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Is There Any Hope Left for DiDi Global's IPO?

For China-based ride-sharing service DiDi Global (NYSE: DIDI), June 30 was the peak of its public debt. At the height of its first day of trading, the company had a market cap of $80 billion. However, the shares' time at that level was extremely short-lived as its market cap has fallen below $60 billion since then.

The stock plunged after China's ruling Communist Party (CCP) suspended downloads of DiDi's namesake app from smartphone app stores in the country, citing cybersecurity risks regarding sensitive consumer data. The ban is likely temporary as more than 377 million of its existing annual users and 13 million drivers are still allowed to use the app. But even as shares have fallen below their IPO price, investors should proceed cautiously before buying the dip.

Image source: Getty Images.

What's going on?

The controversy surrounding DiDi isn't really that different from that of its American counterparts such as Uber and Lyft. Back in May, China's Ministry of Transport already had a preliminary conversation with the company regarding its business practices. DiDi essentially holds a monopoly in China with control over 88.7% of the rideshare market (as of May 2020). Even back in 2017, passenger volumes on the platform were 20 times larger than that of air travel and three times more than rail passengers.

As a result, Didi controls a mountain of passenger traffic data and uses it to questionable ends. For example, the company has been accused of artificially deflating the cost of rides to weed out competitors (like taxi companies) and then raising them back up once its rivals are out of the business.

In addition, ridesharing is still something of a maverick industry. That means labor laws regarding whether or not drivers are employees or gig workers are pretty much nonexistent -- similar to the debate that has raged in the U.S. Drivers are starting to demand a minimum wage for their service, and their grievances have attracted the central government's attention in Beijing. Their pay can also be very inconsistent across the platform, ranging from 79% of the ride cost to just 30%.

The ban was also partly political in nature. The CCP has recently launched a coordinated effort targeting China-based issuers of American Depositary Receipts (ADRs) like DiDi. The company (like many others) incorporated in the Cayman Islands to bypass China's stringent laws on companies' ability to raise foreign capital. That means foreign shareholders get to have a say in how DiDi operates -- which is not something the authoritarian regime necessarily wants.

What is the outlook?

DiDi stock's valuation further complicates the picture. Shares currently trade at just 2.3 times revenue, quite reasonable for a company that reported 106% year-over-year sales growth in the first quarter. However, less than 2% of its sales came from outside of China last year. That means the bulk of the company's business is at the mercy of the Chinese government. If it does something that rubs regulators in the wrong way again -- it may face even tougher challenges.

To keep passenger volume growing, DiDi is also operating on thin margins, so investors should keep in mind the company won't be posting soaring profits anytime soon (though it is currently breaking even).

DiDi's growth is about to fall off a small cliff or into a deep ravine depending on how long its ban from app stores lasts. But that's not all -- the Chinese government also has the power to break up its monopoly, and there is still the possibility for new labor laws to mandate minimum wages for drivers, further eating away at profitability.

I'd be very hesitant to put my money in a company that has attracted Beijing's attention in this manner. At a minimum, investors should wait for updates on the current ban and see how DiDi can steer away from further regulatory action before opening a stake in this tech stock.

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Zhiyuan Sun has no position in any of the stocks mentioned. The Motley Fool recommends Uber Technologies. The Motley Fool has a disclosure policy.


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