Xiaohongshu’s New Financing: A Return to the Old Days or the End of a Chapter? – Bamboo Works

The social e-commerce company whose name means “Little Red Book” has become a relative rarity, attracting Western heavyweights DST in its latest funding round

Key conclusions:

• Xiaohongshu’s new funding round is valued at $17 billion, with DST Global, Hillhouse, Boyu Capital and Citic Capital joining the group of new investors
• The social media e-commerce company’s revenue jumps 85% to $3.7 billion in 2023 as it seeks to move beyond advertising as its primary source of income

By Hugh Chen

As Sino-American relations grow increasingly tense, the once-thriving relationship between the two countries’ capital markets seems increasingly like a distant memory. It wasn’t that long ago that Chinese tech companies freely raised money from American investors, who then cashed out those investments in IPOs on American exchanges without raising many eyebrows.

Against this background, last week’s reports this Chinese social media darling Xiaohongshu raised new funding from prominent Western-linked venture capital firm DST Global, which has distinguished itself as a countertide. The move harks back to a more open era of cross-border tech investment, raising the possibility that international venture capital will still be able to find a home in China’s increasingly isolated tech sector.

Only time will tell whether the investment is an anomaly, an isolated relic from a bygone era, or whether it shows that there is still interest in Chinese technology companies among increasingly cautious Western private equity firms.

Founded in 2012, Xiaohongshu, whose name means “Little Red Book,” emerged during an earlier golden age of international investment in Chinese technology. Like its contemporaries Meituan (3690.HK) and Pinduoduo (PDD.US), Xiaohongshu’s meteoric rise was fueled by U.S. dollar investment. Yet it remains one of the few major Chinese internet companies from that era that still isn’t publicly traded—a unicorn that still wows investors with its potential.

Two other people in similar situations are fast-fashion star Shein and TikTok owner ByteDance. Both companies have had increasing difficulty raising funds, and their plans to list on Western exchanges have hit a number of obstacles both at home and abroad.

Headlines last week, starting with a report in the Financial Times, said Xiaohongshu’s latest funding round had attracted a diverse group of investors. In addition to DST, known for its early backing of Facebook, new investors include Hillhouse, Boyu Capital and Citic Capital, while HongShan, formerly known as Sequoia China, also increased its existing stake. Apart from DST, all the other investors are Chinese, investing from U.S. dollar-denominated funds. The round, which included the sale of existing shares to both existing and new investors, valued the company at $17 billion.

Xiaohongshu’s recent fundraising hints at an impending IPO. Unlike other startups that raise funds to fund their unprofitable operations, Xiaohongshu appears to be flush with cash. Instead, the new round of funding was led by early investors looking to exit and new investors looking to enter, according to local media channel PE Dailyciting an investor close to the company.

The latest valuation of $17 billion is up from the $14 billion that Xiaohongshu was reported to have in mid-2023, when HongShan first invested in the company. However, the latest value also represents a drop from the $20 billion valuation of the company in the second half of 2021, when many Chinese internet companies were still riding high.

From its roots as a magazine-style online shopping guide, Shanghai-based Xiaohongshu has evolved into a unique social commerce platform that combines elements of Instagram, Pinterest and Amazon. The app has become a destination for young urban Chinese, especially women, looking for lifestyle tips, product recommendations and authentic reviews.

Impressive growth

Xiaohongshu’s growth trajectory continues to be impressive, defying the drastic slowdown in growth rates for most major Chinese internet companies over the past two to three years. In 2023, the company’s monthly active users rose 20% year over year to 312 million, while its revenue increased 85% to $3.7 billion. Such rapid growth harks back to an earlier era when China’s mobile internet began to take off in the early 2010s, and positions Xiaohongshu to stand out in today’s more mature internet landscape.

Perhaps even more striking is Xiaohongshu’s recent turn toward profitability. According to investor documents cited by multiple media outlets, the company posted a net profit of $500 million last year. That was a drastic turnaround from a $200 million loss in 2022, underscoring the platform’s ability not only to continue to grow but also to translate that growth into financial success.

Like many social media platforms, Xiaohongshu relies heavily on advertising to generate revenue. According to a recent report by GF Securities, advertising will account for 70% to 80% of the company’s total revenue in 2023.

Recognizing the risks of relying so heavily on a single source, especially as China’s economic slowdown has made advertisers more cautious, Xiaohongshu has been looking to diversify its revenue streams. As part of that effort, the company has significantly ramped up its e-commerce efforts over the past few years, aiming to more directly leverage the purchasing power of its large user base.

Xiaohongshu’s latest e-commerce initiative focuses on a model that leverages content creators who recommend products that align with their own tastes, with Xiaohushu taking a cut of the resulting sales. The company believes this model sets it apart from traditional e-commerce because it fosters more authentic influencer-consumer connections, potentially leading to greater engagement and sales.

The success of Xiaohongshu’s e-commerce strategy will be key, as it will likely keep investors interested in the company and could help boost its valuation. This is especially important given the company’s highly anticipated IPO plans.

Early signs are promising, as Xiaohongshu’s e-commerce initiative showed significant progress during last month’s 618 Festival – considered the country’s second-largest online shopping event each year. The platform saw a significant increase in seller activity on livestreams, with gross merchandise value (GMV) from those livestreams increasing five-fold compared to last year’s event.

Still, challenges remain. With advertising still accounting for 80% of revenue, Xiaohongshu’s e-commerce efforts are still in their early stages. What’s more, the company faces fierce competition in a market dominated by established e-commerce giants like Alibaba, Pinduoduo and JD.com, not to mention other newcomers like Douyin, China’s version of TikTok.

Xiaohongshu’s IPO plans Rumor has it that as early as 2021could face a number of external headwinds beyond the company’s control. The timing and feasibility of the IPO will depend not only on Xiaohongshu, but also on geopolitical dynamics and the ever-changing regulatory landscape for Chinese internet companies.

Recent events around Shein illustrate the growing complexity involved in cross-border listings for Chinese tech companies. After reportedly abandoning plans for a U.S. listing, Shein is now exploring alternatives, with London the favorite and Hong Kong a potential backup.

Both Shein and Xiaohongshu have vast troves of sensitive personal data, albeit from different user bases. Shein primarily collects data from users outside of China, particularly in the United States, while Xiaohongshu’s data comes primarily from Chinese consumers. Despite recent easing of China’s numerous crackdowns on various tech sectors, heightened tensions with the U.S. continue to complicate Chinese companies’ international listing plans.

This brings us back to the future role of international venture capital in China’s tech sector. While the Xiaohongshu case shows that cross-border investment is still possible, it is still likely to be an exception in today’s climate. This could mean that the earlier era of routine U.S. investment in Chinese tech startups and eventual U.S. listings may be over, at least for now. Going forward, success may depend on creative solutions that satisfy both domestic regulators and international investors in this new landscape of heightened scrutiny on both sides of the Pacific.

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