Shares of Sea Limited (NYSE:SE) rose 3% on Aug. 21 after the Singaporean tech company reported its second-quarter 2018 earnings. Sea's adjusted revenue rose 71% against the prior-year quarter to $219.6 million, which beat analysts' estimates by $24 million.
However, Sea's losses widened across the board. Its adjusted EBITDA loss widened from $50.9 million a year ago to $161.9 million. The company's adjusted net loss increased from $86.9 million to $198.7 million, and its total net loss expanded from $92.1 million to $250.8 million.
Those were disappointing numbers for Sea, which was once hailed as the "Tencent (NASDAQOTH:TCEHY) of Southeast Asia" prior to its market debut last year. It also explains why the stock, even after a post-earnings bump, remains below its IPO price of $15. Let's take a closer look at Sea to see if this stock can ever rally.
Examining Sea's core gaming business
Sea Limited's biggest backer is Tencent. Sea's Garena gaming business generates a large portion of its revenues from Tencent-published games like Arena of Valor and League of Legends.
Sea's digital entertainment segment revenues, which mostly come from online games, rose 19% year over year to $139.1 million on an adjusted basis. However, that represented a 5% sequential decline from the first quarter. The unit's adjusted EBITDA rose 21% versus the comparable quarter to $40.2 million, but that also marked a 12% sequential drop.
Sea blamed the sequential weakness on a decline in paying users in Vietnam, where telcos restricted the use of prepaid telco cards for topping up online games. Sea stated that it was "actively strengthening alternative top-up channels" to get the business's growth back on track.
The unit's quarterly active users rose 150% year over year and 27% sequentially to 160.6 million. However, its average revenue per user tumbled 50% against the second quarter of 2017, and 25% sequentially to $0.90, due to the issues in Vietnam.
Reviewing Sea's higher-growth businesses
In an effort to mimic Chinese tech giants like Tencent and Alibaba (NYSE:BABA), Sea has recently expanded its business toward the e-commerce and mobile payment markets.
This seems like a logical strategy, since many markets in Southeast Asia remain fertile ground for those digital platforms. However, it's also a very expensive strategy, and Sea's Shopee online marketplace and AirPay payments platform face a wide range of competitors.
Its toughest rival is Lazada, an Alibaba-backed e-commerce marketplace that also offers its own online payments platform, HelloPay. Alibaba's fintech affiliate Ant Financial, which runs Alipay, merged with HelloPay Group to strengthen its position against AirPay and other competitors last year.
Sea's adjusted e-commerce revenue surged from $2.6 million a year ago to $58.8 million, but that growth was inflated as Sea only started monetizing Shopee last year. On a sequential basis, e-commerce revenue rose 74%. The platform's gross merchandise volume soared 171% year over year and 14% sequentially to $2.2 billion.
However, Shopee remains a money pit for Sea. The unit posted an adjusted EBITDA loss of $188.3 million, compared to a loss of $76.2 million a year ago, and $179.6 million in red ink in the first quarter. Simply put, Shopee is spending over $3 for every dollar it makes, and its losses are wiping out the gains at Sea's gaming unit.
Meanwhile, gross transactions at its digital financial services unit, led by the integration of AirPay into Shopee, rose 608% versus the prior year and 45% sequentially to $2.5 billion. However, adjusted revenue in this segment dropped 36% annually to just $3.4 million -- indicating that Sea is struggling to monetize those transactions. Sea didn't disclose the segment's adjusted EBITDA, but its losses are likely widening.
Lopsided growth and intense competition
Sea's commitment to expanding its e-commerce and payments businesses is clearly causing some major problems.
The organization's total cost of revenues soared 131% to $175.2 million during the quarter, with its digital entertainment cost of revenues jumping 17% to $62.0 million and the cost of revenues of its other businesses (including e-commerce and payments) leaping 396% to $113.2 million.
Those costs won't drop anytime soon, since Sea probably needs to keep ramping up its spending to counter Alibaba's big investments in Lazada. Meanwhile, the growth of its gaming business still faces major headwinds as it struggles to monetize gamers in Vietnam.
That outlook seems dire for a stock that currently trades at about six times this year's sales. Therefore, investors should avoid Sea unless it starts narrowing the losses at its e-commerce business.