Sea Reports Blowout Quarter
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Article Thesis
$Sea Ltd(SE)$(NYSE:SE) had a great quarter, beating revenue estimates and destroying profit estimates. With its new focus on improving efficiency and driving profits, Sea looks like it could deliver compelling shareholder value in the future.
What Happened?
Sea Limited reported its most recent quarterly results on Tuesday morning. The company's results for itsfiscal fourth quarterinclude the following headline numbers:
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Revenue came in more than 10% ahead of estimates, as analysts had predicted a revenue decline while actual business growth was quite attractive, at 7%. Even more important, however, was the company's bottom line beat. Analysts had estimated that Sea Limited was deeply unprofitable during the period, but that was not at all the case - instead, the company showcased highly compelling profits for the period.
A Much Stronger-Than-Expected Performance
Let's startwith the company's revenues. Sea Limited is a tech company that's active across different industries. It offers e-commerce services, digital entertainment, and digital financial services to its customers. The environment for these businesses has not been too good in the recent past due to several macro trends. High inflation for goods such as food, energy, etc., causes consumers to spend more on these items (that are generally not bought online in most cases), which limits consumers' spending ability when it comes to discretionary consumer goods that are bought online more often. At the same time, the waning of the pandemic has caused some shifts in consumer spending. While consumers bought things (e.g. electronics) during the pandemic, at least some consumers are now shifting their spending toward activities, such as travel, going to concerts, dining out, and so on. Last but not least, a strengthening US dollar has been a headwind for companies with extensive non-US operations, as currency rate headwinds hurt their reported revenue performance, all else equal. The combination of these trends - high inflation, a shift in consumer spending, and currency rate headwinds - has hurt many e-commerce companies in recent quarters, while tough comparables vs. the pandemic years also made for rather low business growth rates. It's thus not too surprising to see that analysts were expecting a rather weak top-line performance from Sea.
But Sea Limited managed to blow those estimates away, showcasing positive revenue growth in all business units. The company's e-commerce revenue was up by a very compelling 32% year over year, despite currency rate headwinds. At constant currency rates, revenue growth would have been north of 40%. That's easily ahead of the revenue growth that larger peers such as $Amazon.com(AMZN)$ are reporting, and suggests that Sea is executing very well in the current environment. Its focus on higher-growth markets in Asia and Latin America plays a role in its strong business growth performance as well. But the business growth performance of the e-commerce unit also went hand in hand with strong profitability improvements in this area. While Sea's e-commerce unit had generated an EBITDA loss of almost $900 million during the previous year's quarter, the company managed to generate positive EBITDA of $200 million during the fourth quarter of 2022. That makes for an improvement of more than $1 billion per quarter during a single year, which is, I believe, outstanding. It should be noted that the most recent quarter included a one-time tailwind from $80 million in accrual reversals, but even adjusted for that, the profitability improvement would have been very strong. That was mostly driven by improvements in Sea's Asia e-commerce business, where EBITDA rose by $850 million year-over-year. But Sea also saw its e-commerce business in Latin America improve as the EBITDA loss was cut by two-thirds year over year. If operations in Brazil and other non-Asia markets strengthen further, the company should be able to break even in these markets soon, which will naturally have a positive impact on Sea's company-wide bottom line as well.
The performance in the digital entertainment business was not as great, however. While GAAP revenue growth was positive, EBITDA declined slightly, and both bookings and active users pulled back as well. This can, I believe, be attributed to the waning of the pandemic - as fewer consumers were locked down in Q4 of 2022, relative to one year earlier, demand for at-home entertainment declined. The pandemic was an extraordinary time that had a large positive impact on digital entertainment businesses, including gaming, video streaming, and so on. With things normalizing, it had to be expected that demand declines to some degree, as consumers want to spend more time doing other things again.
Looking at Sea's financial services business, we see great revenue growth of 93%, although from a pretty low level: This remains Sea's smallest business unit by far. Nevertheless, if very strong growth can be maintained, the financial services business should turn into a substantial growth driver of company-wide revenue eventually. The financial services business also was profitable during the period, unlike during the previous year's quarter, as EBITDA improved by more than $200 million year-over-year.
Overall, the solid business growth and Sea Limited's focus on improving profitability across its operations resulted in a net profit of more than $400 million for the period. Management's statements suggest that the company will continue to crack down on expenses in order to drive margin upside, which is great for shareholders - profit, ultimately, is the deciding factor for a company's value, after all.
I do believe that analyst estimates for this year's earnings per share will turn out to be way too low. Right now, analysts are predicting that Sea will generate a loss per share of $1.71 for fiscal 2023. Based on what Sea Limited has achieved in the last quarter of 2022, however, that seems unrealistic. If there's no profit growth at all, Sea could generate earnings per share in the $2.80 to $2.90 range. While there's some seasonality in Sea's results, that seasonality is not very pronounced. Even if Q1 and Q2 are seasonally weaker than the just-reported Q4, this could be more than offset by organic growth throughout the year, while further cost-cutting and efficiency improvement efforts could drive further profitability improvements. After all, this is a relatively new strategy for Sea, thus it seems unlikely to me that all the potential margin upside has been captured during Q4 already - it seems more realistic to me that the company will find additional ways to improve its efficiency throughout the current year, thereby allowing for additional profit growth potential.
It's worth noting that Sea's earnings per share growth is negatively impacted by a rising share count. During the most recent quarter, the diluted share count averaged 612 million shares, vs. 554 million in the previous year's quarter, which makes for a ~10% increase in SE's shares. Share-based compensation totaled $190 million during the most recent quarter, or close to $800 million annualized. While Sea was still profitable when we account for that, a rising share count is negative for shareholders, all else equal, thus investors should keep this theme in mind.
Valuation, Potential, And Final Thoughts
Sea Limited is valued at around $37 billion. Since the company has a cash position of around $7 billion and a debt position of around $3 billion, the net cash-adjusted company value is $33 billion. If Sea Limited were to earn $400 million per quarter going forward, comparable to the most recent quarter, the earnings multiple (adjusted for SE's net cash position) would be around 21. While that's a higher valuation relative to the broad market, it's not a high valuation when we consider SE's growth and strong market position in growth markets (both product-wise and geographically). There's no guarantee that Sea will generate this level of profit going forward, and results could of course be volatile. But the most recent quarterly results suggest that Sea could be a rather profitable company in 2023, whereas analysts had predicted the contrary. It would not be surprising to see this development have a major impact on Sea's share price. Sea traded at as much as $350 during the pandemic, vs. a price in the mid-$60s today. I do not believe that we will see the pandemic highs anytime soon, but there's potential for SE to reverse some of the share price losses we have seen since then. If Sea were to earn $2.80 this year (which is speculative of course), and if we were to put a 30x earnings multiple on that, we would get a share price in the mid-$80s.
Overall, we can summarize that management has been guiding the company extremely well in the recent past. The focus on profitability has had a huge impact, and Sea has become a quite profitable tech company that still generates attractive business growth - it looks like cost-cutting and efficiency measures have not hurt the company's growth momentum. It's hard to forecast what profits might look like a year or two from now, but from what I see today, Sea Limited does not look like an especially expensive stock.
Source: Seeking Alpha
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