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Should You Avoid JD.com, Inc. (JD)?

Is JD.com, Inc. (NASDAQ:JD) a good equity to bet on right now? We like to check what the smart money thinks first before doing extensive research. Although there have been several high profile failed hedge fund picks, the consensus picks among hedge fund investors have historically outperformed the market after adjusting for known risk attributes. It’s not surprising given that hedge funds have access to better information and more resources to find the latest market-moving information.

JD.com, Inc. (NASDAQ:JD) has experienced a decrease in enthusiasm from smart money recently. JD was in 32 hedge funds’ portfolios at the end of the third quarter of 2018, down from 41 hedge funds in our database with JD holdings at the end of the previous quarter. Among investors long JD, there weren’t many billionaires, and hence the stock is not among the 30 stocks billionaires are crazy about: Insider Monkey billionaire stock index. But, just because billionaires are not piling on JD, does that mean you shouldn’t purchase this stock? Absolutely not. We’ll try to find out if the stock is worth buying throughout the article.

In the eyes of most market participants, hedge funds are assumed to be underperforming, old financial tools of yesteryear. While there are over 8000 funds with their doors open at the moment, We choose to focus on the crème de la crème of this group, around 700 funds. These money managers direct the lion’s share of the hedge fund industry’s total capital, and by observing their best investments, Insider Monkey has unearthed a number of investment strategies that have historically outrun the market. Insider Monkey’s flagship hedge fund strategy outperformed the S&P 500 index by 6 percentage points per year since its inception in May 2014 through early November 2018. We were able to generate large returns even by identifying short candidates. Our portfolio of short stocks lost 26.1% since February 2017 even though the market was up nearly 19% during the same period. We just shared a list of 11 short targets in our latest quarterly update.

TIGER GLOBAL Investor Letter

Why are hedge funds investing in this stock? Hayden Capital shared its investment thesis recently. In its investor letter, the fund is discussing recent lawsuit against JD’s founder and CEO, Richard Liu, and some other problems the company is facing. More about it, you can read here:

“JD.com (JD): Over the past few months, there’s been a couple negative developments for our JD.com position. First, in early September news came out that Richard Liu (the founder & CEO) was accused of sexual assault while completing a course at the University of Minnesota, as part of the Carlson School of Management / Tsinghua University’s Doctor of Business Administration program. Most of our partners will already be familiar with the situation, so I’ll won’t rehash it. However those who aren’t can read up on the details here.

Since the initial reports, the police have finished their investigation, and no charges have been filed in the subsequent two months. Richard was released from police custody the next day, and is now working back in China. Additionally, his attorney, Joseph Friedberg, who has a pretty stellar reputation as one of the best criminal defense attorneys in Minnesota, even went so far as to state “I would bet my law license that he’s not going to be charged.”

The female student accuser, in the meantime, has retained two civil attorneys: Florin Roebig (a firm which earned its reputation in Florida Personal Injury cases and doesn’t seem to have much experience in sexual misconduct cases), and Hang & Associates (a small Flushing, NY based law firm, who’s specialty is unpaid overtime cases in the hospitality / restaurant industry, representing immigrant workers). Despite the odd choice of attorneys, my best guess is the likely outcome will be a civil settlement out of court between Richard and the accuser, in an effort to make this headline “go away quickly”.

The more concerning issue, however, is that the event highlighted a potential flaw in our investment process. After the news came out, I started digging a bit deeper into the personal reputation of Richard. In public,Richard is known for coming from a humble family background, having built JD from a small kiosk in Beijing to the $35 Billion business it is today, always treating his employees well (for example, calling his deliverymen “brothers”, and paying them above industry standards), and building JD.com with the idea of trust, integrity, and always playing the long-game.

However, the responses I got back from several sources after the incident, who are current or former employees, were contradictory to this image. In particular, these sources all had separate anecdotes for Richard’s inappropriate behavior, and how it’s a widely known secret within the company that he likes to “flirt with young trainees” (we can talk in more detail about these stories offline). During the initial research process when I was looking into the company, I had spent considerable time looking into the corporate culture of JD. But in hindsight I hadn’t verified the personal background of Richard, as hard as I should have. These rumors of personal character were knowable for those asking the right questions, and it was a mistake of the process to overlook this aspect.

Having said all of this, the next question is how much does Richard Liu’s personal life factor into JD.com as a company and as an investment? Judging by the stock’s initial reaction after this news broke, the market thinks it’s ~20% of the stock price.

However, I’d argue that there are other issues that JD is facing, which have a far larger impact on the company’s future value. Among them are JD’s lack of a data-driven culture vs. competitors (see previous footnote on culture), inability to court top tech talent due to this, Alibaba’s impressive ramp up in its Cainiao logistics capabilities (especially in Tier 1 cities) in the last few years, and the top-heavy management style of the company. JD is addressing some of these issues, such as implementing a rotating CEO program for its JD Mall division this summer, but it’s been slower than investors would like.

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