Sea Limited: Sea Monster Turned Cash Cow
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Thesis Summary
$Sea Ltd(SE)$ (NYSE:SE) hasexplodedby over 20% following surprisingly goodQ4 results. The company has shown great growth and profitability in its e-commerce segment, but the same can't be said ofits two other segments.
All in all, SE is well-positioned to benefit from improving demographics and accelerated digitalization in SE Asia. This is a potential multi-bagger.
Recent Results
Sea Limited has surprised investors, beating on bothrevenue and earningsfor the fourth quarter. Let's have a look at the financials below:
Operating Income and EBITDA (Investor Presentation)
SE operates in three main segments: Digital Entertainment ("DE"), E-commerce, and Digital Financial Services/SeaMoney.
Starting from the top, we can see that DE EBITDA has come down noticeably. DE has, for some time, been the company's cash cow, thanks to the success of its Free Fire game. However, we are seeing anotable slowdown in this segment.
With that said, this negative news has been overshadowed by the success of eCommerce, which continues to grow and has turned a profit for the first time:
E-commerce financials (Investor Presentation)
Sea Limited managed to bring in $196 million in adjusted EBITDA in Q4, and the segment has grown 44% YoY. For a long time, there was a concern that Shoppe, the company's e-commerce brand, would fail to turn a profit. After all, even large companies like Amazon (AMZN) have struggled with this for decades. But SE has surprised investors this quarter.
Financial Services growth (Investor Presentation)
Lastly, Financial Services are up 92% YoY, with total loans receivable at $2.1 billion. Also if we refer to the first slide, we can see that Digital Money has also improved its profitability by a lot, actually turning in a profit in Q4.
Sea has brought in $422.8 million in net income this quarter. Last time this year, the company reported a loss of $616.3 million for the quarter.
When the numbers are this good, there's not much the market can do but bid up the stock price. With that said, let's look at insights from theearnings callto see how SE achieved such great results, and what we can expect moving forward.
Earnings Call Insights
Analysts wasted no time, going straight to the key question we all wanted an answer to. How did Shopee increase profitability so fast?
In terms of top line, we managed to increase our take rate and the monetization across various types of revenue, including the core marketplace revenue, which are relatively high margin as well as other types of revenue as our sellers invest more in the platform to grow with us.
And also on the cost front and expense front, we reduced sales marketing expenses. If you noticed, our sales and marketing for Shopee dropped more than 50% year-on-year, while GMV sustained and grew around 7%..."
Source:Earnings call.
Sales and marketing costs dropped by a whopping 50%. After several years of aggressive marketing efforts, Shoppy has now become a household name, allowing GMV to keep growing without more investment in marketing. A key factor was also core marketplace revenues which carry a higher margin. These consist mainly of transaction-based fees and advertising revenues.
But investors must be wary, that despite the success of Shopee, Financial services were down QoQ:
In terms of the loan book growth, as we -- as I mentioned before, for the credit business and the SeaMoney business as a whole, we don't expect to be -- at least at this stage that we're not going to invest significantly to drive rapid growth and land grabbing.
Source: Earnings call.
The outlook for the DE sector was also not that great. The company does not make a habit of discussing unreleased games, so we don't know much about the coming pipeline. What we do know is Free Fire has been losing momentum.
But also, more importantly, the key focus in the near term still on the core games and, in particular, Free Fire that we want to turn into a strong evergreen franchise. Although we continue to see some weakening in user trends in comparison to the significant growth it achieved during the COVID times, we do believe that there is a core defensible user base we can achieve, and it is a long-lasting franchise.
Source: Earnings call.
Gaming is a big opportunity, but also a competitive industry and repeating the success of Free Fire will be a tall order.
All in all, SE has managed to turn things around in commerce just in time, because, at least compared with previous performance, its other two sectors are floundering. Commerce does represent the biggest opportunity, so the market's excitement is understandable.
Valuation
Following the promising results, SE is up over 20%, but I believe this is still far from its intrinsic value:
DCF Model (Finbox)
Using a 5 year discounted cash flow ("DCF") revenue exit model, we have a target price of $87.42. This assumes the company will increase its EBITDA margin to 12%, with a revenue CAGR for the next 5 years of 15%. In the last quarter, EBITDA margin was close to 14%, with revenues growing 25% for the whole year.
This valuation seems more than possible, and I wouldn't be surprised to see SE trade much higher in the next few years. At its peak, SE was trading at $360.
Risks and Other considerations
Sea Limited operates mainly in South East Asia, and has expanded to countries in Latin America. With these stocks, another layer of currency and political risk must be considered. However, it has become quite clear that investors are starting to favor emerging markets. According to Reuters, January sawthe largest flowinto emerging markets in two years.
The truth is, these kinds of stocks have a lot going for them. SE is riding on the back of favorable demographics and accelerated digitalization.
Takeaway
In conclusion, I remain bullish on Sea Limited despite the current macroeconomic uncertainty. The last quarter is strong proof that the company has found a spot in the market and can run its main operations, e-commerce, at a profit. Moving forward, I expect a lot more good surprises from Sea Limited.
Source: Seeking Alpha
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