2023-04-17 12:14:40 ET
Summary
- Sea Limited is a Southeast Asian consumer business that's now turning to ''Day 2'' and focusing on the bottom of its income statement.
- Essentially, Sea Limited's bottom-line profitability has turned around and is rapidly growing.
- I argue that Sea Limited's valuation is now very compelling. Sufficiently cheap to be enticing and de-risked relative to its long-term prospects.
- After buying back convertibles, its balance sheet starts to look much better. Particularly given that Sea Limited is now GAAP profitable.
Investment Thesis
Sea Limited ( SE ) is a digital economy Southeast Asia consumer business. I had been neutral on this stock throughout 2022. But as you can see in the graphic below, I turned bullish on this company when I believed that the risk-reward was most compelling.
When I wrote Game Changing Quarter , I explained that the company was turning to a new direction to maximize its profitability.
What we see today, is the result of what I discussed then.
In summary, the reason why I'm bullish on Sea Limited is that I believe the market is not paying enough attention to the fact that the ''growth investors'' that were in the stock have now rotated out. And this has left the stock substantially better valued, as the company doubles down on its ''Day 2'' profitable growth strategy.
Why Sea Limited? Why Now?
Bear markets are brutal. If bull markets epitomize the buy now ask questions later investment approach, bear markets are shrouded in pessimism.
It's not only that investors ask questions before investing. It's that no matter how cheap a stock gets, investors demand even more assurances and an even bigger margin of safety before getting involved.
Next, what you see below is Sea Limited's segment disaggregation.
As shown above, Sea Limited's E-commerce segment continues to dominate its business. But what the graphic above doesn't show is that nearly half of Sea Limited E-commerce segment comes from its transaction-based fees and advertising business, as part of its Core marketplace revenues.
Essentially, Sea Limited Core marketplace revenues continue to grow unabated, with Q4 increasing 54% y/y.
Put another way, the key to understanding Sea Limited boils down to this: it is a diversified well-managed consumer business. But there's more to the story than this too.
Throughout 2022, Sea Limited's story was plagued by the following dynamics. Sea's Digital Entertainment segment was rapidly slowing down its revenue growth rates, while Sea's commerce business was still very far from reaching profitability.
But now, that story has unwound. And I make the case that this is often the best setup for investors: when the prevailing narrative is one thing, but the actual business has moved beyond that narrative.
Revenue Growth Rates Fizzled Out, What's Next?
As you can see above, Sea Limited's growth rates have fully fizzled out. However, what distinguished Sea from countless other businesses is that it's displaying solid operating leverage.
What this means, in practice, is that rather than its growth rates slowing down, and its profitability profile taking a turn for the worse, quite the opposite is taking place here. Management has ''regained'' investors' confidence as its E-commerce segment sees positive EBITDA profitability in Q4 2022.
As you can see above, Q4 2022 flipped to positive EBITDA, showing to investors that this business can rapidly become profitable, moving approximately $1 billion in 12 months, from negative $878 million last year to nearly positive $200 million in Q4 2022.
SE Stock Valuation -- Less than 4x Forward Sales
As you know, Sea Limited's valuation has compressed significantly in the past several years. The times when investors were rewarding ''growth at any cost'' strategies are now in the rearview mirror.
What investors today want is a business that can continue to deliver sustainable top line growth, but do so with a focus on GAAP profitability, and that's exactly what SE offers.
Finally, allow me to highlight yet another reason why SE has been substantially de-risked.
Previously, investors had been troubled by Sea Limited's convertible debt. This convertible debt was due to convert into shares in 2026, and investors were concerned that this would lead to a significant number of shares coming into the market.
However, management has sought to get ahead of this maturity date and start to buyback a portion of this convertible debt. Case in point, in Q4 2022, Sea bought back just over $815 million of convertible debt for approximately $610 million.
This means that Sea Limited is now profitable, with more than $3 billion of net cash on its balance sheet , while bringing down its convertible debt stack, and its valuation is significantly reduced!
The Bottom Line
Sea Limited is a gaming, e-commerce, and fintech business. Previously, the business had a narrative around its profitable gaming business, but investors were not asserting much value on its large and rapidly growing e-commerce business since that business wasn't showing a profit.
Ultimately, investors got too caught up in Sea's e-commerce business showing unappetizing and unprofitable growth. And what investors had been left with had been a profitable but shrinking gaming business.
Management listened to investors' concerns and put in maximum effort to turn the business around. And showed investors that not only it can be GAAP profitable , but now investors are more willing to believe that in time its other opportunities, for instance, its Digital Financial Services (SeaMoney) segment could also in time be profitable.
So, even though Sea Limited now operates as a Day 2 company, there are still enough prospects under the hood to entice long-term investors into the name. What's more, investors have ''regained confidence'' in management's vision.
With its valuation now towards a 3-year low, Sea Limited is a very attractive entry point to buy this name.
For further details see:
Sea Limited: Fully Focused On Profits