2023-06-02 07:45:00 ET
Summary
- Sea Limited investors were hammered as SE stock fell more than 35% over the past three weeks.
- Weak holders who chased its highs in May were given an invaluable lesson about valuation and over-optimism.
- I assessed that the market is gloomy now on Sea Limited's prospects, allowing early dip buyers the opportunity to consider adding exposure.
In our previous update , we urged investors to brace for impact as the leading internet company in Singapore-based Sea Limited ( SE ) prepared to report its first-quarter earnings.
Momentum investors chased SE's recovery from its February lows as they anticipated a more robust second half from CEO Forrest Li and his team. However, harsh reality struck as SE fell more than 35% through this week's lows, potentially attracting early dip buyers back into the fray.
Should investors capitalize against the market pessimism after the selloff that hammered investors over the past three weeks? I updated members of our service to pick up exposure, as the selling momentum could subside as SE re-tested its February lows.
SE buyers are at a critical juncture, assessing the company's ability to rejuvenate gross merchandise value or GMV growth while charting its path toward sustainable profitability.
Analysts were concerned about the trajectory of Shopee's (e-commerce unit) GMV recovery but were likely disappointed, as it likely fell 4% sequentially, based on management's commentary.
New investors to SE should note that management stopped proffering quarterly GMV disclosures (and consequently take rates) from this fiscal year. I assessed that while management attempts to channel investors' focus into its ability to chart profitable growth, SE is not a value stock (and is still unprofitable).
As such, if growth investors don't have full visibility over fundamental metrics like GMV, demonstrating its ability for profitable growth (not either or), it's justified for investors to reflect significant execution risks.
Morningstar reminded investors that it anticipates Shopee to remain the company's "main growth driver for the long term," underpinning SE's growth valuation multiple (Forward EBITDA multiple: 14.9x). As such, investors must assess Sea Limited's ability to normalize its GMV growth recovery over time even as it attempts its transition toward profitability.
Garena's (gaming unit) significant slowdown in FQ1 likely spooked investors, as the gaming unit is critical to underpinning Sea Limited's overall adjusted EBITDA profitability.
However, Garena posted a revenue growth of -52.5%, affected by a weaker monetization environment. Management highlighted that " monetization weakened due to a lower paying user ratio." Notably, Garena posted a paying user ratio of 7.7%, down markedly from last year's 10% . As such, Garena delivered an adjusted EBITDA of $230.1M for FQ1, down 46% from last year.
I highlighted in my previous update that investors must not take the concentration risks from Garena lightly, as it's a critical profitability driver for Sea Limited, given the transition for Shopee in the near term.
Accordingly, I reminded investors not to chase SE's previous unsustainable momentum surge, as Wall Street analysts got too optimistic with their estimates. Coupled with an unattractive valuation then, I cautioned that "disappointing news moving ahead could lead to a steep pullback."
However, "disappointing" is unlikely an understatement, as investors must now deal with Garena's uncertainties while navigating Shopee's profitability push (with negative GMV growth).
Coupled with heightened macroeconomic risks, Sea Limited investors are in an unenviable position as the company struggles to chart life after the pandemic bubble.
However, I have consistently reminded members that they should get more excited when the market is pessimistic and less so when it is optimistic. The market was over-optimistic pre-earnings, but the mood seems gloomy now. A look at Bloomberg's pre- and post-earnings article title succinctly captured the nuances.
On May 11, a few days before Sea Limited's earnings release, Bloomberg highlighted that " Sea's 112% rally shines light on path to recovery." It could have encouraged investors who read the news to make investment decisions to add more exposure.
However, on May 16 (post-earnings), Bloomberg turned pessimistic, as it reported: " Sea misses profit estimates, showing turnaround still fragile." Depending on both the news reports to make your buy/sell decisions could have triggered some weak holders to buy high and sell low.
How about now?
SE price chart (weekly) (TradingView)
SE suffered a steep selloff, with a decline of more than 35% over the past three weeks. Therefore, SE investors saw their gains from its February lows toward its May highs wiped out.
As such, I assessed that investors who chased SE's momentum into May highs (including the late buyers expecting a breakout) are likely stunned. Weak holders could also have fled, as they didn't anticipate the significant force of the downside volatility over the past three weeks. The price action clearly demonstrates that sellers were forced out in a hurry, exacerbating the downside volatility.
With a re-test against February lows, SE could potentially bottom out here, even though I must highlight that there isn't price action confirmation. However, SE's medium-term downtrend bias had already been reversed, but dip buyers must emerge from hiding now and push SE's momentum back above the 50-week moving average (blue line).
Failing which, a further drop between the gap toward SE's previous November lows should not be ruled out, demonstrating that sellers remain in substantial control.
Rating: Speculative Buy (Revised from Hold). See additional disclosure below for important notes accompanying the thesis presented.
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Sea Limited: Buying With Both Hands As Shares Plunge