SE - Sea Limited: Best Contrarian Opportunity For The E-Commerce Leader

Summary

• The contrarian opportunity comes as investors are not pricing in the full potential for Sea Limited's e-commerce business, Shopee.
• Shopee continues to bring solid market share in its core regions as a result of strong value propositions to customers and sellers.
• Shopee has been gaining market share at the expense of competitors, bringing increasing scale and better unit economics to Shopee.
• The company has been focused on profitability and long-term sustainability of the business, driving improvements in margins and accelerating its path to profitability.
• My 1-year target price for Sea Limited is $94.51 based on a sum of the parts valuation model. This implies 41% upside from current levels.

This article was first posted in Outperforming the Market on January 13, 2023.

Investment thesis

With misunderstanding and uncertainty comes opportunity.

I think that Sea Limited's ( SE ) valuation reflects uncertainty. Based on the consensus estimates on Bloomberg, Sea Limited is now trading at 45x FY2024 EBITDA. This is for a company with leading positions in gaming, e-commerce and fintech in the markets that it operates in. This is for a company that is lazer focused on cost cutting and turning EBITDA positive on its e-commerce business. This is for a company that is still expected to grow at a double-digit revenue growth in the medium to longer term.

I don't think that investors are pricing in the full potential for Sea Limited's e-commerce business, Shopee. Its e-commerce arm continues to remain the leader in its core markets and has captured top mind share in customers in the region as a result of its strong value proposition to customers. In addition, Shopee's competitors in the region, as analyzed below, are not as competitive as Shopee continues to gain market share in the region.

In an earlier deep dive article into Sea Limited, I shared with members of Outperforming the Market about the huge opportunities the three segments of the company (Garena, Shopee and SeaMoney) will bring in the long-term and how the company's beaten down stock has reached a valuation that makes sense for investors to enter today. While addressing the members questions on Sea Limited, I realized that there were many misconceptions and interest in Sea Limited's Shopee. As such, in this article, I aim to share with readers more about the fundamentals of Shopee, how it compares with local competitors in the market and what Shopee's future looks like.

I have written earlier Sea Limited articles, where I share my deep dive research into Garena here , and why Sea Limited's Garena and SeaMoney are valued at zero at current valuations here .

Deep dive into e-commerce (Shopee)

Brief introduction and history of Shopee

As shared earlier, Shopee is Sea Limited's e-commerce platform. The history of Shopee is relatively short given that it was first launched in Southeast Asia and Taiwan in 2015. The e-commerce platform then made its way into Brazil in 2019. Subsequently, the company even expanded its Shopee platform to new markets in Latin America like Mexico, Chile and Colombia and to Poland and Spain as well. However, the core Shopee markets today are Southeast Asia and Taiwan, as well as Brazil, as Shopee exited markets which it deemed unprofitable in 2022 to preserve capital as the market conditions started to change. This will be discussed further in a later section in this article.

Shopee's business model

Shopee was one of the first few e-commerce players in Southeast Asia in the early days of its operating history in 2015 and gradually emerged as a leading player in the region as a result of a strong value add to both customers and sellers.

Value proposition for customers

The first value proposition, and a relatively simple one, was that Shopee's approach of gamifying the experience of e-commerce and online shopping brought a social element to the e-commerce platform that others were unable to replicate. By having customers win coupons, play games to win rewards and get rewards for logging in daily, the platform was able to build a strong social element and it became not just a platform to these customers, but also a good experience. As a result of gamifying the experience of shopping online, the company actually managed to bring greater traffic to its platform, increase user engagement and it resulted in more e-commerce sales and larger basket sizes.

The second value proposition is equally important as customers are ultimately finding the lowest prices for goods they wish to buy and the best discounts available in the market. As a result of promotional and marketing events like the 12.12 sale, customers can get outsized deals and cashbacks through shopping on Shopee.

The third value proposition is that customers, as buyers on the e-commerce platform are protected and the platform is secure. It was very important in the early days of Shopee to demonstrate that it could provide a secure and safe shopping environment for buyers. Especially in the early days when not everything was bought online or not everyone has had the experience of using an e-commerce platform, there was a need to assure buyers that the sellers are legitimate, their goods are as advertised and that there are no frauds or misrepresentation on Shopee. Features on Shopee like seller verification helped to make sure that the sellers on the Shopee platform have been verified and are subject to certain terms and conditions on signing up to be a seller. In addition, Shopee does an automated screen based on the product categories, names and descriptions to identify inappropriate or illegal items and the listings that are deemed to be inappropriate or high risk are removed from the platform until cleared by the teams in Shopee. There are other features like Shopee Guarantee , which holds payments made by buyers until the ordered products have been deemed received by the buyer. This will certainly help reduce settlement risk as buyers can then be assured that their payment will only go through if they receive the items that they have bought. Lastly, if all else fails, Shopee has a decent dispute resolution team that helps to ensure that buyers or sellers can have a proper way to resolve disputes and seek compensation if necessary.

The fourth value proposition is a subtle one, but Shopee is centered around mobile devices, and enabled e-commerce shopping to be done on the go. This is pertinent as customers were increasingly moving from the PC to their mobile devices as customers started using their mobile devices for more and more applications.

Last but not least, the final value proposition that makes customers like Shopee is the strong payment and logistics infrastructure that enables seamless payment and quick and reliable deliveries. For Shopee payments, as highlighted above, they are protected by Shopee Guarantee, which will ensure that buyers get their items before the payment goes through to sellers. In terms of payment types, there are a wide variety of payment options, including credit cards, bank transfers or mobile wallet services. Most of the transactions on Shopee have been integrated with the Shopee Pay, which is SeaMoney's payment infrastructure, and this is the case for most of its core markets. For Shopee, developing the key logistics infrastructure was key to developing e-commerce in Southeast Asia and Taiwan as these are markets with difficult to access terrain and underdeveloped infrastructure. Shopee works with the largest and most reliable logistics service providers in its respective markets and are usually able to get lower rates and better terms with these logistics service providers as a result of Shopee's large scale of transactions. The buyers and sellers are also able to track the delivery status of their purchased items, which provides added assurance for e-commerce transactions.

Value proposition for sellers

The first value proposition for sellers has to be the strong support that Shopee provides sellers. An e-commerce platform is only as good as the variety and quality of its seller base. This is likely why Shopee provides strong support to sellers as it has a large team of staff with local knowledge that provides quick and localized assistance to sellers when necessary.

The second value proposition is that Shopee provides sellers with a one-stop solution for selling needs, including an integrated payment system, logistics and fulfillment services. Although Shopee does not require its sellers to use its logistics service providers, most of its sellers choose to use them due to the good pricing and reliable service quality of these providers.

Lastly and perhaps most importantly, Shopee has a large and fast-growing user base that sellers can sell to. This is undoubtedly one of the greatest incentives for sellers as they can then have a larger market to sell to and a larger addressable market.

Scalability of the marketplace business model

Shopee has been hugely successful in scaling up as a marketplace platform for reasons highlighted above. It provided buyers with a reliable, social and fun e-commerce experience while sellers are given strong support as Shopee provides one-stop solutions for sellers. That said, the marketplace business model was the key in ensuring that the business is highly scalable.

Another reason for the rapid scaling of Shopee is the social and gamification elements that enabled Shopee to acquire and retain users better, and increase their time spent on the platform.

As a result, in 2021, Shopee was the largest e-commerce platform in Southeast Asia and Taiwan, and it is also gaining traction in Brazil.

Success in marketing and promotional activities

Shopee started to increase brand awareness through its campaigns each month, like the 11.11 Big Sale and 12.12 Birthday Sale. As a result of the promotional activities on these special days in the month, buyers are likely to flock to Shopee during these special promotional events to get larger discounts and save money on their e-commerce purchases. As a result, they associate these dates with Shopee and large discounts and savings.

Success in these marketing and promotional campaigns have led to GMV and market share growth and helped increase the mind share of Shopee in the buyers in its core markets.

Monetization opportunities

As Shopee continues to grow in scale, with the sticky nature of its users due to its social and gamification features, the company can look to monetize this large Shopee user base. While the company is focused on market share growth and GMV at the moment, as the platform continues to scale, I think that we will see Shopee offer sellers paid advertising services, charge transaction-based fees and charge for more value-added services. These are some ways in which Shopee can continue to monetize the large and engaged user base that it has on the platform.

Expansion into new markets

Shopee started its operations in Southeast Asia and Taiwan and later, Brazil. In 2021, Shopee looked to expand its success beyond these markets and move to other markets, which included markets in Europe, India, and other markets in Latin America. It was not meant to be for Shopee's international expansion strategy, as I have highlighted in my Sea Limited article , as the company started exiting markets which it deems non-core to preserve capital and Shopee dipped its toes into the India market, a large market with tough competitors in March 2021 , and with the success of Free Fire in India, saw India as a potential market for its e-commerce business. However, given the ban of Free Fire as highlighted in part 1 of my deep dive series, the company eventually realized that there were high regulatory and government risks in entering the India market. As a result, in March of 2022 , the company exited India and given the relatively early stage of the operations in India and the cautious expansion in the country, there was a relatively limited impact to current Shopee business. The impact came from the loss of a large and fast-growing addressable market as a result of exiting from India.

Shopee aggressively expanded in Europe as it entered France, Spain and Poland in 2021. However, in March 2022 and June 2022, Shopee exited France and Spain respectively. As the company was in France and Spain for a relatively short period of time, during the preliminary pilot phase of operations in both countries, Shopee decided to be prudent and disciplined in expanding into new markets and only invest resources into a market which it thinks that it can compete meaningfully in the long-term.

While Shopee saw strong traction in Brazil based on data from data.ai , suggesting that the company is ranked first by average monthly active users in the Shopping category in Brazil, the company tried to replicate its e-commerce strategy in other Latin America markets, which resulted in expanding into Mexico, Chile and Colombia in 2021. In 2022, as a result of increasing global macro uncertainty, Shopee needed to focus its operations on core markets and decided that they will use a cross border model in Mexico, Colombia and Chile, downsizing its operations there to cross border operations .

In my view, the decision to exit markets in which it has not yet had a deep and strong presence in before the turn of the tides is a good move by management as that enabled the preservation of capital in early 2022 and prevented the company from needing more money to fund expansion into new markets. In particular, the exit from India was a great one in my view as the e-commerce market in India is saturated and highly competitive, with players like Amazon ( AMZN ), Meesho and Flipkart competing with Shopee. The cash burn needed to make Shopee a success in India would not have been possible given the reduction of liquidity in the later part of 2022 as the capital markets started to feel the jitters of higher interest rates and the potential of a recession. I think that the ability to exit markets to ensure the long-term sustainability of the business and expand into new markets prudently gives me more confidence in the management of Shopee.

Shopee operational metrics

Shopee saw huge growth in 2021 as the pandemic helped to fuel the growth and adoption of e-commerce in Shopee's key markets. With movement restrictions and lockdowns, consumers needed to get goods and shop online. The strong growth fueled by the pandemic is likely to cause a high base effect in 2022 as consumers go back to work and school and are able to buy from brick-and-mortar stores. That said, the trend that the pandemic accelerated will likely stay in the future and the pandemic brought a net positive effect to increase the penetration of e-commerce in Shopee's key markets. As a result, in 2023, we are likely to lap that high base effect and I am of the opinion that Shopee can reaccelerate its growth in core markets and continue to increase penetration in these markets.

Shopee competitive landscape

While Shopee is a leader in the Southeast Asia and Taiwan markets, there are other players vying for market share in these regions. In particular, Alibaba's ( BABA ) Lazada has been operating in the region since 2012. Despite its longer operating history and backing from Alibaba, the company continued to trail behind Shopee. In my opinion, this is because of the social and gaming element that Shopee has brought into its platform that brought higher user engagement and thus, it attracts and retains users on the platform better. Also, the marketing and promotional campaigns launched by Shopee seem to have created better mind share in its core markets of Southeast Asia and Taiwan at least, resulting in better performance in sales events and marketing and promotional campaigns. Lastly, the platform that is better able to provide buyers with the best discounts and savings, as well as a better user experience will ultimately have the larger active user base. As a result of efforts by Shopee to protect buyers and large discounts on the platform, Shopee has been able to obtain better mind share from customers and result in better market share in the region. This results in a fly wheel effect as the larger buyer user base attracts more sellers on the Shopee platform, which brings about better deals and more variety on the Shopee platform compared to Lazada.

In Lazada's fiscal year of 2021 ending on March 31st, the company reported revenues of $556,000, down more than 65% from 2020 when it recorded $1.6 million in revenue. In 1Q21 alone, Shopee recorded revenues of $922 million .

Lazada recorded $21 billion in GMV in 2021 while Shopee recorded $63 billion GMV in 2021, implying that as of the full year of 2021, Shopee's e-commerce business seems to be almost three times larger than that of Lazada.

This goes to show the strong market share gain that Shopee has been experiencing, at the expense of Lazada, and how Shopee is able to compete and gain share in the competitive landscape.

Tokopedia is another company that competes in the e-commerce space, but with a larger focus on Indonesia. Tokopedia merged with Gojek, which resulted in the combined entity being called GoTo Group . With the large population and fast growth profile of the Indonesia market, the threat of GoTo Group in Indonesia remains relevant. In 2021, GoTo Group recorded 6,264 billion Indonesian Rupiah in revenues, which translates to approximately $401 million in revenues for the year. This compares to the $5.2 billion in revenues that Shopee generated in 2021. As a result, Shopee is almost 13 times larger than GoTo Group's e-commerce operations. The larger scale does bring benefits like economies of scale, better unit economics and attracting more buyers and sellers to the platform. At the end of the day, Shopee needs to continue to ensure that it remains relevant and attractive in Indonesia by continuing to improve user experience and bring innovation that adds value to both buyers and sellers.

In its existing markets, as can be seen below, Shopee has a scale advantage as it is significantly larger than that of Lazada's or GoTo's revenues. This implies that Shopee's market share by revenue is at least nine times more than Lazada and Shopee's market share by revenue is almost 13 times more than GoTo Group. The competitive landscape in Shopee's core markets does seem favorable given the large-scale benefits that Shopee can enjoy with its market share in these markets. In addition, Shopee continues to be able to compete meaningfully and gain share in these markets as it looks to break even in the Southeast Asia and Taiwan markets.

The global e-commerce market is becoming very competitive, in my view. The largest e-commerce player, Amazon, continues to look to expand internationally and remains a well-capitalized player with strong branding. Other players in specific markets like MercadoLibre ( MELI ) in Latin America and Coupang ( CPNG ) in South Korea are well established players in their own respective markets. As a result, international expansion for Shopee needs to be done prudently in markets in which it can compete and adds strong value to. While I think that Shopee may expand to international markets in the long-term, the near-term goal is still turning profitable, focusing on core markets and ensuring sustainability of the business.

Valuation

As highlighted before, Sea Limited is now trading at 45x FY2024 EBITDA. Considering the significant EBITDA expansion to come as a result of a leaner cost structure as a result of its cost optimization initiatives and improving economies of scale as the business grows, I think that we will likely see a very strong period of EBITDA growth in the near-term.

To value Sea Limited, I use a sum of the parts model. I assume Garena to be valued at 11x FY2024 P/E, Shopee to be valued at 3x FY 2024 P/S and SeaMoney to be valued at 4x FY2024 P/S.

My 1-year target price for Sea Limited is thus $94.51. This implies 41% upside from current levels.

Conclusion

As can be seen in the article, Shopee is a leader in e-commerce, a fundamentally growing business and one whose profitability and margin profile is improving as we speak.

While I think that there could have been some disappointments with the company pulling out of its non-core markets in which it was doing pilot trials in, I think that we are starting to lap the high base effect we saw in 2022 in the coming year in 2023. In addition, the boost in Shopee being EBITDA positive in Southeast Asia and Taiwan is certainly a boost in confidence for the company's business model. By 2025, management expects that both Shopee and SeaMoney together, will be able to generate sufficient cash to self-fund their own long-term growth.

My one-year price target for Sea Limited is thus $94.51. This implies 41% upside from current levels.

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