2023-08-17 11:19:21 ET
Summary
- Sea Limited reported a mixed quarter with only 5% YoY revenue growth, causing shares to drop nearly 30%.
- The company has improved its expense base but struggles with user retention and engagement in its Digital Entertainment segment.
- Valuation remains attractive, but investors should wait for macro factors and company execution to improve before investing.
Sea Limited ( SE ) reported a mixed quarter that sent shares down nearly 30% over the past few days. Total revenue growth was just 5% yoy after the company experienced many quarters of 20%+ revenue growth, driven by the combination of the SE Asian economy recovering from the COVID-pause as well as an increased E-Commerce mix of consumer spending.
While the macro has pressured revenue growth and the company's Digital Entertainment segment is struggling with user retention and engagement, it is impressive how much the company has improved their expense base. While this is largely driven by a reduction in sales and marketing expenses, I believe the company has better positioned themselves for long-term profitability improvement.
With the stock down 30% in recent days and now down nearly 90% from all-time highs, I have moved to the sidelines for now and wait for the macro factors and/or company execution to improve. My long-term view on the company remains largely unchanged, in that Sea is well positioned to compete in the significant opportunity across SE Asia and other emerging economies. However, the macro headwinds combined with mixed execution leave me waiting for internal improvements before turning bullish on the stock.
Valuation remains somewhat attractive at ~1.6x forward revenue and ~13.7x forward EBITDA, though I do not believe investors need to rush back into this name, even after the post-Q2 pullback. This stock remains a show-me story, and I believe long-term investors who are patient will be rewarded.
Financial Review and Guidance
For Q2, the company reported revenue growth of 5% yoy to $3.1 billion, which was slightly below consensus expectations. However, the company's adjusted EBITDA of $510 million came in as a nice positive surprise and helped drive an EPS beat during the quarter.
Although the macro continues to weigh on revenue growth, I believe this stock could remain in the penalty box near term, and have turned to a more cautious approach.
Sea Limited
As discussed later on, one of the biggest surprises during the quarter was the strong E-Commerce adjusted EBITDA of $150 million, which marks a significant improvement from the $648 million loss in the year-ago period. However, I believe the company may need to increase investments into E-Commerce in order to better build out its fulfillment operations as the company continues to expand across the globe.
E-Commerce
E-Commerce revenue during the quarter grew 21% yoy to $2.1 billion, with a majority of this revenue coming from the marketplace, which generated $1.9 billion of revenue, growing 27.5% yoy. While the core marketplace growth remained healthy, the company appears to have experienced a sequential decline in value-added services revenue ("VAS"), which is largely comprised of logistics services.
VAS revenue declined 6.6% sequentially as the company increased investments in shipping subsidy programs. So what does this mean longer-term? I believe Sea may need to continue to increase its investments in building out fulfillment centers around the world, particularly as the company has materially expanded their operations over recent years.
The challenged VAS economics are visualized above, with revenue growing 11% yoy, though still generating an adjusted EBITDA loss of $54 million. Yes, this is a material improvement from the $332 million loss in the year-ago period, but if Sea needs to increase investments here, then it's possible that VAS revenue remains a drag on profitability for the foreseeable future.
In a time where the global macro remains challenged and consumer spending trends are potentially on the cusp of a slowdown, improving profitability is at the top of every company's mind. Inflation remains a real risk for slower consumer spending, and if the global economy dips into a recession, or at a minimum some sort of consumer-driven slowdown, E-Commerce revenue trends would be at risk.
One interesting tactic the company is pursuing is the growth of influencers and content creators through their Shopee Affiliate Program. While this remains in early stages, it appears to be gaining some traction, though I believe it's a little too early to know how big of a potential impact this could bring to GMV, or how the unit economics could materialize.
We also significantly grew the pool of influencers and content creators through our Shopee Affiliate Program. This in turn enables us to efficiently attract more buyers to our platform. These affiliate partners are carefully recruited by our team and can choose to work with us directly or with the sellers on Shopee to promote products to their communities. Feedback from our efforts has been very positive and we are starting to see a tangible boost to our GMV and revenue from this initiative.
Given the magnitude of the E-Commerce segment combined with the improving profitability profile, I believe this will be the main area investors focus on in coming quarters. Sea has reached a significant scale so expectations of returning to 30%+ revenue growth are not overly realistic, and investors may need to be more comfortable with growth around 20% with ongoing improvements towards profitability.
Digital Entertainment
Digital Entertainment revenue was again weak during the quarter, coming in at $529 million, down from $540 million last quarter. A similar story was seen with Digital Entertainment bookings, which were down 4% sequentially to $443 million. Bookings tend to be a great leading indicator of future revenue growth, and with bookings having now declined sequentially for each of the past 5+ quarters, it appears that revenue may continue to be challenged over the coming quarters.
While quarterly active users grew 11% sequentially, user count was still down 12% yoy, as the company continues to struggle with user retention. Similarly, the quarterly paying user ratio came in at 7.9%, up a little bit from last quarter, but down from historical levels of 9%+.
During the second quarter, both quarterly active users and quarterly paying users grew quarter-on-quarter as Free Fire showed sustained signs of improvement in user retention and engagement...these recent trends are encouraging signs of Free Fire stabilizing while remaining one of the largest mobile games worldwide and we will continue to closely monitor if this is the beginning of a longer-term stabilization of the game.
In recent months, we have continued to improve core user experience and optimize features and content to ensure a more seamless gaming experience for all users...there have been sustained healthy trends across our existing long-running franchises, and we will continue to build upon these successes.
For the long term, the company has thrived on its Free Fire game, which remains one of the largest mobile game worldwide and although management noted that user retention and engagement trends have improved, I believe it's too early to call this a change in trends. In fact, I believe the company may need to invest even more into Digital Entertainment, either in the form of continued enhancements to Free Fire, or investing heavily into a new game that can help revive user engagement.
This is somewhat of a daunting task, particularly given the competitive nature of the gaming landscape. On the positive side, adjusted EBITDA for this segment remained healthy at $240 million, representing 54% of booking for the quarter.
Digital Financial Services
Digital Financial Services has remained an area of strength for Sea over the past several quarters. Revenue during Q2 grew 53% yoy to $428 million, with adjusted EBITDA experiencing a significant improvement to $137 million compared to a loss of $112 million in the year-ago period.
At the end of the quarter, total loans receivable remained stable sequentially at $2 billion, with non-performing loans past due by 90+ days remaining around 2% of gross loans receivable. This is significant as the company has continued to refine their risk policies, which increasingly becomes important as the macro environment remains challenging. If, and I believe when, the global macro experiences more of a consumer-led slowdown, it will be essential for Sea to maintain discipline around their lending business, as this could potentially result in significant losses if the risk parameters are not properly calibrated and maintained.
SeaMoney's second quarter performance was strong as we continued to expand our features and product offerings across the business. We are also increasingly seeing growing benefits from the synergies between the Shopee and SeaMoney ecosystems. More importantly, our progress has enabled us to provide underserved segments of our markets with better access to financial services and products.
Over the past quarters, we continued to refine our risk policies with respect to customer credit and selection. Alternative funding from third parties for our credit business also grew as a portion of our loan book as we continue to diversify the sources of funding.
With our expanded offerings and products, we continue to focus on serving the underserved financial needs across our markets and collaborating closely with our ecosystem partners to ensure the healthy and sustainable growth of our business over the long run.
Valuation
Since the company reported earnings, the stock has been down around 30%, which seems like a bit of an overreaction in my opinion. However, this reaction is not too much of a stretch given the ongoing deceleration in E-Commerce revenue, challenged user engagement within Digital Entertainment, and the potential for increased investments over the coming quarters and years, which could ultimately pressure profitability improvements.
Longer-term, I am still a believer in the company and the stock, but believe this could be dead money for the next few quarters until the company improves execution and/or the macro environment improves. Let's not forget, Sea is heavily tied to the SE Asian economies, which have been under pressure, much like the broader global economy.
Valuation can be a little tricky here, given the ongoing dynamic of revenue growth decelerating and profitability improving. In the past, it was much easier for investors to place a revenue multiple on the company, given the strong revenue growth of 30%+. However, this past quarter, consolidated revenue growth was just 5% yoy, and the challenging macro makes it more difficult to believe a significant acceleration will occur in the coming quarters.
Nevertheless, it has been impressive to watch the company improve their profitability, most notably within the E-Commerce segment. Yes, there is still a long way to go here, and investors will be closely watching the balance between profitability improvements and investments to build out their global operations.
For now, I am moved to the sidelines and will wait until macro visibility and company execution improve. Regardless, I believe now is a great time for long-term investors to be doing more work on the name in an effort to build a position over time.
For further details see:
Sea Limited: Need To See Increased Visibility Before Turning Bullish