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PDD Holdings (PDD -16%) is under pressure today after the Chinese ecommerce giant reported Q1 results this morning. PDD, which operates the Chinese social commerce platform Pinduoduo and the global e-commerce marketplace Temu, posted 10% yr/yr revenue growth at US$13.18 bln, but that was below analyst expectations.

• The top line miss was not the only worrisome metric. Despite 10% revenue growth, PDD posted a pretty large decline in profitability. Non-GAAP operating profit in Q1 fell 36% yr/yr to US$2.52 bln and non-GAAP net income fell 45% yr/yr to US$2.33 bln. Part of the profitability declines are attributable to PDD making what it characterized as "substantial investments" in its platform ecosystem to support merchants and consumers amid rapid changes in the external environment.
• These investments weighed on short-term profitability but PDD sees enhanced merchant support as essential to building a healthy merchant ecosystem. These ecosystem investments are expected to help drive sales and reduce costs for a broader base of SME merchants.
• Circling back to the top line, Q1's 10% yr/yr revenue growth was its lowest of any quarter in the past five years. PDD has warned about this before, saying that a slowdown in its revenue growth rate was to be expected as its business scales and challenges emerge. This trend has been further accelerated by the changes in what PDD calls the external environment. We assume this means tariffs and trade tensions generally between China and the US.
• However, it is not just that. On the call, PDD said that competition in Chinese e-commerce sectors has further intensified. As a third-party marketplace, PDD says it faces limitations when it comes to passing on policy incentives to consumers, which puts its merchants at a clear disadvantage compared to competitors that operate a first party business.
• Also, since the second half of last year, PDD has significantly expanded its fee reduction program for merchants. And this year, PDD says merchants are expecting to face further pressure, which has spurred PDD to commit significant resources to support a profitable ecosystem through uncertain times. PDD says this effort will likely weigh on profitability in the short term and even for a considerable period of time to come.

While we think PDD's slowing top line growth and its top line miss are concerns for investors, we suspect the bigger concern relates to PDD's decision to make large investments in its merchant platform ecosystem. That impacted profitability pretty substantially in Q1 and PDD's comments about this weighing on profitability for some time in the future are concerning as well. Trade war tensions are clearly a factor as well, but these investments are giving investors pause.