Sea Limited (SE) just reported Q1 2021 earnings on 18th May 2021 (before market open) that although missed both Wall Street revenue and EPS estimates, shows continued trend of explosive growth in all 3 of its business segments – digital entertainment (Garena), e-commerce (Shopee) and digital financial services (SeaMoney).
Why is Sea Stock Price Down?
Sea’s stock price initially tanked by 5% at market open but quickly recovered and actually ended the trading day up by 4%. Currently, Sea is trading at $226.66 as of the close of 19th May.
Sea however is down ~19% since it’s all-time high of $280 on 19th Feb 2021. Sea has been part of the cohort of high growth tech stocks experiencing a sharp sell-off due to inflationary fears.
Investors may also be concerned about Sea’s widening net losses led by ballooning sales & marketing expenses, even as the company scales and grows its revenues at a breakneck pace.
Reasons to be Bullish on Sea
Sea is still a relatively young company in its growth phase so focusing on its net loss doesn’t paint the full picture. Looking at other metrics, Sea is actually profitable on an adjusted EBITDA level which generally excludes non-operational expenses. Sea is aggressively reinvesting into its business, so its capex and consequently depreciation & amortization costs will be high. Although Sea is probably no longer considered a startup, it still mostly rewards insiders with generous share-based compensation, thus affecting the bottom line.
On a group level, gross profit is actually growing faster than revenue. Total gross profit grew 212% yoy compared to growth in total revenue of 147% yoy. Thus, if Sea starts to reach maturity and reduces operational expenses, we could see profits start to materialize at the net level. However, the question still remains of how much of this revenue is driven by promotional offers and discounts especially in their e-commerce business.
That said, Sea’s digital entertainment unit under the Garena brand is continuing to execute wonderfully, taking full advantage of the gaming boom caused by movement restrictions. Its self-developed game Free Fire continued to be the highest growing mobile game in Southeast Asia, Latin America and India in Q1. Garena continues to be extremely profitable for the group and is likely to continue bank-rolling its e-commerce and fintech segments in the near future. Besides that, Sea has a comfortable cash position of $5.8B which can be used to fund its expansion plans.
Sea’s e-commerce segment under Shopee is its largest and fastest growing one. E-commerce revenue grew by 250% yoy which is insane growth. Shopee dominates e-commerce in Southeast Asia and Taiwan, ranking first in the Shopping category by average monthly active users and total time spent in app on Android in Q1.
Sea’s fintech business SeaMoney is the dark horse here and we will probably not get a good idea of how well this segment can potentially do probably until end 2022 at the earliest. Its digital full banking license issued by MAS in Singapore is only expected to be operational sometime in 2022, and we haven’t heard further news about its plans for Indonesian Bank Kesejahteraan Ekonomi (BKE) which it recently acquired. At the moment, SeaMoney is showing strong growth in terms of mobile wallet total payment volume (TPV) from a low base but is still largely tied to integration with its e-commerce platform Shopee.
Valuation and Price Target
Sea’s is currently trading at a market cap of ~$125B and at a P/S of 23x, which is still not cheap by any means. As top line revenue grows however, P/S will reduce. Sea’s gross margins are pretty healthy around 36% so valuing Sea based on the P/S would suffice for me.
Average PT for Sea based on Tipranks.com is $301.10 implying ~30+% upside and market cap in excess of $160B. As always, take these analyst PTs with a pinch of salt. Personally, I can see Sea easily hitting a $200B market cap within the next 5 years implying a share price of ~$380. We shall see…
My Thoughts
Investors in Sea definitely need to be aware of the higher risk associated with high growth tech stocks especially one like Sea that focuses on emerging markets of Southeast Asia and Latin America. Sea continues to plow most if not all its earnings back into the business and we are unlikely to see Sea turning a profit at the bottom line anytime soon.
Investors need to have a really long time horizon and be able to stomach a lot of volatility in Sea stock price as a long duration asset. Sea investors need to keep their eyes on the prize which is digital market domination in emerging markets.
In my opinion, Sea’s operational results look great and I’m still very bullish on the company’s future prospects. Sea appears to be reaping dividends from investing heavily back into its business, as seen from its rapid revenue, bookings, gross merchandise value (GMV), and user base growth.
What I would like to see is a clearer path to profitability at scale and independent of heavy discounting or promotional activity. The holy grail of these platform technologies is ecosystem stickiness and until I see clear evidence of that, I won’t be going in heavy into Sea just yet.
Currently, Sea makes up around 1.9% of the Family Portfolio. I will continue to add opportunistically around the 200-day MA level of $200 which appears to be a level of support.
What do you think about Sea? Are you a bullish or bearish after Sea’s Q1 earnings?
Disclosure: I’m long SE.
Disclaimer: This is not financial advice. I am not professional financial advisor nor do I work in the finance industry. Anything I write here is purely my personal opinion. Please do your own research and due diligence before investing into anything. All investments come with associated risks. Best to consult a financial advisor if you’re still unsure.