PDD's stock price unexpectedly plunged, hedge funds discovered trading opportunities!

Pinduoduo surprisingly gave an exceptionally pessimistic outlook. During the earnings conference call, the company's CEO, Chen Lei, mentioned at least eight times that the company's revenue and profit are "inevitably" declining.

Chen Lei, who is also one of Pinduoduo's early employees, stated at an analyst meeting: "We are facing many new challenges, including changes in consumer demand, intense competition, and global uncertainty."

Founded by former Google engineer Huang Zheng in 2014, Pinduoduo has captured market share in recent years by combining low prices, aggressive rural expansion, and gaming elements on its platform. It transformed this model into the app Temu for global e-commerce discounts, launched during the 2023 Super Bowl. Temu has become a shopping phenomenon similar to Shein, once one of the most downloaded apps in the United States.

This drove Pinduoduo's market value to increase sixfold from its low point after the 2022 COVID-19 pandemic, making Huang Zheng China's richest man this month. However, he only held the title of richest man for 18 days until Pinduoduo was sold off on Monday.

Chen Lei stated that consumers' purchasing behavior has fundamentally changed, moving away from low-priced products that have been driving rapid revenue growth since their inception.

He said during the earnings conference call: "Consumers are making more cautious decisions to balance quality and value. In response, we have partnered with high-quality brands and manufacturers to create customized products to meet these diverse consumer needs."

Morgan Stanley analysts Eddy Wang and Kathy Zhu wrote: "We believe management's comments on the long-term decline in profitability are too conservative. We believe Pinduoduo is the only e-commerce company in China that can surpass industry growth."

Pinduoduo's stock price hitting its largest historical decline has brought profits to a popular hedge fund strategy, which exploits the disconnect between the stock market and the corporate bond market.

The core of this strategy is convertible bonds, a type of debt that can be converted into shares under specific conditions. It involves buying convertible bonds - which is equivalent to having a call option, allowing the holder to buy stocks at the conversion price - and selling the company's stock as a hedge.

Convertible bond arbitrage trades are usually not one-to-one set up, relying on so-called Delta hedging, which requires market participants to balance their short and long positions. However, the excess returns on short positions meant that the strategy succeeded on Monday.

Three traders indicated that rough calculations suggest the trade may have generated a 2.4% unleveraged return on Monday. One trader added that since hedge funds typically borrow funds to build positions, their returns that day ranged from 5% to 10%.

As companies increase the sale of convertible bonds, this strategy has become popular this year as this type of debt typically costs less than traditional bonds. Chinese tech companies including Alibaba Group, JD.com, and Lenovo Group have all sold such securities this year