Summary
Sea announced its earnings two weeks ago and the stock is down 32% since then.
We look into the numbers of the three different divisions, Garena, Shopee, and Sea Money.
Shopee and Sea Money continue to grow at an impressive rate, but Garena lost more than half of its revenue YoY.
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Introduction
After Sea's $Sea Ltd(SE)$ Q4 2022 earnings, the stock price action was exciting, but Q1 2023 brought almost the reverse, with a drop of 17% immediately after the earnings and continued further downside. SE stock is now down 32% from the day before earnings, barely two weeks ago.
Data by YCharts
Despite this big drop, the stock is still up 15.5% year-to-date.
Data by YCharts
The question you have when you have come so far in this article is probably: is this an opportunity to buy Sea's stock at this cheaper price, or is something fundamentally wrong with this company? Let's find out.
What happened and should we worry?
Seeking Alpha's information showed that Sea's revenue was in line with expectations, at $3.04 billion, up 4.8% year-over-year. Earnings Whispers saw the revenue consensus at $3.06 billion, so it could be a slight miss.
Earnings Whispers
Compared to the EPS consensus, the actual reported number of $0.15 is a big miss. But there was a good reason to explain the magnitude of that miss. There was a goodwill impairment of $117.9 million, which doesn't have any implications when it comes to money profitability. It's a recognition Sea overpaid for an acquisition. As the company hasn't made many acquisitions, this is about Phoenix Labs, which SEA acquired for about $150M in 2020 but it became independent again in February of this year. Therefore, Sea has to write off the company completely from its books.
Without this one-time write-off, the company would still have missed the earnings consensus, but only slightly.
Circling back to the revenue growth. You may be shocked that a growth stock only grows its revenue by 4.8%. However, this was on top of 64% revenue growth in Q1 2022, combined with very tough cost cuts.
Sea's Q1 earnings slides
Garena
If you look in more detail, the company does even better than you would think, except for Garena, of which the revenue falls off a cliff. It was $1.1352 billion in the first quarter of 2022, and just $539.7 million now. That's a drop of 52.5% year-over-year. Moreover, it's a drop of 43% quarter-over-quarter. And the future doesn't look that much better.
Sea's Q1 earnings slides
These are the bookings and a 15% quarter-over-quarter drop is still very big. Year-over-year, bookings are down 44%. The only positive was that management shared that the engagement numbers for Free Fire in April, so the current quarter already, not the one reported, were the best in 8 months.
But of course, users are not enough. They have to be willing to pay. And the percentage of gamers that wants to pay has also dropped considerably.
Sea's Q1 earnings slides
The users were up for the first time in a while, albeit just 1%.
Sea's Q1 earnings slides
Now, overall, revenue in the gaming industry is very lumpy and title-driven. As Garena has not put out a self-developed new title since Free Fire in 2017, it's not really surprising this happens. If you look at the history of even the greatest gaming companies, like Activision Blizzard $Activision Blizzard(ATVI)$ and Take-Two Interactive $Take-Two(TTWO)$, you can see that there were quarters with 40%+ revenue drops.
But Sea has two new titles in the pipeline, and investors can hope Garena can stop the bleeding and return to growth. Don't expect this to be very soon, though. You will need to have several quarters of patience.
Shopee
Fortunately, this weakness was offset by very strong performance in the two other divisions. EC stands for e-commerce, so Shopee. Revenue was up 36.3% year-over-year there, which is very impressive if you know that the company has slashed its sales and marketing expenses budget. On a currency-neutral basis, revenue was even up 41%.
It asks higher fees from merchants, doesn't give away as many coupons etc. The fact that revenue goes up so significantly shows Shopee's strength and resilience, to the surprise of many locals, who thought brand loyalty would be much lower.
On Twitter, there were some takes that the fact there were no more reported GMV numbers was a red flag. Here are a few, for example.
Twitter
And this is what I answered them.
Twitter
Dhaval is a friend, and he thanked me. He said he had missed it. If you missed my previous Sea article as well, you can read it here.
Indeed, management had announced they would not provide quarterly GMV numbers anymore. They will continue to provide the numbers on a yearly basis, though.
One of the drivers of the great revenue growth at Shopee was the affiliate program the company set up with influencers. They can highlight a product through affiliate marketing now. More than 4 million influencers have registered and in Indonesia, Shopee's biggest market, orders that came through these affiliate links more than tripled.
Sea's Q1 earnings slides, red added by From Growth To Value
As you can see in this illustration, adjusted EBITDA was negative $408 million in last year's Q1 but positive $207.7 million in Q1 of 2023. Shopee's core markets in Asia posted $275.8 million in adjusted EBITDA. There are still losses for Shopee Brazil, but they went down from $334.9 million to $68.1 million.
On the call, Forrest Li shared that Shopee had crossed 3 million local Brazilian sellers, accounting for 85% of the Brazil orders.
Forrest Li said on the conference call the company would keep investing in Brazil. Yanjun Wang, Sea's Group Chief Corporate Officer who always answers the questions, added during the Q&A on the conference call:
And given our scale and operational efficiency we already achieved there, we believe we can breakeven any time, but we may continue to choose to invest in the market to capture the significant long-term opportunities we observe in the market.
Sea Money
Sea Money also performed outstandingly again. Revenue was up 75% year-over-year. To me, Sea Money is a big part of the bull case for SEA, just like Mercado Pago was my bull case for MercadoLibre $MercadoLibre(MELI)$.
Sea's Q1 earnings slides
Sea has more than $2 billion in loans receivable outstanding. The non-performing loans, due by more than 90 days, remained stable at just 2%, an impressive number. It could be, though, that Sea sees some dark clouds on the horizon, as it raised allowance for credit loss to $281 million. Just to make sure, this doesn't mean there will be defaults for $281 million.
I saw some comments about how horrible this is and some called the loan losses a huge red flag. I'm sorry, but I'm not sure these people have even listened to the conference call. First, the loan loss is very low at 2%. These people probably meant the allowance of credit, which is not the same.
If they had listened to the conference call, they would have heard that management said the loan book had increased a lot but that these loans were not on their own balance sheet but on the balance sheets of their partners, which is logical if they have bought the loans. But Sea still provided an allowance for credit for all the loans, and hence the $281 million. Nothing to really worry about, just a cautious approach and probably convincing some partners.
Sea uses more and more funds from partners for loans, and it also introduced several insuretech products.
Profitability
If we look at profitability, we move to the best part. Just look at net income to start with.
Sea's Q1 earnings slides
Normally, this would have been $205.2 million if there wouldn't have been a one-time impairment. From a loss of $580.1 million to positive net income in just one year, I can't help but be impressed.
If we look at adjusted EBITDA, you see a huge improvement as well. It's almost the same amount, but while last year, the company lost $509.9 million in EBITDA and only Garena was EBITDA positive, now the SEA had $507.2 million in EBITDA, a difference of more than a billion in just one year.
On top of that, Sea Money contributed to that EBITDA, bringing in $98.9 million, while it was still a negative $124.9 million last year. Even Shopee, a gigantic EBITDA drain last year, with $742.8 million in negative EBITDA, brought in $207.7 million this quarter.
Sea's Q1 2023 earnings slides
If you look at the cash flows of the quarter, you also see how strong the company has executed, not just in the previous quarter, but also in this one. Don't let the EPS miss make you think that was not the case. Just look at the numbers for this quarter and the four previous ones.
Made by the author
As you can see, the numbers have turned around spectacularly in the previous quarter, but in this quarter, they continued to grow a lot.
And this all happened while one of the businesses under SEA, its gaming division Garena, saw its revenue cut in half over the last year. That makes it even more impressive.
The only downside to higher free cash flow is the higher stock-based compensation. There was $199 million in this quarter. Sea decided to compensate for a part with shares instead of cash, as a part of its efficiency effort. But overall, the dilution is small.
Another point of concern for investors before the previous quarter was SEA's rapidly shrinking cash. There were notes outstanding for $3.74 billion and it looks as if SEA is going to have to pay back all notes, as the strike price of the biggest part was $477. I wrote in my Q4 analysis:
The company had $3.74 billion in convertible notes. The biggest part, $2.5 billion, is issued when Sea's stock price was much higher. They were offered at $318 per share. They have an interest of 0.25%. They have a conversion price of $477. The company now repurchased $817.2 million of that debt for $611.3 million in cash. If you look at that, you can see that Sea could buy back this debt cheaper than the money value. It actually made $199.7 million in gains there.
Forrest Li also said on the previous conference call management would buy back all notes. And after years of losing money, this was the first quarter, money came in that was from operations, not from selling shares or issuing notes.
Sea's Q1 earnings slides
This convincingly shows how fast Forrest Li could turn around the company.
Sea continues to invest in building fulfillment capacity. Forrest Li on the Q1 call:
In our largest market, Indonesia, which consists of more than 10,000 islands, 95% of our buyer base is now covered by our delivery services. In Brazil, we already have eight distribution and sorting centers. With the most recent expansion in Northeast Brazil, we have also been working to expand our first and last mile hubs in the market. In recent months, we opened 15 new hubs to further strengthen our logistics capabilities
It's good to see that these investments are not cut.
An analyst asked about the renewal of the Tencent agreement. Garena has the right of first refusal, meaning it can take all games and publish them in Southeast Asia. Only if Garena doesn't want to do this, someone else can publish the game. This agreement ends in September or October of this year. Management answered that if nothing happens, the contract automatically renews and so far, there are no indications that wouldn't be the case.
Is Sea Limited Stock a buy?
I see Sea as a buy, but not a screaming buy. The valuation of the stock has become attractive. The EPS estimate (on a non-GAAP basis) for this year is $2.79, which means a forward PE of 21.5.
Seeking Alpha
Of course, Sea will have to continue delivering and there will be lumpiness in the quarterly results. But if Garena's bleeding can be stabilized or if revenue can grow there again through the introduction of new games, Sea could look dirt cheap here.
For my subscribers, I introduced a Buy-Hold-Sell Scale, with more nuance than just the terms. This is how Sea is rated now.
Made by the author
I think there will be tough and volatile quarters ahead for Sea, as Forrest Li warned already after Q4 2022. But the continued profitability, even at increasing speed, means that the company can operate like a speed boat, despite its tanker-like size.
I continue to be impressed by what this company does. To me, the stock price drop is understandable, but it doesn't mean a fundamental change in the company's execution, to the contrary. Overall, this was a good quarter if you leave out Garena. Of course, Garena is a part of Sea and that means it will have to turn around or at least stabilize.
In Q2, the comps are still challenging but in the back half of the year, Sea faces easier comps. That's another reason why I will keep buying Sea's stock.
Source: Seeking Alpha
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