Sea Ltd: Market's Savage Response is Totally Justified

Sea Ltd (SE) share price dived 29% post-earnings. Both revenue and ESP missed consensus estimate; SE reported EPS of 54 cents on $3.1 billion in revenue, but analysts polled by FactSet were expecting sales of $3.26 billion and EPS of 65 cents. 

Furthermore, Forrest Li has indicated that SE will shift away from the cost-cutting drive that it started last year, choosing instead to ramp-up investments in its e-commerce biz, which Li has guided will impact bottom line and may result in losses for Shopee / the Group.

Garena continued to be weak, though some silver lining

GAAP revenue saw a 2% q-o-q decline, reaching USD 529.4 million. Bookings also declined 4.2% q-o-q to USD 443.1 million. Notably, the adjusted EBITDA reached USD 239.5 million, showing a positive growth of 4.1% q-o-q. This increase was primarily propelled by a sequential rise in Free Fire bookings which has higher profit margins.

The quarterly active user base grew by a noteworthy 10.8% q-o-q, accompanied by a substantial surge of 14.6% q-o-q in quarterly paying users. However, the average bookings per user decreased to USD 0.8, from USD 0.9 in the previous quarter.

Fintech EBITDA ahead of expectation

GAAP revenue increased by 53.4% year-over-year to USD427.9 million, driven by a strong increase in both the number of loans originated and the average loan size. Adjusted EBITDA was USD137 million, compared to a loss of USD111.5 million in the same period last year. Total loans receivable was stable at USD2.0 billion as of March 31, 2023, and the net allowance for credit losses increased to USD278.6 million (~2%). SE’s fintech business will likely continue to ride on the emerging ASEAN fintech sector growth as the industry shifts its emphasis from payments and costly user acquisition to a more directed focus on lending and the distribution of financial products.

E-commerce underperformed way below expectation

Firstly, revenue of $2.1bn was below market consensus. Some of the shipping subsidies are likely netted-off from the revenues resulting in lower revenues. Adj EBITDA was $150m, lower than consensus. Moreover, there is a risk that earnings could decline in the coming quarter as well.

If you take a deeper look in SE’s numbers, there will be more questions on SE’s fundamentals. Gross orders in the e-commerce see an increase of just 10%, yet the revenue increased by 37%! This suggests that SE has achieved its profits through a two-pronged approach: significantly reducing advertising expenses by 49% and implementing substantial charges on both merchants and buyers.

The market's concerns seem valid as SE's strategy over the past three years seems erratic and uncertain. It appears that SE might have compromised its long-term competitive advantage and consumer trust in its pursuit of rapid and substantial profitability over the last three quarters. Now, SE is indicating a shift back towards investment, but is it too late? Potentially, the customers who were deterred by the introduced fees have already abandoned the platform. Notably, SE's capital expenditures in the initial six months of the year have only amounted to $133 million. While this positively impacts short-term cash flow, it could be detrimental if one of their key strengths lies in a robust fulfilment network.

Conclusion: I’m not buying even after a 29% decline.

I am a user of both Lazada and Shopee. Recently, I have noticed that Lazada has been stepping up its marketing efforts to attract users from Shopee. I have personally shifted 80% of my purchases to Lazada. In addition, recent commentary from Alibaba during their 2Q 2023 earnings call revealed that Lazada's orders are growing at a double-digit percentage rate. This implies that Lazada is very likely to regain market share from Shopee.

Fundamentally, the sustainability of Shopee’s competitive moat is questionable. After ding-dong back and forth between cost-cutting and spending, Forrest Li now then realise the Company is achieving its FCF and profitability via sacrificing on its brand and fulfilment capability. Investors who are considering buying the dip will need to grapple with the prevailing uncertainties concerning the extent and duration of Shopee/SE losses. The effectiveness of SE's investment strategies also remains uncertain at this point.

@Daily_Discussion @TigerStars