Why Has Sea Limited (SE) Dropped 10% This Month?

(Wirestock Creators)
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If you’re active on Fintwit, you have undoubtedly heard Sea Ltd. (SE) talked about on many threads. If you’re not active on Twitter, you may not know much about this Singapore-based company worth over $150 billion in market cap. Sea Ltd reported earnings on Tuesday and the stock is down over 10% this month. Is it interesting at this level?

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Overview

  • Sea Limited (SE) is a global consumer internet company from Singapore.
  • The company operates in three core businesses:
    • Garena: Digital entertainment
      • Garena is a leading global online games developer and publisher.
      • This division has 729 million quarterly active users and 93.2 million paying users.
    • Shopee: E-commerce
      • Shopee is the largest pan-regional e-commerce platform in Southeast Asia and Taiwan.
      • Shopee’s Gross Merchandise Value (GMV) is $16.8 billion, growing >80% YoY.
    • SeaMoney: Digital payments and financial services
      • SeaMoney is a leading digital payment and financial services provider in Southeast Asia.
      • SeaMoney now has 39.3 million quarterly paying users for mobile wallet.

Q3 Earnings Highlights

Financials – Overall

  • In the most recent quarter, Sea Ltd beat analyst expectations on growth with $2.69 billion in revenue for the quarter, growing 122% YoY.
    • Nearly 95% of revenue comes from the digital entertainment division (Garena) and e-commerce business (Shopee).
    • Sea Limited has posted 13 straight quarters of >98% YoY growth.
  • Gross profit for the business grew 147.5% YoY to $1 billion (37% margin).
  • Adjusted EBITDA for the quarter actually came in at a loss of $165.5 million mostly due to a $683.8 billion loss in the e-commerce business. In Q3 2020, adjusted EBITDA was positive.
  • It was the second straight quarter of adjusted EBITDA losses after four straight quarters of EBITDA profitability.
  • Sales and marketing expenses grew to over $1 billion for the quarter and over 114% YoY as the company continues to pour into growth (37.5% of revenue).
  • Research and development costs also more than doubled to $231.4 million for the quarter.
  • At the end of October, Sea Ltd had 555 million shares outstanding with $31.3 million in 2023 convertible notes and $207.8 million in 2024 convertible notes.
  • At the end of the quarter, Sea Ltd increased its cash balance to over $11.8 billion.


Digital Entertainment (Garena)

  • Bookings for Garena grew 29.2% YoY to $1.2 billion.
  • Revenue grew over 93% YoY to $1.1 billion (40.9% of total revenue).
  • Adjusted EBITDA for the quarter was highly profitable at $715.1 million (58.6% of bookings).
  • Quarterly active users rose 27.4% and quarterly paying users rose 42.7% YoY to 729 million and 93.2 million, respectively.
  • During the quarter, Garena’s self-developed mobile game, Free Fire, ranked second globally by average monthly active users for all mobile games on Google Play.
    • It was the highest grossing mobile game in Southeast Asia, Latin America, and India.
    • Free Fire has remained in the top spot for over 2 years in Southeast Asia and Latin America.
    • In the United States, Free Fire has been the highest grossing mobile battle royale game for three consecutive quarters.
  • At the end of September, Sea Limited launched Free Fire MAX to continue to drive quality engagement and experiences for users. It is a new standalone version of Free Fire.

E-commerce (Shopee)

  • E-commerce revenue contributed to nearly 54% of total revenue at $1.45 billion for the quarter.
    • Marketplace revenue rose over 150% YoY to ~$1.2 billion.
    • Product revenue rose over 80% YoY to ~$300 million.
  • Gross orders totaled 1.7 billion on the platform, the 9th straight quarter of >100% growth.
  • GMV increased 80.6% YoY to $16.8 billion.
  • Adjusted EBITDA margins widened YoY from a loss of $301.6 million to a loss of $683.8 million.
    • The adjusted EBITDA loss per order was flat at $0.41 per order, but improved in the most mature markets (Southeast Asia + Taiwan).


Management Commentary

Xiaodong (Forrest) Li, Founder + CEO

  • On Garena:
    • “Garena is now serving some of the largest game communities globally, and we are very focused on creating great experiences to engage, entertain and help friends and families spend time together. In particular, Free Fire’s massive and highly engaged user base represents an exciting and growing opportunity for us.”
    • “At the end of the third quarter, we introduced the Free Fire MAX globally to a very strong reception from our community. Free Fire MAX offers an enhanced Free Fire experience through higher quality effects, animation, graphics and features, but retaining the same great game play. Because we are committed to empowering users everywhere, we’ve worked hard to ensure that players of both Free Fire and Free Fire MAX can play together seamlessly.”
  • On Shopee:
    • “Shopee had a fantastic double 11.11 shopping festival with widespread success. It was especially heartening to see an uplift in participation from consumers in rural and smaller towns as they enjoy the convenience and a wide assortment on Shopee.”
    • On Brazil expansion: “Shopee also continued to make good progress in Brazil. In the third quarter, it was once again ranked first by download and the total time spent in app. And second by average monthly active users for the shopping category according to App Annie. While Brazil is still a young market for us, our local teams are focused on better understanding our growing community of local buyers and sellers and improving the experience we offer to them.”
    • On other global expansion: “Looking ahead, we are prudently and efficiently exploring how to maximize our largest addressable opportunities, giving our growing market position. In the recent months, we launched Shopee in Poland, France, Spain and India.”
    • Our focus, first and foremost, is on our markets, existing markets in Southeast Asia, Taiwan, as well as the new growth market in Brazil, where we have achieved a very strong presence.
  • On SeaMoney: “Besides our mobile wallet business, we have launched early initiatives in other digital financial services such as buy now pay later, digital bank and insurtech. These products are still in the early development phase, and we are currently focused on strengthening our models and operations.”

Yanjun Wang, Chief Corporate Officer + General Counsel

  • “If we look at our metrics across the board [for Free Fire], they have improved not only year-on-year, but also quarter-on-quarter with very tough comps during the — especially during the past period where both of our markets were deeply affected by COVID.”
  • “We will continue to focus on that as well as continue to build up our game pipeline with more diversified genres from our self-developed pipeline as well as publishing as well as our investment pipeline.”

Guidance

  • Sea Ltd is only providing guidance for the e-commerce business for the rest of the year, but adjusted guidance up over 6% from previous guidance.
  • In the previous quarter, Sea Limited guided to digital entertainment bookings of $4.5 billion – $4.7 billion for the year.
  • Together, the midpoint guidance for Sea Ltd’s two biggest revenue drivers is ~$9.7 billion (bookings =/= revenue 1:1).

Valuation + Analysis

  • At yesterday’s closing price of $314.41 per share and the 555 million shares outstanding reported by the company, Sea Ltd’s market cap is just shy of $175 billion.
  • Accounting for net debt, Sea Ltd’s enterprise value is $166 billion.
  • We are yet to get fully updated analyst estimates for FY22. According to estimates before earnings, Sea Ltd is expected to do $13.9 billion in revenue and inflect back into EBITDA profitability of just north of $1 billion (~7.5% margin).
  • Based on these estimates, SE is trading at 29.5x FY22 gross profit and over 150x FY22 adjusted EBITDA.

KR: I think about Sea Ltd as two massive companies. Garena has grown quarterly active users to over 700 million users (more than 2x the population of the US!). It has grown mostly on the back of a highly popular game in Free Fire.

Shopee also continues to grow in its core markets. Southeast Asia e-commerce growth in particular is very attractive. It’s clear from the YoY growth numbers even against pandemic comps that the company is operating at a high level.

I can’t tell you the exact reason for the 10%+ dip in the stock in the past month, but I would guess that the market is nervous about Garena’s growth over continued pandemic comps and the fact that the business flipped back to posting EBITDA losses. To be fair, this company is still in its growth stage.

On top of the core business, Sea Limited has upside optionality with SeaMoney and potential global expansion in other markets (exploratory phase). BUT for this growth and upside, you must pay up. At 30x gross profit and positive EBITDA only coming from one part of the business, execution is key for SE to outperform.

Justin looked at Sea Ltd in June with back-of-the-envelope assumptions using our DCF calculator tool. Check out his assumptions there for a most robust look at its relative valuation when the stock was at $295.91 per share!


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