the future profit growth space, assuming a contribution of 21 billion operating profit, the valuation range is conservatively at 10X (no growth, structurally deteriorated competitive landscape, similar to physical e-commerce valuation), and neutrally at 15x PE (slight growth), corresponding to a market value of 380 billion (approximately 70 HKD) to 560 billion (100 HKD), neutral and current market value are roughly close.

Below is a detailed commentary on the financial report:

I. Under high subsidies, only order volume growth, but freight revenue plummets

First, the delivery revenue, which is strongly tied to the home delivery business (i.e., food delivery + flash sale), significantly declined by 17% year-on-year this quarter. Although the company no longer discloses order volume data, according to market research, the instant delivery order volume should have grown by about 15% year-on-year this quarter (for reference only), implying that the per-unit delivery revenue decreased by about 45% year-on-year.

Assuming the per-unit delivery revenue remains unchanged, it implies that the subsidy for delivery fee alone (excluding incentives for riders) was over 9 billion this quarter.

II. In-store business is also not looking good

Besides delivery revenue, the commission and advertising revenue growth of the core local commerce segment also significantly deteriorated this quarter, with the former growing only by 1.1% and the latter slightly better but only 5.7%. According to Dolphin Research, this is mainly due to the food delivery battle, which also led to reductions in merchant commissions and advertising fees. Of course, this suggests that the situation of Meituan's in-store business may not be optimistic.

Although Alibaba's Gaode and JD's recently launched JD Review should have very limited impact on Meituan, Dolphin Research understands that currently, Douyin's in-store business is still growing rapidly. As seen in the previous quarter, due to the significant improvement in the cost-effectiveness of food delivery, some consumers have shifted from in-store consumption to food delivery. Additionally, merchants may have reduced their in-store advertising budgets due to the need to bear more food delivery subsidies.

Based on this, we speculate that Meituan's in-store business profit this quarter may not have grown much year-on-year.

Summarizing in-store and home delivery, the total revenue of the core local commerce segment this quarter was nearly 67.4 billion, with a year-on-year negative growth of 2.8%, slightly below Bloomberg's consensus expectations.

III. Other revenue growth also significantly slows down, making way for home delivery and overseas development?

This quarter, Meituan's innovative business total revenue was 28 billion, with a year-on-year growth rate significantly slowing down to only 16%, which is slightly surprising given Meituan's aggressive expansion in overseas regions such as Hong Kong and the Middle East. Specifically, commission revenue maintained a high growth rate of 101%, likely driven by the rapid expansion of Keete's business.

Mainly due to the slowdown in other revenue (mainly Xiaoxiang Supermarket, which records revenue based on gross sales, thus having a large scale, accounting for about 94% of the total revenue of the innovative segment) growth to only 13%, dragging down the overall growth of the segment. This suggests that besides the widespread closure of Meituan Preferred stores, the investment in Xiaoxiang Supermarket (or other self-operated businesses) has also been significantly reduced, to focus resources on domestic home delivery and overseas business.

IV. Massive loss of 20 billion in home delivery, suspicious narrowing of new business losses?

The most concerning issue of the food delivery battle losses, this quarter, the core local commerce segment's operating loss reached 14.1 billion, assuming the profit of the in-store business remains flat year-on-year, it implies a total loss of about 20 billion for the in-store business this quarter, which is generally in line with the latest sell-side expectations.

In comparison, Alibaba claims Taobao Flash Sale's loss is about 36 billion, considering that Taobao Flash Sale's order volume in Q3 was approximately 85% of Meituan's, it implies that the per-order loss for Taobao Flash Sale in Q3 was about 2.1 times that of Meituan.

From another perspective, after all, 'earning less is also a loss,' the profit of the local commerce segment decreased by about 29 billion compared to last year, from this perspective, the cost Meituan paid in the food delivery battle is roughly 80% of Alibaba's, not much better.

As for the unexpected narrowing of new business losses this quarter, this quarter's loss was 1.28 billion (vs. last quarter's 1.88 billion). Considering the overseas Keeta and Flash Sale warehouses are in the investment period, the loss instead decreased, combined with the slowdown in business revenue growth, it is likely that the contraction of businesses including Preferred, Xiaoxiang Supermarket, and other businesses like Kuaidong is higher than expected.

Additionally, it is worth noting that the unallocated loss this quarter expanded abnormally by about 2.8 billion compared to last quarter. About 1.1 billion can be explained by changes in investment income or impairment and other non-operating factors. For the remaining part, the company explains it is due to the impact of AI and other project investments. Although so, we have to suspect that the narrowing of new business losses might have been shifted here.

Based on this, we conservatively view this 'unexpectedly better performance of less new business losses.' Due to the massive loss of the core main business, the combined loss of new business + unallocated projects is also expanding, the main business is not doing well while still increasing investment in new business, resulting in a massive operating loss of 19.8 billion for the group this quarter.

V. Flat revenue, soaring costs and expenses

From the perspective of costs and expenses, the source of the massive loss, first, this quarter's gross margin was only 26.4%, down another 6.7 percentage points from last quarter. Leading to a gross profit of 25.2 billion, a year-on-year decrease of about 11.6 billion. The main reason behind this is delivery revenue decreased due to exemptions this quarter, while delivery costs need to grow along with order volume (this quarter's costs increased by 24% year-on-year).

In terms of expenses, the main impact is the increase in marketing expenses to 34.3 billion, an increase of 16.3 billion compared to last year (equivalent to 91%), mainly due to direct subsidies to consumers in the food delivery battle, customer acquisition promotions, and overseas business investments.

Additionally, R&D expenses also increased significantly by 31%, likely due to the AI project investments mentioned in the announcement. Management expenses still increased by 10% year-on-year, remaining relatively stable.

Overall, due to the nearly 12 billion decline in gross profit, while expenses increased by about 18 billion, ultimately leading to a sharp drop in profit, Non-GAAP net loss was 16 billion, higher than Bloomberg's consensus expectation of a 14 billion loss.