SEA Limited (SE) is down 20% from its peak of $372.70 per share, owing to a sell-off in numerous technology stocks. The pullback has continued since SEA released its third-quarter results on November 16, 2021, which indicates a miss on expectations.
This article was first published on 1 Dec 2021. As of 17 Jan 2022, SEA Limited had continued to tumble and is now -53% from its peak. Its share price was hit further after Tencent announced it would sell 14.5 million shares in Sea Ltd at $208 each for a total of US$3 billion.
Diving into SE’s 3Q2021 earnings report, we’ll investigate what has led its stock price to plummet following months of gains.
Let’s find out if the sell-off was caused by a shift in the company’s fundamentals or simply by investor emotion, and whether you should be holding, adding or selling your positions.
SEA 3Q21 earnings highlights
Between 3Q20 to 3Q21, SE’s total revenue climbed by 121.8% to US$2.7b. This increase is driven by SE’s primary segments; Digital Entertainment and E-commerce.
When we zoom out and look at the broad picture, we can see that the company’s revenue has been increasing exponentially quarter after quarter for the past five years, which is a remarkable achievement.
SE business segment breakdown
But is it doing well on all fronts? Let’s look at how each of its business segments has performed:
E-commerce
Shopee is SE’s upcoming crown jewel, accounting for 54% of the company’s revenue. In the third quarter of 2021, revenue for this category surged by 134.4% to US$1.5b. The expansion of the Shopee e-commerce platform and a surge in revenue from value-added services and advertising contributed to this increase.
In terms of size, SE’s gross merchandise value was US$16.8b, up 80.6% year on year.
According to App Annie, in the third quarter of 2021, Shopee was the #1 app in the Shopping category on Google Play in terms of total time spent in app and 2 #in terms of downloads and average monthly active users. Shopee also remained the most popular app in Southeast Asia, Indonesia, Brazil, and Taiwan. This is measured in terms of average monthly active users and total app time.
Digital Entertainment
The sole lucrative segment for SE at the moment, aka the company’s golden goose, is Garena.
This segment has been supporting SE’s expansion all this while. From US$569.0m in the third quarter of 2020 to US$1.1b in the third quarter of 2021, its digital entertainment division has grown by 93.2%. This rise was primarily attributable to an increase in:
- active users: increased by 27.4% y-o-y to 729m,
- paying user penetration: increased by 42.7% y-o-y to 93.2m quarterly paying users (makes up 12.8% of active users).
In layman’s terms, this means that not only are more people playing SE games like Free Fire, but they’re also spending more money on the platform.
According to App Annie, Free Fire maintained excellent user engagement in the third quarter of 2021, ranking second internationally in terms of average monthly active users for all mobile games on Google Play. SE also released Free Fire MAX in late September, a new standalone version of Free Fire with upgraded specifications that is compatible with Free Fire, allowing users on both versions to play together.
Digital Financial Services
SeaMoney is currently the smallest segment in SE. While it has the potential to be as successful as Ant Group, it still has a long way to go because it needs to penetrate various markets around Southeast Asia. For the third quarter of 2021, the total payment volume for its mobile wallet was US$4.6b, up 111% y-o-y. Furthermore, in the third quarter, the number of paying users climbed to 39.3m.
SE’s financial performance in 3Q21
Now that we’ve identified the key segments and noted that they have collectively reported good growth, it would seem that the company is doing well. That doesn’t explain the drop in share price, so let’s dig deeper by looking into SE’s financial performance.
Gross profit
SE has managed to keep their gross profit in the 30% to 35% area, which is a healthy range for the company.
Cash and cash equivalent
Compared to prior quarters, SE’s cash and cash equivalents have increased dramatically. However, it is essential to emphasise that the majority was attributable to net cash generated through financing activities (US$7b).
While cash generated from operations was approximately $513m, net cash used for investing is close to $2b.
Without this net cash from financing activity, SE cash and cash equivalent would have dropped significantly.
Raising Guidance
To top it off, the management is increasing its E-commerce guidance for the full year of 2021 for the second time.
It expects its E-commerce revenue to be between US$5.0b and US$5.2b, compared to the previous forecast of US$4.7b to US$4.9b.
Where is the bad news?
From what we’ve seen so far, SE’s results are nothing short of spectacular. So, what’s the deal with the drop?
The main explanation could be related to the fact that it is losing more money.
Rising operating costs & supply chain crisis
While the company’s revenue continues to rise, its costs have risen in conjunction. From US$804.6m in the third quarter of 2020 to US$1.7b in the third quarter of 2021, the total cost of revenue climbed by 108.8% to US$1.7b. When broken down, the cost generator is its E-commerce section, which has had its cost of revenue rise by 139.8%, compared to 61.4% for digital entertainment.
SE attributes the additional costs were mostly attributable to increased logistical costs that is part and parcel of increased sales orders. However, even with the improvement of cost efficiency (which is a typical side effect of scaling up), we can observe that cost of revenue has climbed somewhat faster than sales growth in its E-commerce segment. This may be linked to the present supply chain crisis, which is hitting not only SE but also other E-commerce companies.
Nonetheless, the rise in the cost of goods is not the primary cause; in fact, SE’s gross profit has improved. In comparison to last year’s Q3 gross profit of US$0.4b, SE’s total gross profit increased by 148% to US$1b.
Rising sales and marketing expenses
The company’s increased operating expenses were the true drag on its bottom line.
Jackie Chan and Phua Chu Kang are not dancing to Shopee’s jingles for free. SE has been investing heavily in marketing in order to grow its market share and strengthen its brand.
From US$471.0m in the third quarter of 2020 to US$1.0b in the third quarter of 2021, total sales and marketing expenses climbed by 114.4% to US$1.0b. The sales and marketing expenses of its reporting segments are broken down in the table below, with numbers expressed in thousands of USD:
Together with the increased G&A and R&D expenses, SE reported net losses of US$571.0m in the third quarter of 2021, up from US$425.3m in the previous quarter. Even if share-based compensation is not factored in, the net loss for the quarter is US$448.0m, which is higher than the prior quarter.
Risks
We now know why the SE stock price has dropped. That, however, may not be all. Their 3Q21 earnings report highlighted some important risks for SE.
SE’s cash might be its competitive advantage?
SE has been able to grow its user base and thus revenue at an exponential rate over the last few years thanks to a comprehensive marketing approach. Nonetheless, we must consider SE’s competitive advantage, particularly in its e-commerce industry.
Lazada used to be the most popular online shopping platform for a long time. However, this is no longer the case as Shopee is now in the lead, outperforming Tokopedia and Lazada in the region because of its better incentives and targeted marketing technique. Lazada and Tokopedia’s decline may very well happen to SE if these incentives dwindle or if its competitors develop more novel online buying solutions.
SE’s aggressive marketing spending model is currently boosting its revenue, but this may not be sustainable.
While not an exact comparison, Amazon lost only $2.8b before attaining profitability, while SE has already lost $6.5 b despite growing significantly faster than Amazon.
While the company’s balance sheet remains robust and could sustain such growth for a few more years, we must consider what would happen if it could no longer raise funds through debt and dilution.
Moving forward, SE will have to show that it can reduce its losses while maintaining its expansion. This would be tricky as failure to meet either would disappoint investors.
But its cash cow is drying up
If you look at SE’s Digital Entertainment segment again, you’ll notice that compared to the previous quarter’s user base increase, the increase appears to be modest. This could indicate a concerning trend if it continues.
For a long time running, the SE digital entertainment section has been the driving force behind its e-commerce expansion. A potential slowdown in this user base could imply less cash available to fund its expansion.
SE’s current valuation
| SE | Amazon | Alibaba | MercadoLibre | |
| PS ratio | 13.13 | 3.88 | 2.86 | 9.94 |
| PE ratio | -78.7 | 68.5 | 19.37 | 790 |
| Gross margin | 37.5% | 43.21% | 33.9% | 43.42% |
| Net margin | -21.23% | 2.85% | 2.67%* | 5.13% |
| Debt to equity ratio | 0.53 | 1.07 | 0.14 | 25.42 |
| Revenue growth rate (average of the last 4 quarter) | 132% | 32.46% | 51.8% | 92.1% |
Compared to the tech sell off in April, where SE’s PS was at 16.3, its current PS of 13.13 could signal that SE is now much discounted compared to a few months ago.
Across all four companies, Alibaba appears to be the most undervalued stock based on the PS ratio, owing to the turbulence in the Chinese market. On the other hand, SE is the most expensive of the four, though with the highest growth rate.
In terms of value, betting on SE carries a greater risk compared to Amazon or, in some ways, Alibaba. On the other hand, SE has a bigger potential, particularly in the rapidly rising Southeast Asian market.
Concluding thoughts
SE’s latest results have continued to demonstrate its achievement and it will most certainly continue to do so as the average income and purchasing power in its Southeast Asian market climbs.
However, it has also signalled that the company’s trend of not making a profit is likely to continue for a few more years. SE will face stiff competition from other companies in this field for a long time. This includes Lazada, Tokopedia, and even Grab, all of which have major financial backers.
Is there enough room in the market for all of them? Is this a “winner-take-all” scenario?
With the recent price decrease, investors may be looking at an excellent opportunity to participate in their growth narrative; however, investors should be aware of the aforementioned risks and pick what they are comfortable with.
Stay tuned as we bring you the latest analysis, once SE releases their next annual report and earnings reports.
The author doesn’t hold a position in SE at the time of writing.
Hi may I know what is your view on MELI? It has dropped even more than SEA Limited.