Sea Limited: Great Improvement But There Are Still Some Concerns

Seeking Alpha2023-04-18

SummarySea Limited is now up over 100% from its 52-week low.The company's latest earnings result showed a significant improvement in the bottom line.There are still some concerns regarding the ...

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Dickson8614
·2023-04-19
Nice
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Deonc
·2023-04-18
ok
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This is very encouraging but there are still some concerns. The improvement in the bottom line is largely due to a one-time increase in commission fees, and whether this can continue in the long run remains questionable. The cost-cutting initiatives are also weighing on growth and the gaming segment remains under pressure. After the huge rally, the company's valuation is back in-line with e-commerce peers. The bottom line improvement is impressive but I believe the near-term upside should be limited as growth slows. Therefore I rate the company as a hold.Data by YChartsImproving ProfitabilitySea Limited announced its latest earnings last month and the results showed a surprisingly strong improvement in the bottom line, especially in the e-commerce segment. The company reported revenue of $3.45 billion, up 7% YoY (year over year) compared to $3.22 billion. Most of the growth is attributed to the e-commerce and fintech segments. E-commerce revenue increased 31.8% YoY from $1.6 billion to $2.1 billion, or 60.9% of total revenue. Revenue from its core marketplace grew 53.9% to $1.1 billion. The fintech segment was also strong, with revenue increasing by 92.5% YoY from $197.5 million to $380.2 million, or 11% of revenue.The growth was partially offset by the weakness in the digital entertainment (gaming) segment, which declined 33.2% YoY from $1.42 billion to $948.9 million. Bookings for the quarter were $543.6 million, down 49.6% compared to $1.08 billion. Active users dropped 25.7% from 654 million to 485.5 million while paying users dropped 43.5% from 77.2 million to 43.6 million.The company did a great job of cutting spending as it remains committed to achieving profitability. Costs of sales dipped 8.4% YoY from $1.91 billion to $1.75 billion. While S&M (sales and marketing) expenses dropped 61.1% from $1.22 billion to $473.6 million. This was partially offset by the increase in G&A (general and administrative) expenses, which increased 24% from $284.1 million to $352.3 million. The lower spending resulted in the company flipping from a net loss of $(616.3) million to a net income of $422.8 million, or 12.1%. Adjusted EBITDA also went from negative $(492.1) million to positive $495.7 million. Diluted EPS was $0.72 compared to $(1.12). The company ended the quarter with $6.9 billion in cash and $4.5 billion in debt.Sea LtdPotential ConcernsWhile Sea Limited has made impressive progress in profitability, whether this magnitude of improvement can continue in the future remain highly uncertain. Most of the growth this quarter was attributed to the increases in multiple Shopee's fees last year. For instance, the company started charging a 2.24% transaction fee in September and also raised its commission fee for digital products by 50% in October.This helped the bottom line massively in the last quarter but also presented some potential concerns. For instance, this is already starting to weigh on growth, as higher fees reduce the platform's competitiveness. Revenue from the e-commerce segment looks excellent on paper but this is all contributed by higher take rates. If we dive deeper, the number of gross orders actually declined by 12% while GMV (gross merchandising volume) dipped by 1%.Sea LtdBesides, these increases are not continuous and it should be unlikely to see further increases in the near term. The company will have to pull other levers in order to further improve profitability. It can cut down more on spending, but this may further impact the already slowing revenue growth. Whether the company can sustain profitability and growth at the same time is something worth monitoring closely moving forward.Another concern is the ongoing weakness of its digital entertainment segment. Bookings marked its fifth consecutive quarterly decline while the number of active users and paying users also plummeted throughout the year. The company showed little progress in this segment and is still relying solely on legacy games such as Free Fire, which was released in 2017. The traction of these games has been slowing and their value will only continue to drop over time. I believe the segment will continue to struggle until the company comes out with other new games. This will put more pressure on overall growth as the segment still accounts for nearly 30% of total revenue.Sea LtdValuationAfter the massive rebound in share price, Sea's valuation seems fully valued. The company is currently trading at an fwd EV/EBITDA ratio of 28.1x, which is not necessarily cheap by any means. As shown in the first chart below, the multiple is in line with emerging e-commerce companies such as MercadoLibre (MELI) and Coupang (CPNG), which has an fwd EV/EBITDA of 34.5x and 30x respectively. They are trading at a slight premium but their growth rates are expected to hold up much better in FY23 compared to Sea, as shown in the second chart below. Considering the slowing top-line growth, I believe the near-term upside potential will likely be limited.Data by YChartsData by YChartsInvestors TakeawayI think Sea Limited is finally moving in the right direction but I am still cautious about the company. While the recent improvement in the bottom line is pretty impressive, there still seem to be some uncertainties in regard to the sustainability of its profitability and whether it will post an outsized impact on growth. The ongoing weakness of the digital entertainment segment may also be another meaningful drag on revenue growth in the near term. The company's current valuation is not cheap either, and the slowing growth rate should not be enough to support further multiples expansion. Therefore, I rate the company as a hold for now.This article is written by Felix Fung for reference only. 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