2023-03-08 09:30:51 ET
Summary
- Investors have every reason to cheer as Sea Limited just achieved a remarkable feat - turning profitable on both adjusted EBITDA and GAAP net income fronts.
- But caution is advised as we reveal why investors should be wary of potentially non-recurring items that boosted profitability last quarter.
- Growth investors might be disheartened by management's choice to eliminate vital operating metrics such as GMV.
- Investors could be concerned about whether Sea Limited's underlying growth might stagnate, potentially leading to a decline in the market's assessment of its valuation.
It was a stunning earnings release for its FQ4'22 and FY22 by the Singapore-headquartered Sea Limited ( SE ).
Significant cost-cutting, rationalization, and a focus on efficiency helped the company to turn in its positive quarter on adjusted EBITDA and GAAP net income terms.
Investors waiting in the wings chased yesterday's surge as SE stock closed the trading session more than 20% up from the previous day. With that in mind, should investors who were cagey about jumping on board chase the momentum surge now?
Bloomberg Intelligence assessed that Sea Limited is on track to achieve adjusted EBITDA breakeven on a corporate level in FY23. Moreover, it's well ahead of the previous consensus estimates of -$375M in adjusted EBITDA for FY23, suggesting the company could be tracking significantly ahead of Wall Street estimates.
We applaud the company's ability to deliver a massive improvement in its bottom line. However, we believe investors must take note of the one-off items that could have skewed its FQ4 bottom line to the upside, as these are unlikely to be recurring items.
Sea Limited delivered an adjusted EBITDA of $495.7M in FQ4'22, resulting in an adjusted EBITDA margin of 14.4%.
However, it was uplifted by $130M in "accruals reversal," likely resulting from its cost-cutting efforts. Excluding the $130M item, its adjusted EBITDA would have been $365.7M, resulting in a margin of 10.6%, a significant adjustment.
Sea Limited also delivered a GAAP net income of $422.8M. However, it included a net effect of $152M, accounting for goodwill impairment, gain on debt extinguishment, and accruals reversal. Excluding the $152M net effect, it would have yielded an adjusted net income of $270.8M.
Still, the result was noteworthy, as its profitability inflection was clear for all to see.
However, investors will need to question how far Sea Limited's cost-cutting strategies can go, even as gross merchandise value or GMV growth fell into the negative zone in FQ4.
Accordingly, Sea Limited posted a GMV growth of -1.1%, down from last year's 52.9% increase. It was also down significantly from FQ3's 13.7% growth.
Therefore, analysts on the conference call were justifiably concerned about the trajectory of the company's newfound efficiency phase. Sea Limited's GMV growth trajectory could be significantly impacted, even as it pushes for improved operating leverage.
Management highlighted that it would no longer provide quarterly GMV metrics, stressing it's not a KPI it tracks. Group Chief Corporate Officer Yanjun Wang articulated:
[GMV's] not the key KPI as we continue to focus on tightening our efficiency and profitability as we have experienced. We think it would generally naturally come down the road. And we will discontinue any quarter-on-quarter disclosure of operating metrics like GMV and orders, and we'll move to an annual disclosure in line with global peers. (Sea Limited FQ4'22 earnings call.)
We are unsure why management would think investors wouldn't want to know how its GMV growth could progress from here. Because, as far as we are concerned, it's one of the key metrics we look at for in high-growth e-commerce companies.
Unless Sea Limited believes that it has captured most of the market share in its TAM, then taking out GMV as a critical operating metric might make sense. But, management clearly thinks Sea Limited is still in the early stages of its growth phase, as CEO Forrest Li highlighted:
There may be near-term fluctuations in our results and performance. However, we remain highly confident in the long-term growth potential of our markets and [are] highly focused on capturing these opportunities. (Sea Limited earnings.)
Also, it might be helpful to consider that Shopify Inc. ( SHOP ) still reports quarterly GMV growth numbers. It makes sense, isn't it? As a high-growth company, Shopify wants to continue showing investors that its GMV growth can grow faster than the market average, even as it seeks improved operating leverage.
We believe it's critical. Because if Sea Limited wants investors to give it a high-growth multiple, it will need to demonstrate a good balance between growth and profitability. As a point of reference, this was what Shopify President Harley Finkelstein accentuated at its most recent earnings conference:
So I encourage you to think about the company's growth, not just simply in merchant count, but merchant count and GMV and especially our attach rate, which really does reflect the amount of value that our merchants are taking and their usage of those products. (Shopify FQ4'22 earnings call.)
As an investor, I didn't invest in SE because it has "slow GMV growth" per se. However, despite that, investors can still reverse engineer its GMV metric if it reports its take rates.
However, it's possible that management has anticipated it and, therefore, could withhold such operating metrics moving ahead. With that in mind, we view less disclosure as less constructive, especially for growth-focused investors.
With yesterday's surge, SE re-tested its previous February highs and moved closer to re-testing its August highs.
We suspect SE could face significant selling pressure at its August highs, even though we believe the worst in its battering should be over.
Despite that, Sea Limited still needs to prove that its underlying growth momentum will remain robust, even as it further rationalizes costs.
Growth investors will likely be concerned if SE's GMV growth falls further, suggesting that its previous SG&A spending-induced growth was probably unsustainable.
SE could lose confidence with growth investors with lesser disclosure on critical underlying metrics. Worse still, value investors will not likely consider it a potential investment, as it does not have a consistent record of generating sustainable profitability.
Sea Limited management must be cautious about which side it wants to be on and not alienate growth investors with plenty of choices, given the tech bear market.
Rating: Hold (Revise from Speculative Buy).
Note: As with our cautious/speculative ratings, investors must consider appropriate risk management strategies, including pre-defined stop-loss/profit-taking targets, within an appropriate risk exposure.
For further details see:
Sea Limited: Explosive Quarter Might Not Be That Impressive