When Sea Limited (SE -1.79%) went public in late 2017, I wasn't impressed by the Singapore-based e-commerce and gaming company. Its revenue was soaring, but its losses were widening as it faced tough competition in Southeast Asia from Alibaba's (BABA -0.06%) Lazada.
I turned bullish last August when I realized Sea's profits from its gaming business, Garena, were offsetting the losses from its e-commerce platform, Shopee. But I was still reluctant to buy the stock since it seemed a bit too expensive relative to other e-commerce and gaming stocks.
Yet Sea's stock has still surged more than 450% over the past 12 months, as the pandemic lit a fire under its e-commerce and gaming businesses. I generally don't like to chase high-flying stocks, but I finally started a small position in Sea, for four simple reasons.
Image source: Sea Group.
1. It's not a Chinese tech stock
Last year, Chinese tech stocks accounted for about a fifth of my portfolio. However, it's getting much tougher to own those stocks amid escalating trade, tech, and political tensions between the U.S. and China.
In December, the U.S. passed a law that would delist Chinese stocks from American exchanges if they didn't comply with U.S. auditing rules for three consecutive years. Earlier this month, the Trump administration forced the New York Stock Exchange to delist China's three largest telecom companies over their alleged ties to the Chinese military -- and more delistings could follow. Meanwhile, Chinese regulators launched new antitrust laws to rein in tech giants like Alibaba and Tencent.
In short, Chinese tech stocks are stuck between a rock and a hard place. So I recently sold most of my Chinese stocks and put some of that cash into Sea -- which should be well-insulated from those regulatory threats.
2. Robust revenue growth
Sea's revenue rose 163% to $2.18 billion last year. Its digital entertainment revenue, which mainly comes from Garena, grew 146% to $1.14 billion. Its e-commerce and other services revenue, which mainly come from Shopee and its fintech services, surged 205% to $823 million.
In the first nine months of 2020, Sea's revenue rose another 101% year over year to $2.81 billion. Its digital entertainment revenue grew 81% to $1.32 billion, while its e-commerce and other services revenue jumped 113% to $1.12 billion.
Sea attributed Garena's growth to the popularity of Free Fire, a self-developed battle royale game that was launched in 2017 and remains the highest-grossing mobile game in Southeast Asia and Latin America. It's currently testing out an enhanced successor, Free Fire MAX, in several markets.
Shopee, which surpassed Lazada in total downloads across Southeast Asia and Taiwan last year, benefited from a surge in online shopping throughout the pandemic as its gross orders more than doubled year over year throughout all three quarters of 2020.
Its integrated payments platform, SeaMoney, also reached 17.8 million paying users with its mobile wallet in the third quarter -- up from 10 million users in the first quarter and 15 million users in the second quarter. The expansion of this fintech platform widens Sea's moat against Alipay, the Alibaba-affiliated payment service integrated into Lazada.
3. Improving profitability
In the past, Shopee's losses consistently wiped out Garena's profits. However, Sea gradually reduced Shopee's losses per order by dialing back its promotions and subsidies. As a result, Shopee ended the third quarter with an adjusted EBITDA loss of $0.41 per order -- compared to losses of $0.79 in the prior-year quarter and $1.36 in the third quarter of 2018.
Shopee and SeaMoney remain unprofitable, but the strength of the company's digital entertainment segment is easily offsetting those losses:
|
Adjusted EBITDA (in millions) |
FY 2019 |
Q1 2020 |
Q2 2020 |
Q3 2020 |
|---|---|---|---|---|
|
Digital Entertainment |
$1,021.9 |
$298.4 |
$436.2 |
$584.5 |
|
E-commerce |
($1,043.3) |
($260.0) |
($305.5) |
($301.6) |
|
Digital Finance Services |
($113.4) |
($101.6) |
($110.1) |
($149.3) |
|
Other Services |
($28.0) |
($2.6) |
($6.4) |
($9.1) |
|
Total |
($178.6) |
($69.9) |
$7.7 |
$120.4 |
Source: Sea Limited.
The profitability of Sea's gaming business can be compared to Alibaba's high-margin core commerce business, which offsets the losses from its other unprofitable businesses, or Amazon's (AMZN -2.40%) cloud business, which subsidies the growth of its lower-margin marketplaces.
Garena is admittedly wobblier and less-diversified than Alibaba's marketplaces or Amazon Web Services (AWS), but it could continue to offset Sea's losses at Shopee and SeaMoney for the foreseeable future.
4. It's still reasonably valued
Analysts expect Sea's revenue to rise 78% this year and 46% next year. Its adjusted EBITDA should remain positive, and analysts expect its GAAP net loss to narrow next year.
Based on those forecasts, Sea trades at 15 times next year's sales -- which is a surprisingly low price-to-sales ratio in a market filled with growth stocks trading at 30 to 40 times next year's sales. Sea certainly isn't a value stock, but I believe it's undervalued relative to its growth potential.
The bottom line
Based on these facts, I'm willing to take a chance on this budding tech company as a long-term play on Southeast Asia's growing e-commerce, fintech, and gaming industries. It might be a bumpy ride, but I believe it could generate more multibagger gains over the next few years.
