Shares of Sea Limited (SE) rallied 6% after the Southeast Asian tech company reported its third-quarter earnings on Nov. 21. The company's adjusted revenue surged 60% year over year to $152 million, but its adjusted EBITDA loss widened from $100 million to $184 million. Sea Limited's adjusted net loss also expanded from $127 million to $238 million.
Sea's lopsided results didn't inspire much confidence among investors -- its stock remains below its October 2017 IPO price of $15, even though the company hiked its adjusted revenue guidance range for the full year from 41%-48% to 68%-75%. The reason is simple: Sea's e-commerce platform, Shopee, is still a money pit offsetting the growth of its other businesses.
Image source: Getty Images.
Why Shopee is killing Sea
Sea generates its revenue from four core businesses: Digital Entertainment (mainly licensed video games from its top investor Tencent (TCEHY -0.02%)), its e-commerce platform Shopee, Digital Financial Services (which are built around its AirPay online payments platform), and other services, which provide ancillary services for its e-commerce customers. Here's how those businesses fared during the quarter:
|
Business |
Adjusted revenue |
YOY change |
|---|---|---|
|
Digital Entertainment |
$134.5 million |
7% |
|
E-commerce |
$5.7 million |
1,157% |
|
Digital Financial Services |
$4.8 million |
(35%) |
|
Other Services |
$6.7 million |
256% |
Source: Sea Q3 earnings. YOY=Year over year.
The year-over-year revenue growth of Sea's e-commerce and other services is misleading since the company only started monetizing those platforms last year. Most of Sea's revenue growth came from those two businesses, but they're dead weights on its bottom line:
|
Business |
Adjusted EBITDA |
YOY change |
|---|---|---|
|
Digital Entertainment |
$45.1 million |
19% |
|
E-commerce |
($130 million) |
(65%) |
|
Digital Financial Services |
($8.2 million) |
15% |
|
Other Services |
($5.3 million) |
(160%) |
Source: Sea Q3 earnings.
Simply put, Sea would have generated slower sales growth but remained profitable if it hadn't expanded into the e-commerce market. Sea claims that Shopee is the largest e-commerce player in Southeast Asia, but it counts Taiwan -- which is generally considered part of the Greater China region -- to support that controversial claim.
Instead, most analysts consider Alibaba's (BABA 1.25%) Lazada, which doesn't have a presence in Taiwan, to be the largest e-commerce player in Southeast Asia. Alibaba's affiliate Ant Financial recently merged Lazada's HelloPay payments platform with its own AliPay platform to counter Sea's Airpay and other regional rivals.
Sea is trying to expand Shopee and AirPay against Alibaba's growing ecosystem, but its massive losses indicate that it's ramming itself against a brick wall. Shopee's GMV (gross merchandise volume) rose 153% year over year to $2.7 billion during the quarter, but that only represented 21% growth sequentially from the second quarter.
Image source: Getty Images.
But that's not the only problem...
Sea believes that its Garena gaming unit's long-term partnership with Tencent will provide it with a steady stream of new games to offset its ongoing e-commerce losses. Unfortunately, Tencent is actually spending less money on the development and marketing of new games amid a freeze of gaming approvals in China, which means that Sea will need to rely more heavily on self-developed games like Free Fire, which was a major pillar of growth for Garena during the quarter.
Sea also faces an ongoing slowdown in gaming revenues in Vietnam, where telcos have started restricting the use of prepaid cards for online games. This means that the growth of Sea's only profitable business could decelerate as its other units rack up bigger losses.
Lastly, a series of C-suite departures raises troubling questions about Sea's future. Garena CEO Jin Oh resigned in late August, Sea's chief strategy officer Alan Hellawell departed on Nov. 23, and company president Nick Nash will retire by the end of the year.
The bottom line
High-growth Asian tech companies often aggressively expand into adjacent markets and become jacks of all trades but masters of none. Sea can afford to keep taking losses for now, since its cash and cash equivalents total of $1.21 billion at the end of the third quarter only represented a minor decline from $1.35 billion at the end of 2017. But taking losses to support Shopee simply doesn't make sense as a long-term strategy. Alibaba has much deeper pockets than Sea, and it plans to expand aggressively into overseas markets like Southeast Asia to reduce its dependence on the Chinese market.
It's hard to see how this ends well for Sea's stock, which still can't be considered cheap at 4.5 times this year's sales. Therefore investors should buy shares of battered market leaders like Alibaba and Tencent instead of taking their chances on oddball underdogs like Sea.
