2023-08-17 08:30:00 ET
Summary
- Sea's stock price is down 29% after the earnings.
- While the headline numbers were not great, there were many signs of improvement, and the execution remained strong.
- We dive into the three business divisions of Sea Limited to see the trends at Garena, Shopee and SeaMoney.
- SE stock is very cheap now and it could reward patient long-term investors.
We believe that the learnings from the past help us to be even more effective in executing our strategy.
Founder and CEO Forrest Li on the Q2 2023 earnings call
Introduction
As you saw, Sea's (SE) stock price nosedived after it announced its Q2 2023 earnings.
Superficially, the big drop was mainly caused by the big revenue miss of $150 million. It came in at $3.1 billion, up 5.2%, but missed the estimates of $3.6 billion. We'll point out the reason for the revenue miss later in this article.
When it comes to profitability, Sea did much better. GAAP (!!) EPS of $0.54 beats by $0.08. That means a net income of $331 million, not comparable to the loss of $(931.2) million in the same quarter last year.
The company could add almost $500 million to its cash heap of now $7.7 billion. It has $5.7 billion in cash, equivalents and short-term investments and $2 billion in bonds with a maturity of longer than one year. The $3.9 billion in debt means Sea has $1.8 billion of net cash, even excluding the longer-term bonds. Anyone saying Sea has bad financials has not looked at the balance sheet. All three of Sea's divisions were profitable and total adjustable EBITDA was $510M, up more than $1B from the loss of $506M in Q2 2022. These are the separate results:
- Garena had adjusted EBITDA of $239.5M. Despite the small revenue drop compared to Q1, EBITDA was up 4.1%.
- Shopee's adjusted EBITDA was $150.3 million. For comparison, this was a loss of $648.1M in Q2 2022.
- SeaMoney's adjusted EBITDA was $137M, compared to a loss of $111M in last year's Q2 2022.
I understand why the stock was down on the revenue miss, but the extent of the drop seems exaggerated. Allow me to explain why in this article. We'll start with Garena, Sea's problem child.
More Color On Garena
First, for visual learners, let's look at the results with some graphs. This is the graph of Sea's revenue.
Sea's Q2 2023 earnings presentation Sea's Q2 2023 earnings presentation
As you can see, Garena is responsible for the slow revenue growth. Had Garena remained at last year's level, revenue growth would have been 35.8%. And that despite slashing sales and marketing expenses in half.
Sea's Q2 2023 earnings presentation
Of course, games are always a fluctuating business, with ups and downs because of hit games. Garena still publishes many titles of other companies but what made Garena big and so important for Sea was its self-developed game Free Fire. It was launched in August 2017, six years ago.
These are Garena's stats.
As you can see, bookings are down 38.5% year-over-year, but the decline slowed to 4% quarter-over-quarter. That was still 15% in the previous quarter and 18% in the fourth quarter of last year. As bookings are somewhat a window into the future, this may mean Garena's revenue erosion could slow down in the next few quarters.
We see encouraging numbers from the Quarterly Active Users as well. For the second consecutive quarter, the Quarterly Active Users, or QAU, were up quarter-over-quarter, by 11% this time. As management said for a few quarters, engagement is their focus now, which seems to work out.
In the previous quarter, the first quarter since Q2 2021 that saw growth in QAU since Q2 2021, this was 1.2%. Now it was 11%. This is always the first step in growing monetization. And while the QAU were up, the percentage of Quarterly Paying Users was also up, from 7.7% in the previous quarter to 7.9% now.
If management lays out a strategy to stop the drop, focusing on activating users, and that works out, to me, management is doing things right. Yes, there will be rebates and promotions, but that's an investment for the future. Yanjun Wang, Sea's Group Chief Corporate Officer gave more color during the conference call:
Undawn has been launched and usually with a newly launched game, we first of all are focused on engaging with our user base and try to make sure we have a strong user base and good engagement level from these users. We would not be very much focused on monetization at the initial stage of the game and the performance is still awarding expectations so far
I think we all agree that we would want to see Garena have a new smash-hit game, but those don't come easily. There have been iterations of Free Fire and I think the game will prove to be an evergreen franchise. And, of course, Garena continues to distribute games. But what would really move the needle would be a second self-developed game.
Having said that, we should also not forget that the pandemic was there. Just before the pandemic started, Garena had 354 million QAUs. It now has 544.5 million. Exactly four years ago, it had 310 million. That means QAUs are up 77% in four years. That's a CAGR in users of 15.5%. Most gaming companies would love to see that kind of growth. But of course, because of the fact QAU grew so tremendously during the pandemic, this looks like a big failure, not a great accomplishment.
Investors will be much less worried if Garena returns to steady QAU and revenue growth. And I think that potential is there. Management shared that Free Fire also started to see quarter-on-quarter growth in bookings. Garena looks to be close to its bottom.
Worries About Sea Money?
Outside of Garena, there may have been another reason for concern: SeaMoney. While 53% revenue growth still looks good, digging deeper, you see something else as well. Revenue growth was less impressive quarter-over-quarter.
Sea's Q2 2023 earnings presentation, red added by the author
That's just 3.66% quarter-over-quarter growth or 14.6% if you annualize that. I'm not sure if there is a good explanation. I can't compare this to last year's Q1 to Q2 revenue growth, as the company didn't disclose separate revenue for SeaMoney yet in Q1 2022. Probably, the company made its loans a bit stricter and that resulted in non-performing loans remaining stable at about 2% but also in slower revenue growth.
The slower revenue growth for SeaMoney is something I will watch closely in the upcoming quarters.
Shopee Is Still Strong
Shopee continues to do well. Management said it started ramping up the growth engine for Shopee, which resulted in a double-digit increase in gross orders quarter-on-quarter , which is really impressive. Many commenters didn't see this. They thought the gross orders of more than 10% was year-over-year.
Revenue for Shopee came in at $1.9 billion, up 28% compared to last year's Q2. While some only attribute this to higher take rates, the double-digit increase in gross orders contradicts this. On top of that, advertisement is also a strong growth driver.
I still see some say that Shopee not disclosing GMV is a red flag. Well, they announced this two quarters ago and started not disclosing this quarterly last quarter. The reason is simple: none of Shopee's competitors reports GMV on a quarterly basis and therefore, Sea will also only report it on a yearly basis. In the Q&A section, management confirmed, though, that there was quarter-over-quarter GMV growth.
Another important element to take into account here is VAS or value-added services. That's mainly logistics. As Sea is investing there for better fulfillment and also giving free shipping as a way to boost revenue growth, VAS was up just 11%, which means a drag on Shopee's overall revenue growth. This is expected to continue, as the company will keep investing in logistics. Free shipping means lower revenue according to GAAP rules and this will impact the revenue growth for Shopee for at least several quarters.
This is also the explanation for the rather big revenue miss. Shopee gave more free shipping for its live-streaming events and shipping costs have to be deducted from revenue according to GAAP rules.
I know many competitors are trying to take market share from Shopee. Think of Alibaba's (BABA) Lazada, GoTo (consisting of Gojek and Tokopedia), Temu, which is Pinduoduo's (PDD) marketplace outside of China, and, of course, TikTok. But up to now, there are no clear signs Shopee is suffering.
Of course, TikTok is very strong in engagement, but I think investors don't give Sea enough credit when it comes to engagement. You shouldn't forget that the company grew out of a gaming publisher and if there is one industry they know a thing or two about engagement, it's gaming. Shopee also attacks TikTok on its own domain, before the Chinese company even started selling on a broad scale. For years already, Shopee has live streaming. And the engagement and results are impressive. Forrest Li on the earnings call:
For the 8/8 shopping campaign, around one quarter of our Indonesian buyers watched live streams on Shopee Live and made close to 5 million orders in a single day. In fact, Shopee has already become the leading live streaming e-commerce platform in Indonesia based on a report by Populix.
And yes, there are many influencers. Again Forrest Li:
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. Indeed, over the course of the second quarter, over one million influencers registered with the program.
If you think TikTok is the big bad wolf, Shopee could be the third little pig with a brick house. As Group Chief Corporate Officer Yanjun Wang said during the Q&A:
we are a social commerce platform in our DNA
Yanjun Wang also points out how strong Sea's brands are:
the fact that we can become profitable so quickly while maintaining the size of our ecosystem and our strong market leadership, and able to now also invest in growth while many of our peers still trying to manage their losses or are incurring very, very significant losses, that shows that the resilience and the strength of our ecosystem is and will continue to be an important competitive moat for us.
More Insights From Sea Limited's Q2 Earnings Call
One of the reasons for the big drop may also have been this passage during the earnings call. Founder and CEO Forrest Li:
Given these positive developments and trends, we have started, and will continue, to ramp up our investments in growing the e-commerce business across our markets. Such investments will have impact on our bottom-line and may result in losses for Shopee and our group as a whole in certain periods
The market may be afraid of Sea investing money again. That's often how it goes with market participants. If there's high revenue growth, they want profitability; if there's profitability, they want higher revenue growth without sacrificing any profitability.
I think the sentence Forrest Li added was crucial but mostly ignored:
However, this does not change our unwavering emphasis on self-sufficiency and improving cost efficiency as a key competitive moat. (...) Most importantly, we will remain highly agile and prudent by closely monitoring the conditions of each market and adapting our focus and pace accordingly from period to period.
To me, this is very important. I don't want Sea to rest on its laurels but continue to invest in its future. The areas Sea invests in for Shopee are a better distribution system. I think this is crucial and therefore money well-spent. Forrest Li emphasized again that this happens efficiently:
We will remain highly focused on lowering the cost to serve for the entire ecosystem while continuing to improve user experience over the long run.
The investments already showed results in happy customers. Forrest Li:
As a result of our user-focused efforts, buyer Net Promoter Score on Shopee improved by 10% over the course of the second quarter.
And Shopee was not the only app that got good grades from customers. SeaMoney also did very well. Forrest Li:
As a result of our user-friendly UI and UX design, the rating for our bank app reached over 4.8 stars on both Apple and Google app stores, one of the highest among banks.
Like Amazon After The Dot Com Bust?
Much of the negative feelings about Sea are simply because of the price action. I understand that to a certain extent, but if you wouldn't see the price, you might look differently at the company. Just look at the impressive revenue growth in the last five years.
Sometimes, the market is very wrong. Meta ( META ) was a recent example. To me, the market is very wrong about Sea right now.
If Sea now first puts some extra money into the bank (which they did in the last quarters) and then focuses on growth again, balancing it with profitability, I think there could be a tremendous upside.
When Amazon ( AMZN ) focused on profitability in the dotcom crash, it took Jeff Bezos more than two years to be profitable. Forrest Li did it in two quarters. Before you call this sacrilege, I'm a massive Bezos fan and have read many books about him. I just want to show what an incredible thing Forrest LI has accomplished.
Sea's stock is now down 89% from its high set in 2021.
Amazon's stock was down 93% from its high, as investors were scared of the no-growth quarter in 2001.
Of course, every story is different and I don't say Sea will have Amazon's future. But I want to point out a similarity: an outstanding company, of which the stock has been punished severely, that is forced to focus on profitability because of the macro context. While most of their competitors can't do it, they turn around quickly and show their flexibility. I don't think people see the incredible achievement of Forrest Li enough here.
SE Stock Valuation
Sea's stock is now priced cheaply, at just 13 times the 2024 expectations.
Seeking Alpha
My Takeaway
Many growth investors have abandoned the SE stock ship, and Sea's stock is probably too volatile for value investors. I think the volatility won't go away any time soon in the foreseeable future.
On top of that, if you just look superficially, it's easy to miss the value of an investment in Sea. But I think for patient long-term investors, Sea could be a great investment at this price and I will add to my position.
Although the stock is punished severely, I still see a great future for Sea. Management continues to deliver impressive results, even if they are currently not appreciated by the market.
In the meantime, keep growing!
For further details see:
Sea Limited Stock Is A Strong Buy At Current Price