I have decided to write a stock analysis on Sea Limited (SE) after it’s share price rallied 300% YTD. This high growth stock has surpassed DBS to become Singapore’s most valuable company.
To put things into perspective, I did a price comparison of SE to other platform businesses. SE has emerged as the clear winner completely outperforming its competitors.
Is this a tech bubble in the making? Or is this a giant mammoth growth stock that has been overlooked?
This article will provide a comprehensive deep dive into the business model and operating metrics of Sea Limited. At the end of it, I will also share my personal opinion on whether SE is a good stock buy.
1. What does Sea Limited do?
To start off, Sea Limited is a holding company and by itself has no substantive operations. They conduct their business through its 3 main subsidiaries Garena, Shopee and SeaMoney.
The markets that Sea Limited is in, gaming, e-commerce and payment, are in extreme high growth areas, especially in Asia and emerging markets.
That’s why Sea’s target market segment and influence is primarily around Southeast Asia, Latin America and Asia.
1.1 Garena (Digital Entertainment)
Garena has been around since 2009 and they are a global game developer and publisher.
Garena exclusively licenses and distribute games developed by third parties. Some of the more popular games include League of Legends, FIFA Online 4, Call of Duty and Arena of Valour.
Apart from 3rd party games, Garena also develops its own in-house games. In 2019, Garena launched its first mobile game, Free Fire. Free Fire turns out to be a home run hit for Sea Limited.
The game won the “Most Downloaded” mobile game globally in 2019 for Google Play and iOS App Stores combined. It is also the highest-grossing mobile game in both Latin America and Southeast Asia. In Q2 2020, Free Fire just hit a new record high of 100m active users.
This year Jan 2020, Sea’s Digital Entertainment arm acquired 100% of Phoenix Labs, a leading games studio and developer based in the US. The acquisition gives us hints that Garena intends to further self-develop and push out more in-house games like Free Fire.
Garena has expanded its local game operations to Indonesia, Taiwan, Vietnam, Thailand, Philippines, Malaysia, Singapore and Latin America. Free Fire is also currently available in more than 130 countries globally.
1.2 Shopee (E-Commerce)
Shopee is an e-commerce platform that launched in 2015. Similar to the business model of Lazada, Qoo10 & Taobao, it is a marketplace that connects buyers and sellers.
Additionally, Sea Limited also do purchase products from manufacturers and third-parties to resell them directly on Shopee’s platform.
Tencent owns about 20+% stake of Sea Limited (Shopee) while Alibaba owns Lazada after pumping in about $4 billion capital.
This e-commerce fight between the 2 tech giants is reminiscent across many sectors in Asia. Example, the food delivery segment in China is also between Meituan Dianping (Tencent) vs Ele.me (Alibaba).
E-commerce platforms and food delivery is a highly competitive, throat-cutting price-war game. But it is also where the highest growth and data is.
1.2.1 Shopee’s Market Share and Popularity
In Singapore, Shopee has the highest web visits in Q2 2020 but came in 3rd for Q1 2020. However, it ranks first for both its AppStore and PlayStore.
The popularity of Shopee differs in different parts of Southeast Asia. But you can see it dominates the mobile segment across most countries.
This is because Shopee has adopted a mobile-first approach to leverage on the growth of mobile penetration. They started off with the mobile app first before creating the web version of it.
1.2.2 Why Shopee Dominates Mobile?
Instead of having one common app for all users, Shopee develops different stand-alone e-commerce apps for different markets. This allows them to launch campaigns that are hyper-localised so that there is higher user engagement.
Example, the Thais and Viets trust celebrity endorsers while Singaporeans and Malaysians respond to flash sales and discounts. Then you have Indonesia which has its own dedicated section of Islamic products and services catered to the Muslim market.
Though we all belong to the Southeas Asia region, each country has different buying patterns based on cultural, social and economical factors.
Adding on to Shopee’s dominance in mobile is because they introduced many social and gamification features. There are a variety of mini “Shopee Games” where users can collect “Shopee Coins”. Sellers can do livestreaming selling on “Shopee Live”. Shopee even has “Shopee Feed” where users can continuously scroll through a lively ecosystem like Facebook.
There is an endless flurry of activities to retain users in a short-attention-span world.
Most of Shopee’s revenue and gross orders come from Taiwan and Indonesia. They are the market leader in Taiwan and Indonesia is a huge market for them due to the population size.
Sea’s digital financial services have been around in Vietnam & Thailand in 2014 before rebranding it to SeaMoney in 2019.
SeaMoney offers e-wallet payment services, payment processing, micro-lending and credit lending. Some of their products include AirPay, ShopeePay and ShopeePayLater.
Most of the payments that are done in Shopee are handled and processed by SeaMoney. In 2019, SeaMoney is working on integrating its e-wallet services into Shopee to reduce payment friction for users.
SeaMoney makes up the smallest % of the group’s total revenue as they are fairly new. Its digital financial services are largely concentrated in Thailand, Indonesia and Vietnam. In July 2020, 45% of gross orders in Indonesia was paid using SeaMoney’s mobile wallet services.
Probably the most exciting news for SeaMoney is its bid outcome for Singapore’s digital banking license. Sea Limited has a massive amount of user data and this gives them unrivalled insights as compared to its contenders.
Taking a step back, you can see what Sea Limited is trying to do from a bigger picture. They are trying to be the combination of Tencent and Alibaba. Gaming is from Tencent, e-commerce is from Alibaba and payment is from both WeChat and AliPay.
Sea is firing on all 3 cylinders and it is charging ahead at full throttle speed.
2. Sea Limited’s Financial Overview
Now that we know a little background about each of Sea Limited’s divisions, let’s look at the group overall financials.
Sea Limited IPO in 2017 and here is their past 3 years financial performance.
Their revenue in FY 2019 is about US$2.2 billion and the growth has been staggering. It is a 3-digits growth rate for both years. Gross profits are about US$600 million in 2019. But the company’s operating earnings and net profits are still in the red. Sea Limited has not made its first profits yet.
This is completely normal in high-growth companies, especially in the platform market. The priority for them is not profitability in the early years, it is building up the user base and platform to create a strong network effect. (e.g. Grab, Amazon, Meituan Dianping and etc.)
Let’s break down the group’s financials by business segments.
2.1 Sea Limited’s Financials by Business Segment
Digital Entertainment makes up the largest portion of the group’s revenue and they are the only segment that is profitable.
While Shopee is showing hyper growth in revenue and user base, their losses are also accelerating over the years.
Digital Financial Services and their middleman business makes up a small part of the group’s total earnings.
2.2 Sea Limited’s Cash Position
Sea Limited made a positive operating cash flow of US$70 million in 2019. This is despite the fact that their net loss for 2019 is about US$1.5 billion. So how did the difference of US$1 billion+ reconcile?
The primary reason for the increase in cash flow for 2019 is due to an increase in deferred revenue of US$637 million and an increase in accrued expenses of US$354 million.
Accrued expenses is just payments that they have not made yet. That’s why they have more cash.
As for deferred revenue, the revenue recognition policy for gaming typically uses an item-based revenue model. This means that whenever a user pays for in-game purchases or virtual items in the game, it is recorded as “Deferred Revenue”. Though cash is received, revenue is not recognised on the income statement.
It is only recognised over the lifespan of the virtual item or upon consumption of the virtual item. For virtual items that are durable or extends over an extended period of time, revenue is recognised over the average lifespan based on the users’ historical usage patterns and playing behaviors.
This means that US$637 million in deferred revenue would eventually flow to the revenue line item in the income statement to boost net income over the months or years. Depending on how and when the virtual items are being used.
As for their cash balance, they have a huge pile of it. Though most of them were raised from equity financing rather than organic cash generation.
The US$3.5 billion cash at FY 2019 would give Sea Limited a strong buffer to sustain through the years. The question then is how long?
3. Sustainability of Sea Limited’s Growth
3.1 Sea Limited’s Cash Burn Rate
One common metric to look at for early start-ups is the cash burn rate. This measures how many years can the company sustain before requiring another financing again.
Gross Burn Rate is a calculated by taking the year-end cash on its balance sheet divided by total operating expenses.
Sea Limited’s total operating expenses for 2017, 2018 and 2019 are US$590 million, US$1 billion and US$1.5 billion respectively.
Sea Limited’s cash balance for 2017, 2018 and 2019 are US$1.44 billion, US$1.26 billion and US$3.57 billion respectively.
2017 and 2019 has a higher gross burn rate as a significant amount of cash was raised from investors.
In 2017, Sea Limited raised US$960 million for its IPO and another US$674 million from the issuance of convertible notes.
In 2019, Sea Limited did another equity financing by issuing ordinary shares worth US$1.5 billion and a 2nd round of convertible notes at US$1 billion.
By the metrics of gross burn rate, there is a runway of about 2 years+ before they run out of cash again.
Net Burn Rate takes into account revenue and it is calculated by taking the year-end cash balance divided by its operating loss.
Generally, net burn rate is slower than gross burn but the latter is a more conservative metric to test a company’s sustainability.
3.2 Sea Limited’s Marketing Expenses
Another commonly used metric is to look at how much they are spending on marketing (subsidies, vouchers, free shipping & etc.) as a % of revenue.
You can see that in 2017, Sea Limited spent 100% of its revenue to penetrate the market and gain a foothold in the region.
Sea Limited has made the strategic decision to invest in Shopee marketplace by incurring sales and marketing expenses in advance of their monetization efforts.
They could be profitable right now by cutting down expenses, but they chose to continually re-invest and acquire users.
It is a good sign that marketing expenses are slowly declining over the years. Ideally, it should come to a point where the brand and network effect becomes so strong that the cost of acquiring user becomes free.
The biggest risk here is the failure to monetize its products and platforms from the cash injected by investors. Monetization rate should overtime catch up with the cash burn rate.
Return on investment is positive when the average spending of a user, be it on Garena or Shopee, is higher than the average cost of acquiring a user.
Failing to do so means they are literally burning cash away.
Example of it could be spending all the money to attract users shopping on Shopee. But when the funding gets cut off, all users hop over to other platforms. So user acquisition, retention and monetization strategy is critical to Sea’s success in the future.
4. Sea Limited’s Monetization Strategy
Sea’s financial earnings largely depend on 2 operating metrics. First is the number of users and second is the level of user engagement.
Garena earns its revenue primarily by selling players in-game virtual items and season passes. Shopee earns its revenue from advertising for sellers and commissions from transactions. SeaMoney earns its revenue also from the volume of payment transactions.
High user base leads to higher chance of user engagement which in turns lead to higher revenue.
Sea Limited spent so much on marketing because it wants to attract more users over. Both Garena and Shopee are platform businesses which benefits from a virtuous cycle network effect.
This means that the incremental value for each newly acquired user becomes higher over time.
For example, when more people are on Garena, people would want to join Garena because that is where all their friends are. This, in turn, attracts more users. Similarly, when there are more buyers on Shopee, this would attract more sellers, which in turn attracts more buyers.
4.1 Digital Entertainment (Garena) Operating Metrics
Garena’s revenue is derived from 1) number of quarterly active users and 2) number of quarterly paying users. The more active users you have on the platform, the higher the number of paying users there should be.
For Q2 2020, both the number of active users and paying users have been showing tremendous Y-o-Y growth.
To see if the game remains attractive or if Garena is effectively monetizing its business, we can also calculate the monetization rate by taking the % of paying users to the number of active users.
It has been increasing steadily and their monetization rate is somewhere around 9% on average. That means 9 out of 100 users on Garena would spend some money to purchase in-game virtual items.
4.2 E-Commerce (Shopee) Operating Metrics
The operating metrics to measure the health and growth of Shopee is dependent on Gross Merchandise Value (GMV) and Gross Orders.
GMV refers to the total value of orders on Shopee’s platform including shipping and other charges. A higher GMV indicates more sellers, more goods or either that more high-ticket items.
Gross Orders refer to each confirmed order from a transaction between a buyer and seller. Higher Gross Orders indicate more people are buying stuff from Shopee’s platform.
Both GMV and Gross Orders for Q2 2020 are showing a Y-o-Y triple-digit growth rate.
To evaluate the monetization rate of Shopee, we can comapare its revenue as a % to GMV. This tells us how much money Shopee is earning for every dollar of goods and services sold on Shopee’s platform.
As of Q2 2020, Shopee is earning about 6.4 cents for every dollar of goods sold. Monetization rate has been ramping up steadily across the quarters. This is despite the fact that fee reliefs and financial support programs are provided to sellers that are affected by the pandemic.
Both Garena and Shopee has been showing strong healthy growth rates in user base. Monetization rate has also been going up and overall this is a positive direction for Sea.
5. Macroeconomic Analysis for Sea Limited
So what’s next for Sea Limited?
Since more than 50% of their revenue comes from Southeast Asia. I thought it would be key to look at some macro data around this region.
5.1 Population in Southeast Asia
Firstly, Southeast Asia is home to some 570 million people and economic growth in the region has averaged 5%. This is contrast with the world’s average of 2%.
By 2030, Southeast Asia is expected to become the 4th world’s largest economic region. Sea Limited is well-poised to capture the growth in this region.
5.2 Internet Mobile Users in Southeast Asia
Secondly, internet users in Southeast Asia have increased by 100 million since 2015 to 360 million in 2019. About 150 million Southeast Asians will turn 15 over the next 15 years. If we use 15 as the age when they would carry a mobile, that works out to be about 10 million new mobile users each year.
Most of the time spent on mobile is social and communication apps followed by videos. But user engagement in video apps has doubled over the last 3 years with the rising popularity of TikTok.
That’s why Shopee is moving towards social user experience and videos rather than just a marketplace for people to buy/sell goods. They are synthesizing the social and video features of Facebook and TikTok onto their shopping platform.
For example, Shopee partner up with KCON to Livestream K-pop music and annual concert series exclusively. They also enhanced Shopee Feed with a new feature called Shopee Stories. Sellers can now create short-form video contents and sell their products to their followers on Shopee Feed.
Sea Limited knows what people wants and they are smart to catch on social trends to retain users and boost engagement.
5.3 Southeast Asia Internet Economy
Thirdly, the Southeast Asian internet economy has grown at a compounded annual growth rate (CAGR) of 33%. At this trajectory, it is estimated that the internet economy would be worth about $300 billion by 2025.
The trailing 12 months of Shopee’s GMV (including Taiwan) is only about $24 billion. That is about 25% of Southeat Asia’s GMV in 2019. If we just use the same proportion in 2025, it would be about $125 billion. This gives you a sense of how much future value we can capture.
Within the Southeast Asia region, Indonesia and Vietnam has the highest expected growth followed by Philippines and Thailand.
In e-Commerce, the number of people buying/selling items online has tripled from 2015 to 150 million in 2019. As for gaming, the number of active users for online gaming has increased by 50 million from 130 million to 180 million in 2019.
All in all, the Southeast Asia region is a perfect hotbed for Sea Limited to thrive in. They would definitely see their businesses capturing more value under the backdrop of a young growing population who are internet-savy.
6. Is Sea Limited (SE) a Good Stock to Buy?
Concluding this Sea Limited stock analysis, is SE a good stock buy? My short answer is yes. I have made the mistake of over-worrying on unprofitable cash-burning businesses. Meituan Dianping is one of them when I took a “wait-and-see” approach.
Based on my experience, a wait and see approach usually ends up you missing the train, or in some cases, a rocket. (Tesla)
My strategy now is just to buy, if you think it is a solid company. Then DCA when it drops.
So instead of waiting for the dip and buy, now I buy and wait for the dip.
6.1 Why Sea Limited (SE) Stock is a Buy?
The good thing about SE is that its gaming segment is already profitable. It is generating a positive cash flow that can be redeployed to Shopee and SeaMoney.
I believe Garena would continue to develop more games like Free Fire. Pony Ma is just a phone call away and there will never be a lack of ideas for gaming content. Sea can easily leverage on the existing games portfolio of Tencent, hyper-localise it and distribute/sell it.
The cash from Garena can then acquire more users to Shopee. When more users come on board, that would attract more sellers and that gets the flywheel rolling.
Shopee has already deepened its presence across most countries in Southeast Asia and Taiwan. This momentum is not showing any hints of slowing and it would eventually reach a tipping point. Analyst consensus for Shopee’s profitability is around 2021.
Finally, SeaMoney has full of opportunities ahead in the digital payment and fintech space. Not to mention the 1 billion unbanked in Asia.
The difference between SeaMoney and other competitors is that they already have a large user base from both Garena and Shopee. There is already a big use case while others have to actively search for one.
Digital banking license is also on its way. The total revenue for the 3 Singapore banks in 2019 is about $35 billion. Let’s say SeaMoney just take a conservative 1% of market share, that would already be $350 million. That is almost a 35x from SeaMoney’s current revenue of $9.2 million in 2019.
Given the sheer size of the internet economy, fast-growing population and rising online users, it won’t be very long before Sea Limited becomes profitable.
If you believe in Southeast Asia, like Grab, EDB or UOB, Sea Limited (SE) is the stock to own. There is a massive macro tailwind behind them. It is in the right market, right region and all it needs is the right time to bloom.