DiDi's brewing problems at home to put the brakes on overseas growth
News flow on Chinese ride-sharing giant DiDi Global (DIDI.N) caught our attention over the past two weeks following reports of a company-wide layoff affecting 20% of total employees (approximately 3,000 people). According to Chinese media outlet LatePost, layoffs had already started in January and the process was expected to be complete by the end of February. However, the layoff would reportedly not be extended to DiDi’s overseas operations. Meanwhile, the company continues to face challenges from the Chinese government’s ongoing cyber/data security investigation and new regulatory measures.
“Didi Chuxing slashes 2,000 employees with a big knife! How did China's car-hailing leader come this far?” [translated from Chinese] 16/02/2022
“Didi Reportedly Layoffs 20% of CEOs and Employees in All Businesses” [translated from Chinese] 14/02/2022
We take a dive into Beijing’s crackdown of DiDi and the company’s aggressive overseas expansion and what it could mean for the business and stock. Although we don’t explicitly advocate a buy or sell recommendation on DiDi, we neither see upside catalysts nor reasons to hold the stock despite DiDi now trading at a big discount to global peers. We see more pain looming in the horizon after DiDi weathers past the regulatory fog with the company likely needing to play catch up both at home and abroad.
Navigating Through the Regulatory Storm
Chinese regulators had initially opposed DiDi’s US listing saying that its data could be exposed to foreign powers. However, the company pushed ahead with its listing in June 2021, drawing the ire of Beijing. Shortly after its blockbuster USD 4.4 billion initial public offering (IPO), the Chinese government announced a cybersecurity probe into DiDi, thereby forcing its services off domestic app stores (still unavailable), and prompting the stock to delist.
On 3 December 2021, DiDi announced its plans to delist from the New York Stock Exchange (NYSE), as well as to convert existing ADRs into tradeable shares on the Hong Kong Stock Exchange (HKEX). The stock, which listed at USD 14.00 has since fallen 74% to USD 4.03 (as at 18 Feb 22). DiDi shares have plunged 23% year-to-date, likely on speculation of mounting risks associated with US de-listing and potential prolonged time gap with a Hong Kong re-listing.
There are three main de- and re-listing pathways for Chinese ADR companies, namely
1) Full de-listing (privatization) from the NYSE and primary listing in Hong Kong
2) Remain listed in the US and pursue an HKEX dual listing, and subsequently de-register (de-list) with NYSE
3) Remain listed in the US and pursue a secondary listing and de-register with NYSE after.
We reckon option 3 is the most likely path taken by DiDi to avoid uninterrupted trading and investor panic. While dual listing may help boost DiDi’s valuation, this process could take up to two years given higher regulatory requirements, and potentially draw further scrutiny from Beijing. Although privatization is the fastest way to de-list, we think it’s unlikely given potential legal ramifications resulting from US shareholder losses.
The entire process of remaining listed in the US, while pursuing a secondary listing, and then de-registering with NYSE and converting HKEX as its primary exchange will probably take a full year to materialize. Should the company file for a Hong Kong IPO in March 2022, it won’t be until at least June before its official filing and completion of secondary listing. After, DiDi can de-list from the NYSE and convert its ADS into common shares, subsequently avoiding any legal ramifications from US shareholders. The company would then need to apply for primary listing to make HKEX its main exchange, which would take another 3-6 months (bringing us to year end 2022).
DiDi would also need to make several corporate adjustments to satisfy Hong Kong’s more stringent rules on VIE structures and shareholder protection. The process should be mechanically straightforward since it is an effective migration of existing shares from one exchange to another, rather than a new share issue. Additionally, the HKEX may provide some exemptions to aid DiDi’s compliance under a new regulatory regime.
Backyard Cleanup Stifling Overseas Expansion and New Initiations
Prior to the cybersecurity probe, DiDi has consistently held around 85-90% of the domestic ride-hailing market. Given that passengers and drivers are motivated by convenience and financial incentives, we think it is unlikely that DiDi or any ride-hailing business can maintain that level of dominance. In fact, we see the company potentially ceding 10-20% of its market share in the medium to long term as it drops passenger and driver incentives to achieve profitability. At the same time, other competitors may struggle to match DiDi’s financial war chest (currently approximately holding CNY 63.4 billion cash), thus it should see their dominance sustained.
Currently, DiDi remains vulnerable to local policy shifts and is facing a monopoly investigation. In addition, profits from domestic ride-hailing segment are neither enough to offset nor fund new initiatives set forth by DiDi despite a healthy balance sheet.
We think the company will focus on ensuring its domestic market position in the coming years, while international expansion and other investment initiatives (such as autonomous driving, bike/e-bike sharing, freight and financial services) will take more of a backseat position given that many of its markets are still under “investment phase”. Much of its international success are centered in three countries, namely Brazil, Mexico, and Russia, but rising political tensions and fierce competition in international markets will make it tough, even for new entrants with significant dry powder, to be truly successful unless considerable utility can be provided to its customers to stay on its platform.
DiDi’s Egyptian Adventure
In line with this blog’s Middle East focus, we looked at one of DiDi’s newer market entry ploys – in the crowded ride-hailing market of Egypt. As noted above, the app has achieved strong market positions in Brazil and Mexico, but what happens when it expands into other markets where there are already well-established players – could they be too late to the party?
The Egyptian ride-hailing market size is anticipated to reach USD 2.99 billion by 2028 registering a CAGR of 15.8%. Revenue in the ride-hailing and taxi segment in Egypt is projected to reach USD 1.02bn in 2022. The number of users is forecast to amount to 14.17 million by 2026. The average revenue per user (ARPU) in Egypt is expected to amount to US$94.88. These figures make Egypt a tempting early expansion target for several key competitors of DiDi, due to its strong population and economic growth, as well as structural boons such as public transport safety and reliability issues. Industry insiders have pointed out that the costs of establishing a ride-hailing business in Egypt are relatively low, given that the country’s expanding middle class is largely concentrated within the densely populated cities of Cairo and Alexandria. This results in greater efficiency and economies of scale, and therefore, lower costs. Uber and Dubai-based rival Careem have been active in the market for nearly a decade, and newer entrants such as Russia’s InDrive and UK-based UVA are already trying to carve out market share.
DiDi’s own attempts to break into the Middle Eastern market appear to date back to August 2017, when DiDi made an unspecified investment in Careem, at the time the dominant ride-hailing app in the Middle East which was putting up a hard fight against Uber’s attempts at market penetration. However, in March 2019, Uber acquired Careem for USD 3.1 billion, which likely led DiDi to rethink its market entry strategy in the Middle East. Uber claims to have 90,000 active drivers across Egypt, although it has previously stated to have as many as 200,000 drivers as they were possibly including Careem’s drivers.
In September 2021, DiDi launched in Alexandria and took on the larger Cairo market in early 2022. In January 2022, Arabic language media outlets reported that DiDi was entering into a price war with Uber, Careem, and InDrive. Uber announced it had cut prices by about 10%, and while Didi’s prices are still slightly lower and it is highly unlikely they are operating at a profit while trying to gain market share. Apart from heavy investment into price, it is difficult to see what DiDi’s competitive edge over the other apps will be. InDriver has its auction function to differentiate it (in which users can set bidding prices for rines), and zero commission during its launch phase. This zero commission strategy made InDrive popular among drivers as Uber and Careem charge commissions upwards of 20%. Now as a combined force, Uber and Careem have scale dwarfing that of its competitors in Egypt, which is essential in providing customers with short pick up times and drivers with sufficient revenue streams.
All in all, apart from price cutting, we are yet to see how DiDi differentiates itself from other apps in this crowded market, and their longer term strategy is unclear. As highlighted earlier in this newsletter, an inevitable ditching of passenger and driver incentives to become profitable could lead to a loss of 10-20% in market share (domestically), that’s even if DiDi is able to achieve the scale whereby it remains attractive to the rest of its user base in a post price war scenario. These dynamics are also relevant to DiDi’s attempts to enter other crowded ride-hailing markets like Australia, South Africa, and Japan. This aggressive pricing strategy will indeed continue to boost the scale of DiDi’s international business, but this is predicted to remain a loss-making effort in the short to medium term, as highlighted by sell-side forecasts below.