A look at Sea Limited (SE)

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Hi all, I’m 2 months new to the board and like many before, I have been mind-blown by the treasure trove of information here.

SE was briefly mentioned here a couple weeks back and I thought I would provide more details as a shareholder.

Business

Sea Limited (Ticker SE), headquartered in Singapore, operates predominantly in Southeast Asia, home to a population of over 650m people. In recent quarters, SE has entered Latin America and India. It operates 2 main business segments.

Digital Entertainment: SE operates Garena Gaming which produces and distributes mobile games. It has a very strong presence in Southeast Asia, Latin America and increasingly, India and the Middle East. Garena produces its own games and has a right of first refusal for Tencent’s games in Southeast Asia. Think of Garena as the Tencent of Southeast Asia and Latin America.

E-commerce: SE operates Shopee, a relatively new entrant to Southeast Asia’s nascent e-commerce industry. Shopee runs a marketplace where sellers pay a fee to list their items. Think of Shopee as the MercadoLibre of Southeast Asia.

SE also operates a digital payments service called SeaMoney but that’s a relatively small part of the business right now.

Competition

Digital Entertainment: There are many global competitors but Garena is the largest in Southeast Asia.

E-Commerce: Shopee competes with Alibaba-backed Lazada and others. In spite of its relatively late entry into the market in 2015, Shopee is the fastest growing player. It is now the clear leader in the region in terms of GMV, MAU, downloads and time spent on the app.

According to my poll of the Mrs and a few female friends, Shopee’s mobile platform is by far the easiest to navigate. Prices are also competitive.

Management and Strategic Shareholder

Forrest Li (43 years old) is the CEO and Chairman. He’s a China-born Singaporean and graduated from Stanford’s MBA program. According to TMF, he adopted his English name from Forrest Gump because he identified with the character’s quiet and humble nature. He owns 30.6% of SE.

Tencent, China’s largest gaming and social network company, and also the 2nd largest Chinese company by market cap, owns 33.4% of SE. Tencent has been a strong strategic partner for SE, especially in the Digital Entertainment side.

Financials

Revenue (USD’M)


Year       Q1       Q2       Q3       Q4        FY
2017      93.9    101.5    94.1      124.6     414.2
2018      155.0   183.8    204.9     283.2     827.0
2019      351.9   436.2    610.1     777.2     2175.4
2020      714.9

Revenue Growth


Year       Q1       Q2       Q3       Q4        FY
2017      
2018      65%       81%     118%     127%      100%
2019      127%     137%     198%     174%      163% 
2020      103%

GAAP Gross Profit Margin (the company does not publish non-GAAP figures)

You’ll see that margins are relatively low for a “tech” company but I’ll talk more about each segment later. Note that GP Margin has been improving yoy since 2018.


Year       Q1       Q2       Q3       Q4        FY
2017      28.9%    25.4%   11.5%     18.9%     21.1% 
2018       5.5%     4.7%    2.7%     -2.8%      1.8%
2019      11.2%    22.3%   33.3%     34.1%     27.8% 
2020      28.9%

Non-GAAP* Net Profit Margin (*I adjusted GAAP figures for SBC and change in FV of convertible notes)

Again, note that NP Margin has been improving well yoy since 2018.


Year       Q1       Q2       Q3       Q4        FY
2017     -71.3%   -85.5%   -135.1%  -160.2%   -116.0%
2018    -120.4%  -108.1%   -115.9%  -113.4%   -114.2%
2019     -67.4%   -49.3%    -28.7%   -30.9%    -39.9%
2020     -33.5%

FCF Margin

The company has been burning cash over the past few years. It does not disclose FCF on a quarterly basis. FCF margin improved in FY 2019 but it may continue burning cash as it grows. I want to see this metric improve. At end Q1 2020, the company had a cash position of $2.6b (and financial liability of $1.4b in convertible notes). FCF was -$176m in FY2019.


Year       FY
2017     -81.8%
2018     -81.5%
2019      -8.1%

Earlier, I mentioned the low GP Margin. Diving into each business segment sheds more light.

Digital Entertainment GPM


Year       Q1       Q2       Q3       Q4        FY
2018      42.6%   42.6%    43.2%    40.7%     42.2%
2019      51.2%   58.6%    64.4%    65.6%     61.6%
2020      61.4%

E-commerce GPM


Year       Q1       Q2       Q3       Q4        FY
2018    -118.2%   -68.8%   -58.8%   -52.4%    -65.3%
2019     -33.4%   -19.7%    -4.5%     0.6%    -10.3%
2020      -7.1%

Looking at both segments, we can see that Digital Gaming enjoys pretty high GPM of > 60%. The E-commerce business started from scratch in 2015 and GPM has been increasing steadily since then. How high can it go? Mercado Libre has a GPM of 48% so I would use that as a rough reference. The e-commerce business potentially can improve GPM by over 50 percentage points.

Overall, financials show a company that is growing rapidly with fast improving margins.

Valuation

TTM Rev = $2,538m. Assuming 40% growth pa over the next 5 years and 20% net margin, net margin = $2,730m. Applying a 40x multiple gives $109.2b value. Current market cap = $36.900.

Risks

As it currently stands, overall profitability of the business depends on the e-commerce segment. E-commerce is competitive by nature. Poor execution in this segment is a risk to the company.

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Originally I was interested in the eCommerce division and digital payments. Revenue growth looked very promising on the top level. What stopped me from investing was the concentration risk of their gaming division.

In the annual report
“In 2017, 2018 and 2019, our digital entertainment business contributed 88.2%, 55.9% and 52.2% of our total revenue, respectively.”

“In 2019, our top five games, which included Free Fire, contributed 94.5% of our
digital entertainment revenue”

No other game was mention other than Free Fire (looks like a clone of pubg)
It’s possible that Free Fire may contribute a majority of the 94.5% of entertainment revenue.

Another issue is that the company is running 3 different type of businesses.
Only the eCommerce and digital payment division have synergy.
In my opinion it is difficult to achieve sustained high growth without focus.

These are the reasons why I chose not to invest in SEA

Shig

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I looked at SE as I‘d owned in the past BABA and JD. So, I do have pretty good understanding of Chinese e-commerce market which is close to SE’s market. I decided not to invest in SE for the following reasons:

  1. Their growing e-commerce business will continue having low margins (compared to our stocks). So, the gaming part will become less important with higher margins and low margin retail more influential for SE.

  2. They compete directly against big guys with deep pockets - specifically against Baba‘s owned Lazada. I think that pressure on their margin will persist in short/medium and long run (always?). The region is crowdy place both for population and competition. Why Meli has such high margins in Latam - I don‘t know, perhaps lack of competition?

  3. Yes, there is huge secular trend for e-commerce, but look at Amazon retail business, look at Chinese e-commerce business. 1p business is very low margin. Amazon without Aws would definitely not have current valuation. Alibaba has different model (platform, 3p) hence, margins much better.

  4. After having been invested in some Chinese companies for few years - this is definitely different culture compared to Europe and US. SE is based in Singapore, but culture very different from our. Ultimately, I am not sure if shareholders and capital „givers“ have the same protection and status in Asian culture compared to our. I could be totally wrong here, but I feel uneasy about that.

I could have been totally wrong by not investing into SE around 30 or 40 but as Saul says - it‘s not important what company u have not invested does, it‘s important what company u have invested does. I feel better having invested into DDOG, CRWD, AYX and other our companies and don‘t regret missing SE. Just my personal opinion, could easily understand people catching e-commerce waive via SE which has been rewarding recently.

Best,
V

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Hey V,

Just wanted to give a very quick reply to some of your points. Three out of the first four of your reasons would also be reasons for why Shopify wouldn’t succeed (I’m not saying SE is Shopify, but just that we should keep an open mind).

1. Their growing e-commerce business will continue having low margins (compared to our stocks). So, the gaming part will become less important with higher margins and low margin retail more influential for SE.

Shopify has lower margins (~50%) compared to those our “Saul Stocks” (70-90%). Lower margins doesn’t necessarily mean that they won’t be successful. Declining margins are a better predictor of a bad business model.

2. They compete directly against big guys with deep pockets - specifically against Baba‘s owned Lazada. I think that pressure on their margin will persist in short/medium and long run (always?).

First, Lazada is the only big player with deep pockets that they’re competing against…and they’re WINNING! Going back to the Shopify parallel, they competed against Amazon (the textbook example of a big player with deep pockets)…and WON!

3. Yes, there is huge secular trend for e-commerce, but look at Amazon retail business, look at Chinese e-commerce business. 1p business is very low margin. Amazon without Aws would definitely not have current valuation. Alibaba has different model (platform, 3p) hence, margins much better.

Again, Shopify, MercadoLibre have lower margins and no cloud hosting services, but their businesses (and stock prices) have been extremely successful. No one is saying SE is going to be the next Amazon (and it doesn’t need to be), but its becoming the lead player in eCommerce, gaming, and digital payments.

On a separate note, I think someone said that SE’s divisions don’t have synergies with each other, which isn’t true. Look to MELI for synergies in eCommerce and payments, look to Tencent for synergies in payments (WeChatPay), gaming (Tencent’s main business), and eCommerce (various partnerships).

Sorry if this response seems disorganized, I’m in a rush!

CloudAtlas

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Also to add, lower margins are taken into account with their valuation. Once their valuation is adjusted and corrected for that (SE’s trailing EV/S is 13.3, much lower than our SaaS valuations to account for the lower gross margins and therefore lower future profit margins), then the only thing you need to worry about is growth, which SE has ALOT of. The growth and continued sustainable advantage will generally be the main determinants of its stock price.

CloudAtlas

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Hi Shig,

What stopped me from investing was the concentration risk of their gaming division.

When I saw that they had relatively few games in their line-up, it actually got me excited, lol. If they can introduce more games to the market, the gaming division can continue to grow well. And best of all, they have the first right of refusal from Tencent’s entire library of games i.e. a strong pipeline for Southeast Asia. They can see what works well in Tencent’s markets and then localize content for Southeast Asia. Since the agreement was inked in Nov’18, SE has introduced Speed Drifter (Jan’19) and Call of Duty (Oct’19) to good success.

Another issue is that the company is running 3 different type of businesses.
In my opinion it is difficult to achieve sustained high growth without focus.

While that is a valid concern in general, there are examples of companies that have more than 1 business and grow very well. I would look at the numbers to decide if running more than 1 business is hurting them. Both Digital Entertainment and E-commerce are currently growing in excess of 100% yoy so I’m not that worried. Continuous monitoring needed, as with all our other companies.

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2. They compete directly against big guys with deep pockets - specifically against Baba‘s owned Lazada. I think that pressure on their margin will persist in short/medium and long run (always?).

As Cloud Atlas noted, Sea Limited seems to be winning this battle. And I should add that Sea has the backing of another Chinese giant, Tencent. Tencent owned 40% of Sea at the time of its IPO and partners with Sea in gaming.

I should also add that Mercadolibre is one example of an ecommerce company which was able to fend off the big guys (Amazon) in its region.

Dave

Long SE

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Hi V,

I understand your concern on governance. It’s ultimately hard to convince someone who uses a broad paintbrush to paint China, Singapore and Asia in one broad stroke, so I’m not going to try :slight_smile:

I’ll just correct a couple of misconceptions of the business.

So, I do have pretty good understanding of Chinese e-commerce market which is close to SE’s market.

The Southeast Asian market is very different to China. China, much like the US, is one homogeneous market with a common language and roughly similar culture/buying tastes/habits. Southeast Asia, on the other hand, comprises 11 different countries, each in different stages of economic development, with vastly different languages, culture, and buying habits. It is very difficult for companies to succeed across this region, which is why I’ve been impressed with SE thus far.

If big guns with deep pockets were a good pre-cursor for success, Walmart would not have failed terribly against AMZN in the US, AMZN would not have failed terribly against BABA in China and BABA would not be doing so badly against SE in Southeast Asia. Understanding the local market is far more important. After BABA took a huge stake in Lazada, they brought in their top-level Chinese executives to work with the equally proud Caucasian executives in Lazada. You can imagine this is not a good recipe for success. This is one reason why Lazada has not been doing well in Southeast Asia.

SE’s E-commerce business functions as a 3p marketplace. While it carries a small amount of inventory ($27m inventory vs $2,175m sales at end 2019), it is not a 1p retailer. (Likewise, MELI is more a 3p retailer).

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Hi folks,

Many thanks for ur feedbacks - u definitely follow SE much closer than me. Appreciate ur rebuttal of my concerns!

  1. If SE is 3p e-commerce retailer the business model is much better (in my eyes) for shareholders and margins will be substantially higher than 1p. I just have developed allergy toward 1p retailers after having owned JD and Zooplus (aka European Chewy). Just checked their last report - indeed 3p is much bigger than 1p. They should be able at some point to reach GM margins of SHOP in Meli in this case.

  2. What about Capex? Even 3p model is pretty capex intensive. In recent years/quarters Alibaba had to substantially invest in capex in order to build reliable delivery network. I expect that if SE is growing they should be massively investing in capex.

  3. Agree that even if Lazada grows like weed in South East Asia backed by BABA this does not mean that SE will loose. Could be the opposite. Expect more competition - think PDD appearing in China and competing with BABA and JD. Again does not mean SE will loose.

  4. Agree on the potentially very powerful virtuous circle of having a platform integrating online shopping, payments, entertainment (games) etc. Could be very powerful business model.

  5. I think that there will be a valuation discount (most likely) compared to US companies due to the fact of being located where it is. But this could be already in the price.

  6. Didn’t dig into gaming part, cannot comment much about that but wasn’t the company pretty much dependent on Tencent for this part? Aka concentration risk. Should Tencent decide (most likely they will not) terminate partnership, SE gaming part would suffer?

Bottom line - appreciate a lot all comments above which corrected me putting SE into 1p e-commerce category. 3p model is much more rewarding for shareholders in my eyes. Worth taking a second and closer look for me!

Many thanks and best regards,
Vic

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SE’s E-commerce business functions as a 3p marketplace. While it carries a small amount of inventory ($27m inventory vs $2,175m sales at end 2019), it is not a 1p retailer. (Likewise, MELI is more a 3p retailer).

I would appreciate it if someone would explain the meaning of 1p vs 3p. Is there a 2p?

Thank you in advance.

draj

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nice writeup and thanks for sharing. I looked at SE a while ago but was thrown a wrench by their “adjusted revenue” number. If anyone has any insight on how they calculate that it would be much appreciated.

For instance the “revenue” grew 103% yoy, but the “adj revenue” only grew 57%

It also looked like they had quite a lot of dilution

And the other thing that sort of turned me off was the negative CFFO, which fell from (17,815) to (223,669) yoy

however, I know these can be common for fast-growing companies and they can still be great investments

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Draj, very briefly - 1p is first-party relationship (SE is direct seller in this case). 3p is third-party relationship (SE is not direct seller but a platform for different third party to sell to another party). 1p works like normal supermarket - u buy let’s say toothpaste from producer and then carry on ur balance sheet and then sell to a retail client at some time in the future. 3p is totally different - u prove a platform like Ebay or Amazon Fulfillment Services (FBA). The 3p has inherently better margins. Here is a quick link https://feedvisor.com/university/amazon-1p-vs-3p/

There is no 2p to my knowledge in this context :slight_smile:

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eBay and Amazon Fulfillment Services are two different models, right there?

eBay never dirties its hands on merchandise, acting as the go-between on items between seller and buyer and collecting only a commission from the seller.

AFS warehouses merchandise and receives/inventories/ships it for sellers to buyers, collecting fees for warehouse 3PL services.

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Hey gmcnatt, quick answer to your first couple questions:

This is the difference between adjusted and unadjusted revenue (quickly pulled from the most recent financial statements):

“Adjusted revenue” of our digital entertainment segment represents revenue of the digital entertainment segment plus change in digital entertainment deferred revenue. This financial measure is used as an approximation of cash spent by our users in the applicable period that is attributable to our digital entertainment segment…other companies may present such measures related to gross billings differently or not at all

So for the digital entertainment segment, adjusted revenue takes into account services that were purchased in previous quarters, but weren’t used until this quarter. For its eCommerce and digital financial services segments, adjusted revenue is revenue minus sales incentives (ie discounts). I personally base my valuations off of unadjusted revenue , just because its more conservative and shows how much customers are committing to the company during that quarter.

As for the stock dilution, that has to do with their convertible debt. Once their stock price got past a certain point, it automatically converted to stock (realize that SE’s stock price was $13 at the beginning of last year, so they’ve clearly ZOOMED past any convertible triggers). That’s why if you check their balance sheet between Q4 '18 and Q1 '19, their debt drops dramatically and their shares outstanding begin to increase dramatically. Q1 '20 was the first quarter that their QoQ share increases were “under control”.

I would have to do some digging to CFFO (which, honestly, I probably won’t do), but I remember seeing that and not being concerned. It may have to do with the convertible debt? (Yes, I was an accounting major and realize that debt doesn’t factor into cash flow from operations, but a sizeable charge-off from devaluing your debt DOES affect net income, which in turn affects your cash flow from operations)

Hope this helps,
CloudAtlas

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Hi gmcnatt,

I looked at SE a while ago but was thrown a wrench by their “adjusted revenue” number. If anyone has any insight on how they calculate that it would be much appreciated.

Adjusted rev takes into account deferred revenue (where cash has been collect but services not yet rendered) and sales incentive net-off (revenues that were net off against sales incentives).

For example, if revenue for the quarter was $100, deferred revenue increased by $10 and sales incentive net-off was $10, SE would report Revenue of $100 and Adjusted Revenue of $120.

Hope this helps.

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Hi CloudAtlas & StrugglingFool

thanks for the explanations, very helpful. might do some more digging. lots to get through in the next week or so

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So for the digital entertainment segment, adjusted revenue takes into account services that were purchased in previous quarters, but weren’t used until this quarter. For its eCommerce and digital financial services segments, adjusted revenue is revenue minus sales incentives (ie discounts). I personally base my valuations off unadjusted revenue , just because its more conservative and shows how much customers are committing to the company during that quarter.

The explanation is clear but the numbers are not. If we are adding to unadjusted revenue an amount representing prior year RPO then use then the adjusted number should be greater than the unadjusted number. The percentage discrepancy may occur because the adjusted and unadjusted numbers have different prior year values.

Is it possible that discounts applied to adjusted revenue could alter the percentages by such a large number, (50% more or less.)

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tbh when I saw the discrepancy in adj revenue vs “regular” revenue, and it’s an ADR, it was sort of a non-starter for me.

I’d just need more time with it, or a better explanation

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To confirm what CloudAtlas said above re Lozada - as well as BABA is doing in China, its experienced its share of troubles in other countries.

https://www.japantimes.co.jp/news/2020/03/27/business/alibab…

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Hi StrugglingFool

Sorry for the late reply.
While both are growing at very fast rates, personally I was only interested in half of the business.
If you love both and the thesis for buying stays the same. I would definitely consider buying it.

You would have to piece out each business and apply a value that is reasonable to both.

I wouldn’t use the same valuations we give to the SaaS companies since the revenue is not reoccurring and EV/S valuation could be misleading.

Last thing to consider is currency risk. I invested in STNE and for a while I couldn’t see why the stock was still in the gutter after the sell off. It wasn’t until I realized that the currency for its revenue is in Rials.

Shig