Xiaohongshu's New Funding: Return To Old Times Or End Of A Chapter?

Key Takeaways:

• Xiaohongshu was valued at $17 billion in a new funding round, with DST Global, Hillhouse, Boyu Capital, and Citic Capital joining as new investors
• The social e-commerce company’s 2023 revenue surged 85% to $3.7 billion, as it tries to expand beyond advertising as its main income source

By Hugh Chen

As China-U.S. relations grow tenser by the day, a formerly flourishing relationship between the two countries’ capital markets feels increasingly like a distant memory. It wasn’t long ago Chinese tech firms freely raised money from U.S. investors, who later cashed out those investments with IPOs on American stock markets, hardly raising an eyebrow.

Against that backdrop, reports last week that Chinese social media darling Xiaohongshu raised fresh new funds from prominent Western-linked venture capital firm DST Global stands out as swimming against the tide. Such a move harkens back to a more open era of cross-border tech investments, holding out the possibility that international venture capital may still be able to find a place in China’s increasingly isolated tech sector.

Only time will tell if the investment is an anomaly representing an isolated holdover from an earlier era, or whether it shows there’s still some appetite for Chinese tech firms 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 China tech. Like contemporaries Meituan (3690.HK) and Pinduoduo (PDD.US), Xiaohongshu’s meteoric rise was fueled by U.S. dollar investments. Yet, it remains one of the few major Chinese internet firms from that era still unlisted – a unicorn that continues to captivate investors with its potential.

Two others in similar situations are fast fashion sensation Shein and TikTok parent ByteDance, which are both finding similar fundraising increasingly difficult and whose plans to list on Western stock markets have run into numerous headwinds both at home and abroad.

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

Xiaohongshu’s latest fundraising hints at an approaching IPO. Unlike other startups raising funds to fuel their money-losing operations, Xiaohongshu appears flush with cash. Instead, the new funding round was driven by early investors looking to exit and new ones keen to enter, according to local media outlet PE Daily, citing an investor close to the company.

The latest valuation of $17 billion is up from the $14 billion Xiaohongshu was reportedly worth in mid-2023 when HongShan first invested in the company. However, the latest figure also represents a retreat from the company’s valuation of $20 billion in the latter half of 2021 when many Chinese internet companies were still at their peaks.

From its roots as a magazine-style online shopping guide, Shanghai-based Xiaohongshu has evolved into a unique social commerce platform blending elements of Instagram, Pinterest, and Amazon. The app has become a go-to destination for young Chinese urbanites, particularly women, seeking lifestyle tips, product recommendations and authentic reviews.

Impressive Growth

Xiaohongshu’s growth trajectory continues to impress, defying a dramatic slowdown in the last two to three years in growth rates for most major Chinese internet companies. In 2023, the company’s monthly active users grew 20% year-on-year to 312 million, while its revenue surged by 85% to $3.7 billion. Such explosive growth echoes an earlier era when China’s mobile internet began to boom in the early 2010s, and positions Xiaohongshu as a standout in today’s more mature internet landscape.

Perhaps even more striking is Xiaohongshu’s recent pivot to profitability. According to investor documents cited by multiple media outlets, the company earned a net profit of $500 million last year. That marked a dramatic turnaround from its $200 million loss in 2022, highlighting the platform’s ability to not only keep growing but also to translate that growth into financial success.

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

Recognizing the risks of such heavy reliance on a single source, especially as China’s economic slowdown has made advertisers more cautious, Xiaohongshu has been trying to diversify its income streams. As a part of that effort, the company has significantly ramped up its e-commerce efforts in the last few years, aiming to tap into the purchasing power of its large user base more directly.

Xiaohongshu’s latest e-commerce initiative centers on a model that leverages content creators who recommend products aligned with their own tastes, with Xiaohushu taking a cut of resulting sales. The company believes such a model sets it apart from traditional e-commerce by fostering more authentic influencer-consumer connections, potentially leading to higher engagement and sales.

The success of Xiaohongshu’s e-commerce strategy will be crucial, as it will likely keep investors interested in the company and could help to lift its valuation. That’s particularly significant given the company’s highly anticipated plans for an IPO.

Early signs are promising, with Xiaohongshu’s e-commerce initiative showing notable progress during last month’s 618 festival – considered the country’s second biggest online shopping event each year. The platform experienced a substantial surge in merchant livestreaming activity, with gross merchandise value (GMV) from these livestreams soaring to five times that of last year’s event.

Still, challenges remain. With advertising still accounting for 80% of its revenue, Xiaohongshu’s e-commerce efforts are still in their nascent stages. Moreover, 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, the Chinese version of TikTok.

Xiaohongshu’s IPO plans, rumored as early as 2021, could face multiple external headwinds beyond the company’s control. The timing and feasibility of any IPO will depend not only on Xiaohongshu, but also on geopolitical dynamics and a constantly shifting regulatory landscape for China internet companies.

Recent developments surrounding Shein illustrate the growing complexities involved in cross-border listings by Chinese tech companies. After reportedly abandoning plans for a U.S. listing, Shein is now exploring alternatives, with London emerging as a frontrunner and Hong Kong as a potential backup.

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

That brings us back to the future role of international venture capital in China’s tech sector. While Xiaohongshu’s case shows cross-border investments are still possible, it’s still quite possibly an exception in today’s climate. That could mean the earlier era of routine U.S. investments in Chinese tech startups and eventual U.S. listings could be over, at least for now. Moving 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.

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.